Ocado: An Alternative Way to Bridge the

Last Mile in Grocery Home Delivery?1

During the U.S. internet frenzy of 1998-2000, numerous new, pure play Internet grocers promised consumers that they could have groceries at prices equal to or lower than existing bricks-and-mortar grocery stores, while simultaneously enjoying unparalleled convenience without having to leave the house and battle the crowds at the stores themselves. The most prominent of these companies was Webvan, which reached a stock market value of $7.9 billion at the end of its IPO. Webvan, Home Grocer, PeaPod and several other Internet grocers made huge bets that selling groceries online was a growth market and represented a new way of doing business. Unfortunately, as has been illustrated by the widely publicized collapses of these high profile Internet grocers, there was a substantial gap between theory and practical application. What the grocers discovered was that covering the “last mile” to consumers’ homes to deliver groceries to their doorstep represented a substantial challenge with numerous operational and logistical difficulties. In contrast, there are currently several examples of grocery and other food delivery companies that appear to be making effective use of the Internet as a link with customers. In particular, both Tesco in Britain and Albertson’s in the U.S. currently have Internet channels for selling groceries that are profitablei. Whereas many of the failed Internet grocers appeared to be hoping to capture a large portion of the overall grocery market, companies such as Tesco and Albertson’s view Internet ordering of groceries more as an additional sales channel. This channel is unlikely to ever represent a majority of grocer sales, but even a small portion of sales can be quite significant due to the huge size of the overall market. Are these new forays into the Internet likely to fare better than their earlier counterparts? Ultimately, only time will tell as to the degree of profitability attained, but it is possible to create useful comparisons between selected examples of the old (Webvan) and new attempts (Ocado, Sainsbury’s and Tesco in particular).

1 Copyright 2002 – Michigan State University. This case was prepared from published sources and personal interviews with Ocado and Sainsbury’s executives by Dr. Ken Boyer (Michigan State University) and Dr. Mark Frohlich (London Business Scool) as the basis for class discussion rather than to illustrate either effective or ineffective handling of a business situation. Software for solving the delivery routing problem written by Alex Rodrigues. This case has been published as case #602-057-1 by the European Case Clearing House.

1

The Grocery Industry The U.S. Groceries and other food retailers operate in one of the more mundane, yet fundamental and pervasive industry segments in the world. Everyone eats, thus everyone must purchase food from some retail outlet. Consequently, the grocery industry is a huge, fragmented and enormously competitive environment. Annual sales in the U.S. are $434.7 billionii, yet the competition for these sales dollars is intense, with the top 10 supermarket chains holding less than 50% of the market shareiii. The intense competition is often described as leaving supermarkets to operate on razor thin margins that average 1-2 percent of sales. Exhibit 1 provides an overview of the top ten supermarket chains in the U.S. and the top 8 in the U.K. While groceries are perhaps the most universal commodity, this competition often spurs supermarkets to go to great lengths to develop new technologies and methods of streamlining both their supply chain and their marketing efforts. For example, supermarkets are associated with the first application of bar coding and UPC coding for inventory and transaction purposes. The first application of this technology was at the Marsh Supermarket in Troy, Ohio on June 26, 1974. In the intervening years, it is estimated that prices would have risen twice as fast without the use of the UPC symbol and that the application of this technology has been 20 times more valuable than its creators originally projected. Today there are over 5 billion scans per day with the UPC codeiv. An extension of bar coding technology utilizes direct product profitability (DPP) to track scanning data by brand, category etc. to gather information on coupon use, the effects of promotion and shelf displays. The use of DPP has led to greater integration and coordination between market research and salesv. More recently, there has been a great deal of interest in the use of the Internet as a technological tool to improve the entire grocery supply chain. In theory, the Internet can be used to link customers with grocery stores from their homes and will help integrate the supply chain by closely linking marketing, sales, operations and logistics. United Kingdom In comparison to the U.S., the grocery market in the U.K. is both smaller and more homogeneous. The total size of the market is around ₤80 billion ($120 billion), of which the top three retailers (Tesco, Sainsbury’s and Asda) account for more than half of the sales (58%). Not only are there fewer grocers fighting over the pie, but also the stores in the U.K. tend to be much busier than in the U.S. For example, the average $/sq. foot ratio for the top 10 U.S. grocers is $450.29/ sq. ft., while the sales per square foot for Tesco is $1,595.74/sq. ft. and Sainsbury’s is $1,554.12/sq. ft. This means that both grocers sell 3 times as much in the same amount of space as American grocers. The busyness of U.K. grocery stores is legendary and is well described by the term “trolley rage” – i.e. customers that are frustrated and stymied by the crowded markets. The combination of a homogenous market, in which it is hard to gain ground on competitors, and a network of stores that is much more heavily utilized, makes home delivery of groceries in the U.K. substantially more attractive than in the U.S. Grocers such as Sainsbury’s and Asda look at home delivery as a potential channel for making inroads on Tesco’s market leadership, while regional grocers like Waitrose (whose market is concentrated in SE England) view home

2

delivery as an opportunity to expand across the U.K., thus Waitrose is partnered with Ocado. A final factor that makes home delivery more attractive in the U.K. relative to the U.S. is the greater density of people, particularly in the expensive, heavily populated greater London region. Home Delivery Home delivery of groceries is both an attractive concept for harried, busy consumers who dislike their weekly shopping duties and an amazingly complex challenge for businesses to achieve at a reasonable cost. The ideal target customer for this service is a person who leads an extremely busy and hectic life, dreads visiting busy grocery stores (where they often are jostling with fellow busy people who also can’t get to the store any other time) and has a fairly high income. While the group of customers that fit this profile will never be a majority of the market, it has been estimated that there is a market of between ₤3 billion and ₤9 billion (5 – 15% of the total market) in the U.K. and between $5 billion and $25 billion (1% - 5% of the total market) in the U.S. Grocery stores are increasingly looking at home delivery as an alternative channel to grow their business and capture or divert business from other grocers in a cutthroat industry. While there may be a substantial market for home delivery, providing this service in volume at “reasonable” prices presents a substantial challenge. In particular, there are three substantial hurdles:

1. Grocers must pick the individual orders for customers – thus increasing costs substantially over existing supermarkets where customers select their own orders.

2. Grocers must either deliver the goods to the consumer’s home (i.e. conquer the last mile) or hold the orders for customer pick-up – both of which involve a substantial increase in both costs and operational complexity.

3. While hurdles 1 and 2 can be surmounted, the third hurdle lies in convincing consumers that this service is worth the additional price of delivery (Tesco, Sainsbury’s, Albertson’s). In Ocado’s case, orders over ₤75 have no delivery fee, so the hurdle in this case is whether this service can be provided in a profitable manner. If it can save consumers time (as yet an uncertain proposition because of the need for customers to “learn” how to manage placing Internet orders), then they may be willing to pay a premium for this service. If not, then the existing model of customers serving themselves at supermarkets will remain substantially the same.

This case provides an overview of several grocers which are tackling these challenges head-on and provides some information for the reader to develop their own prediction regarding the future of grocery home delivery.

The Current State of Grocery Home Delivery Tesco Britain’s top supermarket chain has annual sales of ₤20 billion ($30 billion) in 690 British stores. While Tesco initially was criticized for its go-slow approach to selling groceries over the Internet, it has become the world’s largest online grocer and now sells through 250 outlets and had revenues from home deliveries of ₤356 million ($520 million)vi in the year ending February

3

28, 2002. Most importantly, Tesco has managed to develop an operational model that is profitable, with a net operating margin of 5% on approximately 4 million orders per year. All of this has been achieved with a relatively small investment of $59 million. Tesco has kept the operations of home delivery simple by using existing assets rather than building high-tech warehouses. Online orders are filled by Tesco employees at the nearest Tesco store, then picked up and delivered via van. This approach works well for lower volumes of business, albeit at an increased cost per order or customer relative to existing sales where customers pick the groceries themselves and there is no need for delivery. Sainsbury’s Sainsbury’s is the second largest supermarket chain in the U.K., with annual sales of ₤14.9 billion ($22.3 billion) in 463 stores. During the year ended March 31, 2002, Sainsbury’s had online sales of ₤110 million ($165 million) through its online ordering service (Sainsbury’s To You). This service was available through 53 stores, covers 71 percent of UK households and averages 27,000 orders per weekvii. While the volume of online business has been growing steadily, profitability is still elusive, with losses of ₤50 million ($75 million) for the year ending March 31, 2002. Sainsbury’s hopes to use online ordering to complement a series of business initiatives intended to help it overtake Tesco for market leadership in the U.K. – a position which Tesco has occupied since the early 1990s. The business model is very similar to Tesco’s with one notable exception. Most orders are picked from local stores, but in central London Sainsbury’s employs a semi-automated picking center at Park Royal. According to Robin Lasseter, Head of Online, “We believe that a central picking center can provide better quality and fewer substitutions for our customers in the central London area. These customers are very selective and expect a higher level of service.” Albertson’s Albertson’s is the second largest supermarket chain in the U.S.viii, with 2,500 stores, 220,000 employees and $37.5 billion in annual salesix. More importantly for the purposes of the current study, Albertson’s is one of the few remaining American supermarket chains to still be offering Internet ordering of groceriesx. Similar to Tesco, they have pursued a dramatically different operations strategy than many of the failed online grocers. Rather than build a separate infrastructure for filling customer orders, Albertson’s employs “e-shoppers” to stock customer orders through existing stores, or as Matt Muta, V.P. of Web Technologies states “we use existing store infrastructure and IT systems of existing stores, so we’re not adding a lot of additional cost”. Albertson’s initially offered consumers only the option of picking their orders up when they first offered online shopping at seven Seattle area stores 2 ½ years ago. Having achieved some success with this focused strategy, Albertson’s expanded its delivery options in October, 2001 when it offered pick-up service at 38 San Diego area stores or home delivery to consumers within a 6-8 mile radius of these stores. Albertson’s marketing strategy has also been tailored to match with its operations strategy – rather than providing free delivery, a $9.95 fee is charged for delivery and a $5.95 fee is charged for store pick-up. Thus, initial efforts to develop Internet-ordering have resulted in an increase in per store revenues – while Albertson’s will not

4

release public figures, a conservative estimate is that revenues associated with online orders are around $250 million. MyWebGrocer In contrast to the other companies described in this case, MyWebGrocer does not handle any grocery items in any way. Instead, they provide software, hardware and technical support for single grocery stores or small chains that do not have the resources or inclination to develop their own proprietary online ordering system. MyWebGrocer has developed an online system that is largely standardized, but which also allows a degree of customization for individual stores. All software development, maintenance, support and hosting occurs at MyWebGrocer, which charges $4 per customer order (i.e. Jane Smith ordering from Lowe’s foods through MyWebGrocer). This order is then transmitted to the local store, where employees pick the order using a handheld picking device. Individual stores are then responsible for developing their own delivery or pickup systems, with guidance provided by MyWebGrocer. Approximately 130 stores and 26 customers (a chain grocery is one customer but may have multiple stores) utilize this service, including D’Agostino (new York City), Lowe’s (north Carolina), Rice Epicurean Markets (Houston) and Santoni’s Market (Baltimore). According to Bob Clare, owner of Shoprite of Oakland, NJ, another MyWebGrocer client:

“Full service grocers simply have to look at the online channel as a way of providing the ultimate in convenience for an increasingly impatient consumer”.xi

Ocado What is Ocado? Ocado was formed by three ex-Goldman Sachs directors (Jonathan Faiman, Jason Gissing and Tim Steiner) in early 2000 and was originally named Last Mile Solutions. Financed by a ₤46 million investment and 40% ownership stake by Waitrose, Ocado has taken a deliberate and carefully planned approach to developing its business, under co-Managing Directors Nigel Robertson and Roger Whiteside and Logistics Director Robert Gorrie. This approach is in stark contrast with the shoot for the stars approach taken by many of the failed Internet grocers such as Webvan and Home Grocer. Ocado, renamed from Last Mile Solutions in late 2001, spent the better part of 2 years developing and planning all aspects of its business with a core group of 15 – 20 employees. This planning phase was followed by a phased rollout of service, starting north of London and working down toward central London between March and July of 2002. This approach is based on recognition that the idea of mass-market home delivery requires new techniques on the part of both companies and customers. Nigel Robertson states “It makes sense to learn all the problems in the early days, before we commit advanced resources to the operation. And believe me, there will be a learning process to go through. We don’t have any doubt of that”xii. Equally important to the long-term success is the understanding that customers need to be nurtured and guided to learn a new (and hopefully easier) way of shopping for groceries, or as Nigel Robertson states:

“We are working to change the habits of a lifetime”

5

About 20 miles north of central London, in the town of Hatfield, Hertfordshire, England a 300,000 square foot distribution center is in its first year of operation. This distribution center is the center of Ocado’s operations – built to handle orders placed over the Internet for home delivery to customers in the London metropolitan area. The ultimate capacity of the distribution center is equivalent to the sales volume of approximately 20 stores. Marketing Challenges When building a business from scratch and seeking to achieve rapid growth it is critical to get a marketing campaign that rapidly builds brand awareness. Katie Spriggs, Head of Marketing, realizes that there is great pressure on her to launch the business and attract customers to both a new name and a new way of buying groceries. The marketing effort faces two key, yet conflicting challenges. First, it is essential to grow the market very quickly in order to fill up the Hatfield distribution center. One of the key elements of Webvan’s failure was its inability to attract sufficient orders to utilize its distribution centersxiii. Similarly, Ocado is under substantial pressure to fill its Hatfield facility (designed to handle the equivalent business of 20 supermarkets) with orders since the break-even point for such a facility is at least 70% utilization. Katie succinctly summarizes the need to generate orders in saying:

“my job is to feed the beast – to get the customers”. The second key marketing challenge is in many ways in conflict with filling the distribution center. While it is important to generate orders, it is also critical to generate orders that fit together in some type of densely concentrated pattern in order to facilitate delivery. For example, four customers that live 5 miles from each other are much less valuable than four customers that live within a 1-mile radius. In short, the ideal goal is to attract customers in closely packed areas. In theory this is possible, but in practice there are numerous complicating factors – including variations in daily ordering patterns, travel times and order sizes. For example, if you and your next door neighbor both order that would make delivering to both of you fairly efficient UNLESS your orders are for different days, or even for the same day but different times. One of Webvan’s major failings involved a failure to balance these competing objectives of fast growth with dense growth. In the rush to build market share, Webvan was fairly indiscriminate in its marketing campaign in terms of advertising service using mass media to market to a wide area of customers. In contrast, Ocado seeks to rollout its service by focusing tightly on fairly dense geographic areas and by developing a high route density within each area. Simultaneously, Ocado has tightly profiled its “sweet spot” customers: according to Katie these customers “are primarily female, with both spouses working and with one or more children under 15 at home. A big selling point to these customers is to avoid ‘trolley rage’ from having to shop in crowded stores at late hours.” Ocado is selling more than just groceries, it is selling a personal relationship that saves time for its time-starved customers.

“We find that a 1 hour delivery slot is very important to our customers and offers a substantial improvement over the 2 hour slots offered by our competitors. Of this group of ‘sweet spot’ customers 25% have tried home delivery of groceries, but only 7% are still using

6

the service with our competitors. We intend to offer both timely and reliable service that will create loyal, repeat customers.” – Katie Spriggs

Katie Spriggs and Ocado’s marketing staff operate on two fundamental principles that seek to balance the two objectives:

A. Launch and Learn – not Spray and Pray. B. Farm an Area, not Slash and Burn.

Rather than employing mass media techniques such as television, radio and newspaper/magazine advertising, Ocado concentrates on direct marketing to a focused area. In order to build initial customer awareness, Ocado developed a four step-marketing plan:

1. Every customer in the phased roll-out areas was sent an introductory letter. This letter described the Ocado business model, emphasized the partnership with Waitrose and provided an initial introduction to the website for ordering.

2. Potential customers were sent an introductory packet including an Ocado branded coffee packet – along with an invitation to “sit and have a cup of coffee with Ocado”. The idea was to introduce Ocado as a relaxed, value-added business that would help free up customers’ time.

3. The third mailout was a follow-on packet with an offer of ₤10 off each of a customer’s first five orders. This packet also contained an Ocado apron.

4. The 2nd Follow-on packet was sent several weeks after the apron packet. This packet served as a reminder to customers and included an Ocado oven mitt.

Another important component of the marketing campaign is backfilling, which involves targeting specific areas that have already been direct marketed and seeking to increase route density. This is done through follow-up direct mailings, passing out fliers and advertising at train stations and by using available customer service team members (CSTMs that deliver customer orders). In the early stages of rollout, the CSTMs are likely to have routes that include a lot of downtime in which no deliveries are scheduled (this is necessary to ensure that deliveries during peak periods are met). Rather than having CSTMs return to the central DC or simply wait around for the next delivery, Ocado uses the CSTMs to approach potential customers on a door-to-door basis in areas where there are a high proportion of sweet spot customers. The CSTMs are trained to introduce themselves and the Ocado service, leave a brochure and generally provide a personalization of the service. Order Picking Challenges One of the major obstacles to making home delivery of groceries profitable is the transfer of item selection/picking from consumer to provider. For decades, the prevailing supermarket model has been one in which the shelves of the store are stocked with a variety of items and the consumer is then permitted to browse the store and select their own groceries. This application of “self-sourcing” first appeared at a Kroger store in 1916 in Cincinnati, Ohio and quickly resulted in a fundamental change from the previous format where customers came to a store, told a clerk behind the counter which items they wanted and the clerk picked, packaged and sold those items. The predominant model in the U.S. and U.K., as well as most of the developed world, is one where store employees stock the shelves (usually at night or in off-peak hours) and customers

7

walk the aisles while pushing a grocery cart/trolley and select the items they desire. When finished, customers proceed to the checkout line where a clerk scans their items, processes payment and bags the groceries (sometimes). For the most part, customers accept this arrangement and the grocery stores look for ways to encourage consumers to do even more of the work – such as self-bagging of groceries or even self-checkout at automated express lines.

So, the obvious question is – “Why would stores try to reverse this trend and take more work back into their hands”?

It is commonly accepted in the grocery business that many customers look forward to grocery shopping as if they were going to the dentist to have a tooth pulled. Shopping involves battling with traffic to drive to the store (or riding the bus or subway), finding a parking spot, battling with other customers (often while pulling along or avoiding a pair of noisy, quarreling children under five), then battling traffic to return home, all while carrying, picking and bagging our own groceries. All of which can be succinctly summarized in the words of Shawn Sell: “What a ho-hum waste of time”xiv. Yet, we all have to eat, so we persevere. One answer to the above question is that there is a group of people such as Shawn Sell that is willing to pay a premium to have their groceries picked and delivered to their house. Consider the estimate of 2 hours and 40 minutes for one trip to the grocery store for Shawn Sellxv, if the same order could be placed online in twenty minutes, then delivered to home, how would you value the 2 hours and twenty minutes saved? What is the value of this market if it represents 1 – 5% of the U.S. grocery market ($450 billion total) or 5 – 15% of the U.K. market ($120 billion total)? The second answer to the above question is actually a component of the first. In theory, “professional” shoppers should be able to pick grocery items more efficiently than the average consumer for a number of reasons, including repeatability (if a person spends 40 hours a week picking groceries they will get much better much faster than the average once a week shopper), route planning (software can be used to develop an efficient route through the store) and specialization (one worker picks only a subset of grocery items). In order to examine the proposition that “professional” shoppers are more efficient, let us briefly compare two approaches to picking groceries:

(1) Store-based picking (utilized by Albertson’s, Tesco, Safeway, Sainsbury’s and grocery clients of MyWebGrocer): Stores hire employees to take individual orders and walk through the store picking groceries to order. This is potentially more efficient than consumer shopping because of repeatability, route planning and the ability of employees to work during non-peak hours – thus less traffic. However there are numerous disadvantages, including congestion (in practice it is not possible to pick more than 1 or 2 orders at a time because of crowded stores –particularly in the U.K.; in fact, many store shoppers in Britain are upset when the stores’ Internet shoppers get in their way), variation in skill levels and assignments, and a large amount of product handling.

(2) Distribution Center-based picking (utilized by Ahold, Sainsbury’s, Ocado and Webvan): groceries are picked from a central DC which has numerous advantages: removes a link in the supply chain (only if pure DC approach – as used by Ocado – see Exhibit 3) which

8

can reduce costs and get fresh items (produce) to consumer more quickly, aggregates inventory to save money and provide higher service level (hence fewer substitutions), and allows workers to specialize by picking a smaller variety of items and not walking long distances between items. However there are also numerous disadvantages, including: high fixed cost of investment, longer travel times to customer homes, coordination challenges in processing a large number of orders through multiple stations and workers.

Numerous existing grocers have proven that store-based picking can work, but at a cost. At Tesco, pickers are assigned to one of six zones, where they pick orders for up to six customers at a time using a touch-pad computer that plans efficient routes through the store and scans each item to check that it is the right one. Orders are then assembled in the back of the store for delivery. Tesco claims that the average 64-item order can be filled in 32 minutes, or 30 seconds per item, at a cost of about $8.50 per order, including labor and depreciationxvi. This estimate is remarkably close to the estimate provided by Mike Spindler, president of MyWebGrocer, of $7.80 per orderxvii. Thus, store-based picking works, but with a few significant downsides:

(1) While “more efficient” than customer picking it still represents a substantial increase in costs that the customer must be willing to pay for.

(2) In crowded stores the addition of employees picking for home delivery will exacerbate an existing problem.

(3) Customers must be willing to accept that they can’t handle fruit, produce and other perishable items and pick according to their personal criteria. Furthermore, the problem of what to do when an item is out of stock is an ever-present difficulty. When a consumer sees that something is out of stock (not an uncommon event given that 5 – 8% of items may be out of stock at any given time in an average supermarket) he or she intuitively makes a decision to either buy a different product, a different size or forgo the product altogether. There is no way that home delivery grocers can perfectly deal with substitutes, other than making sure there are none – something that is unlikely to ever happen.

DC-based picking on the other hand has a fairly miserable record. Webvan claimed that workers would be able to pick 450 items per hour or 20 times the productivity of a store shopperxviii. This productivity was based on the ability for workers to pick groceries in large batches without having to waste time and effort traveling between locations. Each worker was going to pick groceries using an automated carousel and then place groceries in a tote that would be automatically routed through the DC by a system of conveyors. While exact data on the productivity Webvan achieved is sparse, several things are clear from the failure of this approach. First, Webvan did not get anywhere near this level of productivity. Second, dedicated facilities of this type are very expensive and typically only feasible when highly utilized. Unfortunately for Webvan, none of their DCs ever approached this level of utilization. Third, picking groceries is a very complex task, partly because of the need to keep things at the proper temperature (there are three basic groups: frozen, chilled and ambient). More recently, Asda announced in December, 2001 that it was abandoning its use of dedicated picking centers at Croydon and Watford and transferring picking to 13 of its retail stores in South East Britain. So why does Ocado think that it can do better than Webvan and Asda? First, as shown in Exhibit 3, a purpose built facility with no stores to support effectively (at least in theory) removes a link

9

in the supply chain. If Ocado can make the DC-based picking approach work, then it can remove the costs of running stores, which typically run 20-25% of sales. These cost savings can be used to offset the costs of picking and delivering the orders. Second, Ocado believes that it has learned valuable lessons from the efforts of its predecessors. In particular, Nigel Robertson states “Our Hatfield facility is built on a larger scale [to approximate the size of a typical DC that supplies about 20 stores]. So it’s much easier for us to deal with ‘peakiness’ and maintain availability. Also we’re completely focused on home deliveries – they’re not an add-on to a retail operation [as with Asda]”xix. In particular, there are three major differences between Ocado’s approach and that used by predecessors. First, Ocado is taking time to allow learning to take place. The first picking operation was a largely manual process setup in a warehouse in Hemel Hempstead. This allowed Ocado to learn and refine its processes before committing to a more automated approach at its Hatfield purpose-built facility. In addition, Ocado is rolling out this new and yet to be proven approach at a single facility, while Webvan ignored time-tested principles by trying to do something new not in one or two places, but in 8 or more at a time. As everyone at Ocado readily admits – “this is a new business, we try our best to get a good answer, but we are under no illusions that everything will work perfectly out of the box – so we are always ready to adapt and revise”. Second, Ocado has designed the Hatfield facility so that it can be opened up in three phases:

1. Phase 1 involves constructing the entire footprint of the facility (all walls and roofing), but only 2 out 3 bays of the facility are finished (i.e. concrete flowing poured and all utilities hooked up. During phase I, all orders will be picked using an automated trolley system running through bay 1 (which has all of the refrigeration equipment necessary) and outgoing orders will be packed in bay 2 and inbound orders received.

2. Phase 2 involves finishing out bay 3 (i.e. pouring flooring and installing utilities etc.). Then packing is moved to bay 3 and orders will delivered via a trolley on the outside of bay 2. Then, bay 2 will be installed with the automated cranes and trolley system necessary to operate at higher volumes.

3. When sufficient volume is reached (approximately 10,000 orders on peak days), the final layout will consist of picking refrigerated and frozen orders in bay 1, picking of ambient orders in bay 2, and packing of outgoing orders and receiving of inbound orders in bay 3.

The ultimate capacity of the Hatfield facility will be 20,000 orders on a peak day (the authors estimate that Ocado’s goal is to achieve picking rates of above 200 items/employee per hour). According to Robert Gorrie, Logistics Director, “This phased approach reduces our initial investment in Phase 1 by 40%, primarily through the savings in not having to buy all of the equipment for the final state immediately. In the long run, it costs a bit more, but it conserves resources in the short run while we are building the business.” Order Delivery Challenges Delivering groceries to customers’ homes is a challenge not faced by traditional grocery stores. This is an expensive and difficult prospect since there are numerous government regulations for the temperature and delivery conditions of refrigerated and frozen food. The Head of Customer

10

Service for Ocado is Andy McWilliams, who is in charge of all aspects of home delivery once the order has been packed at the Hatfield DC. According to Andy, “We view home delivery as a not just a necessary element of our business, but one of the key ways we can amaze customers. Our goal is to build a customer centric network and focus on building relationships with customers. Ocado wants to build a reputation for friendly service that contrasts with the traditional British image of ‘a man in a white van’ delivery which has only 60% reliability and a distinct reputation for rudeness.” In order to foster a customer centric approach, customer service team members are given a 2 week training session that familiarizes them with all aspects of Ocado’s business, including the website, order fulfillment/picking and delivery. Then each new customer service representative rides with a veteran CSTM as an apprentice for a week. Every shift has a 20 minute briefing at the beginning of the shift where they are reminded of key things for the day – such as special promotions, not to leave refrigeration compartment door open on hot days and the status of company orders and expansion plans. These briefings are often given by one of the managing directors, either Nigel Robertson or Roger Whiteside. Ocado is trying to build an open corporate culture where employees are encouraged to do what is necessary, even if the given task falls outside their normal job description. The goal is to develop a corporate culture similar to the one at Southwest Airlines, thus many of the same employee relationship building techniques are employed. A huge challenge is presented when developing daily routes. Unlike an organization like the post office or a newspaper, the orders for home delivery of groceries vary substantially on a daily basis. The goal is to average about 15 deliveries per route, but there is a trade-off: more deliveries per route is more efficient and less costly to Ocado, but this also brings a higher risk of “missing” a delivery window – either by being too late or too early. Scheduling is also complicated by spikes in demand – in general, Friday is the busiest day with about 25% of the orders for the week. There is also a great deal of variation within a day – on weekdays 40% of the orders are for mornings while 60% are for afternoons, but on Saturday this pattern is reversed with 70% of the orders in the morning and 30% in the afternoon. A three-step procedure is used to develop routes:

1. A forecast is made of the number of deliveries for each day (for example, a Thursday might have 3,900 deliveries scheduled).

2. This forecast is divided by the number of drops/route (i.e. 15 drops/route, or if a greater cushion or safety factor is used, this number might be lower).

3. The number resulting from step 2 represents the number of routes to be developed (in this case 3,900/15 = 260 routes). This number is given to a software program named Descartes which then utilizes the customer order information (delivery slot and location) along with routing information (i.e. maps of the area and estimated travel times between locations) to develop that many routes. Descartes has travel speeds assigned for every major street/route (these times are modified to provide a cushion – i.e. a route with an average speed of 18 miles an hour may be entered with a speed of 17 miles per hour) and a drop time (i.e. the time to park, unload the van, walk to

11

customer’s door, unload groceries and return) which can also be modified to include a cushion.

During the early stages of Ocado’s growth, they have been averaging substantially below their goal of 15 deliveries per route as they seek to grow their market. Thus, initial costs are quite high but they have been delivering close to 100% of their orders on time. In addition, Ocado’s goal is to average less than 2% returns (either because of a damaged product or a substitution for an out of stock product.). As their sales and order volume increases, both of these metrics will be challenged, but delivery costs should decrease as they get closer to 15 deliveries per route. When a customer has a complaint regarding service or damaged goods, a tool called “Andy’s Toybox” is employed in which each CSTM is given a selection of items such as wine, crackers, cookies etc. to give to customers to maintain or build goodwill. Andy’s Toybox also typically holds some inexpensive toys or candy to be given to children.

Delivery Scheduling Exercise Exhibit 5 provides an illustration of the challenges involved in developing routes to meet pre-scheduled delivery windows while also trying to keep costs down. The table lists 45 imaginary customers of a home delivery grocer, their locations (using X,Y coordinates which can be thought of as distances East-West and North-South of either a distribution center or a store) and the delivery window that customers have booked. Try to develop a delivery route which minimizes the number of delivery trucks needed (and to a lesser extent the distances traveled) for two situations: (1) assuming that there are no delivery windows – i.e. customers will take a delivery anytime from 9:00 AM – 5:00 PM, and (2) using the windows shown in Exhibit 5. Assume that this represents a single day of deliveries, that all customers must be served within their windows, that all trucks must complete their route and return to the DC by 5:00 PM. Note, the routes can operate between 9:00 AM and 5:00 PM, drivers are briefed on their routes from 8:30 – 9:00 AM and checked in on return at 5:00 PM.

12

Exhibit 1. Largest Supermarket Chains in America and Britain

# Stores (> $2 million

in sales)

2000 Supermarket

Sales ($ millions)

Square Feet (Thousands)

No. of

Checkouts or Registers

FTE Employees

United States 1) Kroger Cincinnati, OH

2,366 43,120

100,653 26,581 220,925

2) Albertson’s*

Boise, ID 1,715 31,461 67,048 17,228 139,537

3) Safeway*

Pleasanton, CA 1,482 28,829 51,854 14,025 111,103

4) Wal-Mart Bentonville, AK

908 22,947 54,735 25,309 237,786

5) Ahold USA*

Chantilly, VA 874 20,022 39,769 12,389 90,293

6) Delhaize America Salisbury, NC

1,435 15,042 39,346 12,044 67,103

7) Winn-Dixie Jacksonville, FL

1,081 13,731 40,174 11,490 87,136

8) Publix Lakeland, FL

645 13,021 25,382 7,213 65,926

9) Great A& P Tea Montvale, NJ

553 8,075 16,492 6,107 44,888

10) Supervalu Eden Prairie, MN

539 7,197 16,357 5,240 35,920

TOTAL 11,598 203,445 451,810 137,626 1,100,617 Sales

($ billions) Market Share

United Kingdom Tesco* 30.0 25.3% Sainsbury’s* 22.3 17.5% Asda* 18.8 15.3% Safeway* 12.9 10.5% Morrisons 7.0 5.7% Waitrose* 3.8 3.1% Iceland* 3.2 2.6% Kwik Save 3.0 2.4%

TOTAL $101.0 82.4% Notes: Source for U.S. data is Weir, T., “53rd Annual Consumer Expenditures Study: Sales Boom with the

Economy”, Supermarket Business, Vol. 55, No. 9, September 15, 2000, pp. 27-45. Source for U.K. data is Marketing, “Is Safeway Falling Too far Behind”?, May 23, 2002, p. 17.

* Indicates company with an online retail channel.

13

Exhibit 2. Comparison of Current Internet Grocers and Webvan

Ocado www.Ocado.com

Sainsbury’s www.sainsburystoyou.com

Tesco2

www.tesco.com Albertson’s3

www.albertsons.com MyWebGrocer.com4

www.mywebgrocer.com Webvan5

Corporate Headquarters Hatfield, England London, England London, England Boise, Idaho, U.S. Chicago, IL, U.S.

Delivery Area 1.2 million people in service area north of London and Central

London as of July 31, 2002

53 stores 73% of U.K.

95% of U.K. Seattle, San Diego/southern Cal., Portland , San Francisco.

26 grocery stores/chains, 126 individual stores, including: Piggly Wiggly (Rome, GA), Lowe’s (Winston-Salem, NC), D’Agostino (NY city).

Chicago, California (5 hubs), Portland, OR,

Seattle, Dallas/Ft. Worth, Atlanta

Sales Information Not Available $22.3 Billion

$165 Million (online) $30 Billion (in 2001) $520 million (Online)

$38 Billion $242 Million (Online)1

$40 million online sales $1.5 million in fees to MyWebGrocer6

$178 million (2000)

Pricing ₤5 ($7.50 delivery for orders < ₤75), free for orders > ₤75.

₤5 ($7.50 delivery) $5 - $10 (delivery) $9.95 (delivery) $4.95 (Pickup)

$10 ($8 for over $75 dollar order) for D’Agostino. $4.95 pickup; $19.95 delivery; Lowe’s.

No charge on orders over $50 – initial. No charge on orders over $75 – later.

Picking/Order Gathering Semi-Automated picking at central DC – Hatfield, England.

Manual picking-nearest store, except London where picking is from semi-automated DC.

Manual picking-nearest store

Manual picking-nearest store

Manual picking-nearest store Automated picking-central hub

Delivery Delivered from Hatfield DC., with a spoke system for delivering to outlying areas

Delivered from nearest store, except London, where delivered from picking center.

Delivered from nearest store

Initially, only pickup. Later, delivery within 6-8 mile radius

Pickup or delivery within restricted area

Hub and spoke delivery system from centralized picking centers.

Notes: 1 According to company press releases (www.Albertsons.com), sales increase 1-10% when online ordering is offered. Figure calculated using conservative estimate of a 4% increase in sales across 390 stores. 6 This estimate is the authors’ based on a review of information available on the company’s website. MyWebGrocer charges a fixed $5 fee per order handled.

Sources: 2 Hall (2001) and Tomlinson (2000); 3 Koller (2001) and Urbanski (2001); 4 www.MyWebGrocer.com; 5 Himelstein and Khermouch (2001) and Rizzo (2001)

14

Exhibit 3. A Simplified Grocery Supply Chain

Distribution Center

(Typical Annual Volume $500 million - $1.5 billion)

Manufacturers, Processors and Growers

Ocad

Grocery Stores

15

Exhibit 4. Cost estimates for various grocery picking and delivery options

Picking Estimates

Customer TescoA

Store-based picking

OcadoB

Central DC picking

Items/Hr 64 120 200 Average Order 32 items 64 items 64 items

Labor Cost ? $16.50 $16.50 Equipment &

Overhead ?

Existing Store $40 million DC designed to handle 20,000

orders/day Delivery Estimates

Orders/Hr 2.5 2 Labor cost/Hr ? $16.50 $20.00

Van CostC ? $40,000 $60,000 Van cost/orderD ? $3.00 $2.50

NOTES: A Picking data from Reinhardt, “Tesco Bets Small – and Wins Big”,

Businessweek, pp. EB26-EB32, October 1, 2001. Delivery data are authors’ estimates.

B Data based on author estimates. Higher cost of van and delivery labor is based on Ocado’s desire to use personal delivery as a distinctive competence rather than a low-cost activity.

C Assume that delivery vans are depreciated over 5 years and that the DC is depreciated over 10 years.

D Van cost/delivery includes cost of gasoline/petrol and maintenance of vehicles. Tesco and other store-based pickers have lower costs per delivery because of greater proximity to customer and can make more deliveries per order.

Exhibit 5. Sample list of Customers with Delivery Slots

Customer Location ID X-Location Y-Location Traffic Delivery Window DC 0 0 0 1 NA

Melnick 1 4 4 1 9:00 AM - 11:00 AMSmith 2 8 -4 1 11:00 AM - 1:00 PMLee 3 -17 -25 3 1:00 PM - 3:00 PM

Guyton 4 -21 11 2 3:00 PM - 5:00 PMFarran 5 25 4 1 3:00 PM - 5:00 PM

Christenson 6 5 -19 2 1:00 PM - 3:00 PMRobb 7 4 13 1 11:00 AM - 1:00 PMDiorio 8 15 -25 2 9:00 AM - 11:00 AM

Azzouz 9 -15 25 2 11:00 AM - 1:00 PMSenk 10 19 -14 2 3:00 PM - 5:00 PM

Turnley 11 -18 -5 1 1:00 PM - 3:00 PMWong 12 1 3 1 9:00 AM - 11:00 AM

Seagraves 13 25 -11 2 11:00 AM - 1:00 PMLowery 14 -9 -4 1 1:00 PM - 3:00 PM

Hale 15 5 18 3 3:00 PM - 5:00 PMTaylor 16 4 -15 2 9:00 AM - 11:00 AMTrosko 17 5 6 1 3:00 PM - 5:00 PMWilson 18 20 -3 1 1:00 PM - 3:00 PMBrown 19 -8 -8 1 11:00 AM - 1:00 PM

Tomber 20 -6 15 2 9:00 AM - 11:00 AMShaw 21 0 14 2 11:00 AM - 1:00 PM

Remold 22 -14 -8 1 9:00 AM - 11:00 AMPalmgren 23 1 20 3 11:00 AM - 1:00 PM

Martin 24 7 -20 2 3:00 PM - 5:00 PMLeventhal 25 4 3 1 3:00 PM - 5:00 PM

Joshi 26 8 2 1 3:00 PM - 5:00 PMHengemuehle 27 -24 -23 3 1:00 PM - 3:00 PM

Boyer 28 -1 21 2 1:00 PM - 3:00 PMGifford 29 3 -8 2 9:00 AM - 11:00 AMFrohlich 30 -12 -20 3 9:00 AM - 11:00 AM

Evon 31 3 24 3 11:00 AM - 1:00 PMCline 32 3 -13 2 11:00 AM - 1:00 PM

Rodrigues 33 -20 0 1 3:00 PM - 5:00 PMBaillie 34 13 6 1 9:00 AM - 11:00 AMAbbas 35 -15 -16 3 1:00 PM - 3:00 PMChang 36 -9 9 2 11:00 AM - 1:00 PM

Eubanks 37 24 -2 1 9:00 AM - 11:00 AMHult 38 -12 -3 1 3:00 PM - 5:00 PM

Griffin 39 3 14 1 1:00 PM - 3:00 PMLarriva 40 9 -14 2 3:00 PM - 5:00 PMMarinez 41 -20 0 1 1:00 PM - 3:00 PMMollsen 42 20 -7 2 9:00 AM - 11:00 AMQuispe 43 0 -21 3 1:00 PM - 3:00 PM

Pyle 44 -8 0 1 1:00 PM - 3:00 PMSanchez 45 7 1 1 11:00 AM - 1:00 PM

17

ENDNOTES i Hall, J., “British Supermarket Giant Cooks up Plans to Go Global – Tesco’s Move to Duplicate High Growth at Home Comes with Big Risks”, Wall Street Journal, July 5, 2001, p. A9; and Koller, M., “Grocer Builds Net Traffic – Albertson’s Expands in Seattle, Pushes Online/Storefront Strategy”, Internetweek, No. 872, August 6, 2001, pp. 13-14. ii Weir, T., “53rd Annual Consumer Expenditures Study: Sales Boom with the Economy”, Supermarket Business, Vol. 55, No. 9, September 15, 2000, pp. 27-45. iii Urbanski, A., “The Super 50”, Supermarket Business, Vol. 56, No. 4, April 15, 2001, pp. 1-18. iv Industrial Distribution, “Universal Product Code turns 25”, Vol. 88, No. 10, Oct, 1999, pg. A7. v Taylor, T.C., “The Great Scanner Face-Off “, Sales and Marketing Management, September, 1986, Vol. 137, No. 4, p. 43. vi Veitch, M., “E-Grocers Square up for Food Fight”, VNUNET.COM, April 23, 2002. vii Wearden, G., “Sainsbury’s Online ‘Far from Profitability’”, news.zdnet.co.uk, May 29, 2002. viii Op. Cite, Urbanski. ix Op. Cite, Koller. x Krantz, M., “Old-Line Firms Thumb their Noses at Naysayers: Bricks and Mortar Rule for Investors”, USA Today, August 23, 2001. xi Press Release, MyWebGrocer.com, June 10, 2002. xii “Ocado’s Online Grocery Gambit goes Live”, E.Logistics Magazine, February, 2002. xiii Himelstein, L., and Khermouch, G., “Webvan Left the Basics on the Shelf”, Business Week, July 23, 2001, p. 43. xiv Sell, Shawn, “When the grocery shopping gets tough, take away the scanners, give me back the clerks”, USA Today, pg. 10D, May 19, 2000. xv Ibid. xvi Reinhardt, A., “Tesco Bets Small – and Wins Big”, Business Week, pp. EB26-EB32, October 1, 2001. xvii Spindler, M. “Grocers find Profitable Growth in the Darndest Places”, MyWebGrocer Press Release, June 10, 2002. xviii Anders, G., “Co-Founder of Borders to Launch On-Line Megagrocer”, Wall Street Journal, April 22, 1998. xix “Ocado Moves into Full Launch Mode”, E.Logistics Magazine, February, 2002.

18