The on-line grocery business has just moved beyond the stage of outlining operating models into the realm of proving them. Like dot-com companies in other sectors, on-line grocery players will be held to higher standards than before by investors, and their prospects for profitability will be heavily scrutinized.
"The stock market has punished a lot of the home-delivery stocks," said Mark Rowen, an analyst with Prudential Securities, New York. "They'll have to prove that they can make their models profitable. The market is more skeptical now than six months ago." It's against that backdrop that SN presents this week's special theme, "The Net Shopping Battle." Internet companies with varying strategies are racing to gain the advantages of first movers before financing runs out. Bricks-and-mortar operators, meanwhile, are weighing the risks of making major moves against those of doing too little. Analysts are trying to filter the workable company models from the likely failures.
The stories that follow in this Retail section analyze how this is playing out for the major participants in the on-line food retail game in the United States and abroad, and also profile the consumers they are trying to address. The other sections of SN this week also focus on how the Internet is affecting food retailing.
The recent near-collapse of on-line grocer Peapod -- which last month found a soft landing through a pending deal with new majority owner Ahold -- helped to fuel skepticism about the sector by market observers.
"The Peapod situation illustrates the challenges for dot-coms in food," said Gary Giblen, who tracks food-retailing companies as president of Giblen Associates. "I think there is room for pure dot-coms in the drug area, but in food it's hard. There are bulkier items, and the physical movement of product is more challenging."
A slightly more optimistic outlook came from Jonathan Ziegler, San Francisco-based managing director of Deutsche Banc Alex. Brown, New York, who said there is "a major role for the Internet to drive productivity and sales within the grocery retail sector." Ziegler's concern, however, was whether the home-delivery grocery model can prove itself workable. He pointed to the case of Webvan, the Foster City, Calif., operator. "In San Francisco, there's very good word of mouth on Webvan," Ziegler said. "But the stock price tells us that some day it must make money. In order to do that, the company will have to either raise prices to reduce the break-even level or change the cost structure through more volume. But would the curve upward in pricing more than offset the downward curve of customer erosion that results from the price increases? It's too soon to determine."
Driving interest in on-line grocery are predictions about its potential volume. According to Forrester Research, the sector, which represented sales of about $513 million in 1999, will grow to $16.8 billion by 2004.
But it's hard to generalize about the prospects of the industry because companies fall into a number of different categories. Niche players like Streamline and ShopLink are targeted to upscale consumers while companies including NetGrocer and HomeGrocer aim at mass customer bases. Some dot-coms go for the ethnic niche while others target the urban convenience market. Meanwhile, a service like Priceline, which isn't really a grocer but rather a pricing facilitator, gears itself toward consumers who are most likely to be coupon clippers.
On-line grocers also differ widely in the amount of labor they employ. NetGrocer, which outsources delivery by using Federal Express, serves the nation with only 90 employees. That contrasts with HomeGrocer, which plans to hire 4,000 employees this year just to bring its home-delivery service to five markets.
One common denominator is that all players are fine-tuning their models in the midst of industrywide debates over the optimal approaches. Is it better to go with in-store picking or a dedicated warehouse? What type of delivery approach is best? Most questions don't have definitive answers, and companies including Albertson's are testing more than one model at the same time.
The costs of the on-line ventures are heady and the financing pipeline may be a little drier. A report last month by Forrester Research predicted most on-line retailers won't be able to survive the increasing competition and decreasing availability of funding. This may be complicated by falling stock prices for e-tailers, who rely on public markets for capital infusions.
Capital spending outlays vary by company, but Webvan's numbers have gained some attention. The company, which is well financed, is rolling out automated distribution centers, each costing $30 million to $35 million. Webvan finished the first quarter with more than $500 million in cash but will probably need to get more financing early next year.
The industry's ongoing hunt for dollars may become more challenging. "Indulgent parents will pay for their kids' college because they know that after four years it will be over and the man will come back and go earn money on his own," said Mark Husson, an analyst with Merrill Lynch, New York. "These Internet retailers need that same kind of visibility of a payback or they will not stick around."
Not surprisingly, retailers are emphasizing their prospects for profitability. "We are very confident we will be profitable at some point this year," said Ed Albertian, chief operating officer of Streamline. "It's looking good for us. And that's something we're totally focused on."
Likewise, Webvan and HomeGrocer are saying that their warehouses can reach the break-even point in 12 to 15 months. Analysts will be closely watching such company predictions and holding executives accountable.
Possibly the most anticipated development in this sector will be the on-line buildup of the brick-and-mortar players, a stage that is beginning. Albertson's is still in the very early phases of a test that marries an on-line ordering site with a retail unit. Safeway has just announced a deal in which GroceryWorks will become its exclusive on-line grocery channel, and will be supplied by Safeway. Ahold expects to roll out mini-distribution centers in Ahold supermarkets through its recently announced deal with Peapod. These giant retail chain players, and others in their size category, have yet to show their real effect on a market that has until now belonged to dot-coms.
"Will the ultimate battle, then, be dot-com vs. brick-and-mortar? HomeGrocer's Dan Murphy, vice president of merchandising, contends his on-line venture is better positioned in this sector than traditional retailers. "Their core competency will always be brick-and-mortar stores and they do that well. But they're not in the food business, the technology business and the delivery business -- we're the only one in all three."
But others point to a role for both dot-coms and stores. NetGrocer, for instance, contends its strategy is merely to target the center store, leaving the perishables and fresh foods niche for supermarkets, who can do that better. Priceline, meanwhile, is setting itself up as a partner with traditional retailers. And the Safeway and Ahold scenarios indicate that further alliances between dot-coms and established retailers may be forthcoming, according to analysts.
Eventually the winners in the on-line sector will be known, and the struggle will have changed food retailing in many ways. Some of these will be positive. Companies have managed to create new businesses with new supplier relationships that can be leveraged for the future.
Consider the case of ShopLink. The time demands of its home-delivery service meant the company was "asking suppliers to re-engineer their businesses for us, to fit the way we do things," said John Icke, chairman and chief executive officer.
For instance, the fish wholesaler had to adjust to delivering on the day of order and the bakeries had to create separate delivery slots for ShopLink that were earlier than their traditional schedule. But vendors made these changes for ShopLink, just as suppliers are adjusting to demands of other on-line grocers.
Another positive is that on-line grocery sales may enhance the retailer's relationships with consumers. This may be the promise that bricks-and-mortar companies need to develop a lasting interest in this sector.
"There's an opportunity for supermarket companies to roll out information to consumers beyond just groceries and expand the top line," Ziegler said. "They can provide everything from travel to community events. They can become an integral part of consumers' lives."
