A DIRECT APPROACH

Mark Hamstra

NEW YORK -- Maybe Joe Fedele hasn't heard the news that pure-play Internet grocery is dead.

In an interview with SN, the co-chairman and chief executive officer of FreshDirect here recently discussed his vision of creating a Web-based grocery empire that takes a new approach to Internet-based food shopping. Rather than promoting the convenience of buying groceries on the Internet, Fedele is positioning FreshDirect as a price- and quality-driven alternative for consumers accustomed to New York's notoriously expensive supermarkets.

The privately owned start-up already is commanding plenty of attention from the media and from food-loving fans in Manhattan. FreshDirect is generating more than $1 million per week in sales, Fedele said -- although it is not yet profitable -- serving just a fraction of Manhattan's neighborhoods and focusing primarily on high-end perishables.

"I learned through 27 years of retailing that offering a better product at a better price is really all that matters," he told SN during a recent tour of the company's 300,000-square-foot warehouse/food-processing plant just across the East River from Manhattan in the borough of Queens.

"Sam Walton said that retailing doesn't have to be convenient," he said, a reference to Wal-Mart's development of big-box discount stores in remote locations.

Traditional supermarkets have built their business models on leveraging the convenience of their sites, but that's "not the right formula," Fedele said. "You've got to have a better product at a better price. That will change behavioral patterns. Convenience is a repercussion of what we do, but it's not our driving force."

Fedele speaks from experience. In 1993 he co-founded one of New York's most popular -- and inconveniently located -- supermarkets, Fairway Uptown in West Harlem. He sold his stake in Fairway in 1999 and was soon approached by investors seeking to launch an Internet-based grocery company where the food would take center stage. The company started building the plant in late 1999 and opened for business in September of last year.

"I think the key here is that they are not trying to be a grocery store," said Meredith Adler, analyst, Lehman Bros., New York. "They are a gourmet, high-end retailer."

She said the company is not necessarily replacing consumers' need to go to the supermarket, but is instead filling in where New York's supermarkets have failed in providing high-quality meats and produce.

The 'Food Guy'

A minority partner in the venture, Fedele describes himself as the "food guy" at FreshDirect. As CEO, he shares the day-to-day oversight of the company with his partner, Jason Ackerman, who holds the titles of co-chairman and president and handles much of the logistical side of the business.

"He has the skill sets of technology and finance. I have the skill sets of food," Fedele said.

Ackerman was a former vice president with Donaldson Lufkin Jenrette. His uncle, investment banker Peter Ackerman, who was involved in the buyouts of Price Club and Ralph's, is a significant investor in FreshDirect. All 350 employees own stock in the company.

Fedele's 30 years of experience -- he started in retail in 1973 and spent much of his career buying and selling perishables -- helps the company achieve the low prices it touts in ads that are ubiquitous throughout New York's mass transit system. He said that by buying directly from producers and eliminating many of the steps supermarkets take to put their products on display, FreshDirect is able to offer consumers lower prices than supermarkets can. Prices are reported to be about 25% lower than those of competing supermarkets.

"Everything comes directly from the source," Fedele said. "There is no consolidation point. Where they make it, I buy it."

The company carries about 6,000 stockkeeping units of perishable product, including 600 SKUs of produce, plus about 5,000 SKUs of dry goods.

Fedele said FreshDirect's high-tech warehouse system (see Page 42 for more about this) enables it to both maximize low prices and maintain high quality.

For example, the company does not process any meat until customers have actually ordered it. The company accepts orders until midnight each day, when its meat cutters arrive and work through the night in 33-degree coolers processing cuts for the following day's deliveries.

"Everything is customized per person because it's made to order," he said. "We don't make things to stock on the shelves. We batch-manufacture everything, and our waste is zero."

In addition to cutting all its own meats in the food-processing facility, the company also roasts its own coffee and squeezes it own orange juice fresh each day. Much of its bread is baked in-house, with the aid of a computerized system that guides bakers through the process.

The 200 computers on the production floor "tell us exactly what to produce," Fedele explained. "We never produce anything until it has been sold."

The company employs several chefs and bakers, including a few that were brought in from New York's top restaurants and bakeries.

The facility is a combination of temperature- and humidity-controlled storage environments and an order-assembly system modeled after those of large shipping companies like United Parcel Service and Federal Express. Bar codes track products and orders throughout the four miles of conveyor belts as orders are assembled into cardboard boxes for delivery.

The site also includes an on-site lab to test food samples for pathogens, and the entire processing facility conforms to "hazardous analysis of critical control points" -- or HACCP -- food-safety guidelines.

The facility cost about $45 million to build, or nearly half of the $100 million that the company has raised from private investors thus far.

The investments in technology pay off in customer satisfaction, Fedele said. Customers report that they get nine days of shelf life from the produce they buy from FreshDirect.

The average order totals $97, and Fedele said about 70% of orders are perishables and frozens. Of the $1 million-plus per week in business that the company tallies, about $210,000 is produce and $200,000 is meat, with the rest spread out among delicatessen items, appetizers, cheeses and other products.

On one recent night, the largest order -- to a woman on the Upper East Side -- totaled $432, about 83% of which was perishables. It was that customer's ninth order.

Nearly three-fourths of those who try the service use it again, Fedele said. Trial is encouraged by offering of $50 off the first order, which Fedele said reinforces the company's low-price image.

The existing facility, Fedele said, could handle about $900 million per year in volume, or more than 10 times its current output. Fedele said the company expects to begin serving nearby Westchester County, N.Y.; Connecticut and Long Island, N.Y., by early next year. The company hopes to be in New Jersey by 2005.

FreshDirect currently serves an area inhabited by about a fifth of the 1.5 million people living in Manhattan, but Fedele said the company expects to be able to reach every single household in the borough by the end of the year, as well as some neighborhoods in Brooklyn and Queens. The company recently began offering service to parts of Manhattan's Upper West Side.

An Expensive Proposition

Whether or not Fedele will become the Sam Walton of Internet grocery remains to be seen. So far, the company has enjoyed tremendous word of mouth among the well-moneyed residents of New York's Upper East Side, but analysts said it will face some hurdles as it seeks to reach areas with less wealthy and concentrated demographics.

"The challenge for them is that it's very expensive to do what they're doing," said Christine Overby, senior analyst, consumer packaged goods, Forrester Research, Cambridge, Mass.

She said the company currently has several factors working in its favor, however -- including its limited geographic scope and "strong consumer value perception."

FreshDirect shares some characteristics with Tesco.com, the London-based Internet-grocery service affiliated with supermarket retailer Tesco, she said. Tesco.com generated a profit of about $12 million last year on about $450 million in sales, making it both the largest and most profitable Internet-grocery company in the world.

Both Tesco.com and FreshDirect serve urban markets with a high population density, where many consumers have to trudge back and forth to the supermarket on foot. Unlike FreshDirect, however, Tesco.com picks its orders from its stores, as do many of the Internet-based grocery services in the United States. Both Safeway, Pleasanton, Calif. -- which has a joint venture with Tesco.com to operate its online service -- and Albertsons, Boise, Idaho, have been growing their Internet-grocery operations using a store-pick model in several West Coast markets.

Peapod, the online-grocery division of Ahold USA, Chantilly, Va., uses a warehouse for delivery in its headquarters market of Chicago, but elsewhere fulfills orders from the various Ahold retail stores in the markets where it operates. It recently said it was profitable in all but one market, although it did not identify which market that was. Lakeland, Fla.-based Publix Super Markets uses a warehouse in Pompano Beach, Fla., to support its PublixDirect online-shopping service in three southern Florida counties. A plan to expand that service to the Orlando market was put on hold last year.

A handful of other retailers also have dropped their Web-based grocery services recently, including Roundy's, Pewaukee, Wis., and Marsh Supermarkets, Indianapolis.

Webvan, the Foster City, Calif.-based Internet-grocery company that filed for bankruptcy protection in 2001 and now is often cited as a poster child for failed Internet companies, also had a model based on fulfillment from high-tech warehouses.

Fedele said he is unfazed by the failures of previous e-grocery concerns, which also included grocery-delivery service Kosmo.com in New York.

"It doesn't matter who gets there first," he said. "It matters who gets there best."

He told SN the company will be profitable "within a few months," although he has since been quoted as saying the company will be in the black by October.

Educating Consumers

One of the appealing features of FreshDirect is its Web site, Fedele said. The company has a photo studio in its offices where it photographs samples of every item it sells. It has 870,000 digital pictures stored in its database, he said.

The Web site, maintained in-house, is designed to make the shopping experience more educational and interactive than what consumers can get in their local grocery store. Customers can shop for products according to the degree of ripeness, taste, country of origin and other factors.

"People really shop by the attributes and functionality of the foods," Fedele said.

This month, the company began offering video cooking classes on the site.

To provide customer service, the company staffs 40 in-house telephone operators.

The company also has a "super LED" sign atop its warehouse, visible to millions of commuters traveling through New York's Midtown Tunnel each day. Fedele said the sign is paid for through barter, by displaying advertising for vendors.