PEAPOD'S PROGRESS

ELLIOT ZWIEBACH

SKOKIE, Ill. -- Prospects at Peapod are picking up.

Just one year after the end seemed imminent, the on-line grocery company has been given a second life with the acquisition of majority control by Ahold.

Things seem to be falling into place very well, Marc van Gelder, president and chief executive officer, told SN, "and once all the pieces are under control -- sites, marketing, merchandising, fulfillment and transportation management -- then we can make money."

After 12 years in business, the company has yet to make money, with losses last year of $56.7 million, nearly double the $28.5 million lost in 1999. However, the company is on the verge of profitability this year in two areas -- Chicago and one of its East Coast markets -- van Gelder said.

He declined to say whether the profit will show up in the second or third quarter of the year, nor which East Coast market it will come from, "because one market could turn a profit right before another," he explained.

With the imposition of delivery fees on virtually all orders, Peapod expects to be completely profitable by 2003, van Gelder said.

"And once we are profitable, we anticipate profits going forward because we have the right models to achieve it, and the demand is there," van Gelder said.

Any possible slowdown in the economy is unlikely to slow Peapod's progress, van Gelder added. "Peapod is not a luxury service. Families still have to eat, and if there's a recession, those families will be even busier trying to make ends meet, and that's where we come in.

"With the time we're able to save consumers, they can spend three extra hours playing tennis if the economy is good or three extra hours working if the economy is down."

According to van Gelder, Peapod's short-term plans include the following:

Expanding into another East Coast market this year.

Introducing a new, faster Web site this summer.

Testing a batch-pick system for orders later this year.

Experimenting with a store pickup system in 2002.

Reducing input time for first-time customers by allowing Peapod to access personal information from Ahold's loyalty-card files.

Peapod, which was founded in 1989, operates in five markets: Chicago, Boston, Washington, Long Island, N.Y., and Norwalk, Conn.

Orders are filled out of large distribution centers in Chicago and Gaithersburg, Md., and out of fast-pick centers -- set up in store back rooms -- in the other three markets.

Until last year, Peapod also operated a distribution center in San Francisco and had partnerships with Kroger Co. in Columbus, Ohio, and Randall's Food Markets in three Texas cities -- Dallas, Houston and Austin. But after the merger with Ahold, Peapod decided to exit those regions and concentrate on markets in which Ahold has retail operations, as well as its home base of Chicago.

Peapod's sales last year were $92.8 million, up 27.6% in all markets and, excluding markets the company left, up 45%, van Gelder said. The company is forecasting a 40% sales increase this year, "because we're running record results almost everywhere," he added.

"Washington is doing very well, and we're still growing in New York and Connecticut. Sales in Boston are also increasing, though not as fast as in the other three -- though we did have the major benefit last year of ShopLink and Streamline going out of business there -- and sales in Chicago, where we compete with Webvan, are up slightly."

Customer counts are expected to jump 7% this year, van Gelder said -- from 112,000 shoppers to 120,000 -- and profits will build as Peapod continues to pick, pack and deliver orders more efficiently and as gross margins continue to rise, he added.

The gross margin for a $125 order is $40, or about 32%, which encompasses the order size, the mix of products and a delivery fee, van Gelder explained. A year ago margins were in the 25% range, but the shift to Ahold enabled the company to move the percentage into the low 30s because Ahold can get products at a lower cost than Peapod could on its own, he said.

Before Ahold acquired 51% of Peapod last April, the on-line grocery company appeared to be on the verge of collapse after losing a major financing package. However, as the Netherlands-based retailer was broadening its operating base by moving into food service, it opted to increase its share-of-stomach by acquiring majority control of Peapod.

The partnership with Ahold is a key to Peapod's expectations for long-term success, van Gelder said, "because we get the benefit of expertise from the company's founders [Andrew and Thomas Parkinson], who are still with Peapod, plus the logistics expertise and increased buying power from Ahold, which gives us the best of both worlds -- all the best from a clicks operation and from a bricks-and-mortar operations."

Gary Giblen, senior vice president and director of research for C L King Associates, New York, said the Ahold connection has certainly enhanced Peapod "because Ahold has greater procurement power. Peapod is now a company that can buy as efficiently as any chain, plus it has a built-in customer base from Ahold's stores that it didn't have before, with a lower cost of acquiring customers."

Giblen also said he believes Peapod could someday lose its identity "and simply end up as Ahold's home delivery service, without the distinctive name."

Ellen Baras, an analyst with William Blair & Co., Chicago, said it's still not clear if the public will accept on-line grocery shopping. "But if Peapod can achieve its profitability goals this year, then that's strong evidence it can be a sustainable business going forward -- and if it becomes totally profitable by 2003, that would mean Peapod has found a way to balance market size with operating scale on an ongoing basis."

But Peapod may have to do more consumer education to alter public perceptions that its on-line pricing is higher than supermarket prices, Baras said.

She also said a downturn in the economy is unlikely to affect Peapod's business, "although if one member of a two-member household that's using Peapod loses his job, then that couple would have the time to shop the traditional way and may turn away from Peapod."

Jonathan Ziegler, San Francisco-based managing director of Deutsche Banc Alex. Brown, New York, said Peapod's ability to outlast most of its competitors means it has a good chance of attracting more business, "because now that so many others have folded their tents, Peapod owns most of the markets it used to share, and where customers interested in home delivery once had three or four places to go, they now have only Peapod.

"And with virtually no competition, imposing a delivery fee is more realistic and makes it more economical for Peapod to earn a profit."

Van Gelder said Peapod plans to expand into additional markets as it moves toward profitability. "At this point we're not expanding until all our markets are profitable, but we anticipate our next expansion will be at the end of this year," he said.

"Our first priority is to expand in the most densely populated areas but eventually we will be in all East Coast markets where Ahold operates," he said. Those markets would encompass areas of New England and New York (Stop & Shop); upstate New York and Ohio (Tops); Pennsylvania and the mid-Atlantic region (Giant of Carlisle, Pa.); the Southeast (Giant of Landover, Md.); and the South (Bi-Lo).

Peapod's expansion plan "is to grow beyond the markets we're in now where we're reaching capacity," van Gelder explained. "So, for example, as we near capacity in Norwalk, Conn., we could look at moving into Westchester County [just north of New York City], though that is not necessarily our next growth target.

"We want to grow primarily in markets that have a high, dense population, with a lot of big families with kids and where Ahold has a strong presence, which could include Westchester, N.Y., parts of New Jersey, Philadelphia or Charlotte, N.C.

"But we expect to be in all Ahold markets by 2003."

Since becoming part of Ahold, Peapod has introduced its service in Boston and Washington under the names Peapod by Stop & Shop and Peapod by Giant, respectively.

Van Gelder said Washington has been an extremely important market for Peapod "because computer literacy is very high there, with 56% of the population using computers, and we expect our business to ramp up quickly there."

As Peapod expands its operating area, it focuses on zip-code marketing, van Gelder said, "because in our business, you can have a lot of customers, but if they live all over an area, it's not convenient from a transportation point of view. So we prefer to expand from one zip code to another."

Peapod uses two delivery models: distribution centers in the Chicago and Washington areas, "where there are millions of people and where we can ramp up volume quickly," he said; and a fast-pick system in store back rooms in Boston, Long Island and Norwalk, "where the smaller format is the right model."

The distribution center model includes two grocery facilities in the Chicago area -- one of 92,000 square feet in Lake Zurich, Ill., and another of 75,000 square feet in Niles, Ill. -- and a 92,000-square-foot warehouse in Gaithersburg, Md., that Peapod acquired last fall when Streamline left the area. Warehouse capacity is about $120 million per year, van Gelder said.

A total of seven fast-pick centers -- five in Boston, one in Long Island and one in Connecticut -- each use approximately 8,000-square-feet of otherwise empty back room space that Peapod outfits with its own system for picking dry groceries; perishables are picked from the store floor. Capacity at the fast-pick locations is about $12 million a year, van Gelder said.

Peapod employees pick one order at a time in both formats, although the company plans to test batch-picking, van Gelder said, with a rollout planned for the distribution centers and seven fast-pick centers later this year.

The company plans to expand with both formats, he added. "When or where we open a third warehouse will depend on how quickly we grow," van Gelder said.

He also said the imposition of delivery fees is a key element in the company's imminent profitability.

Delivery fees vary by market, although the company has phased out almost all free deliveries. Peapod has also imposed an order minimum of $50 "because otherwise we can't make money," van Gelder said.

With the $50 minimum, customers in all markets are charged $9.95 for orders up to $75; $4.95 for orders of $75 to $100 in Chicago, Long Island and Connecticut; and $5 for orders over $75 in Washington. The company offers free delivery only in Chicago and only on orders over $100.

In the past, Peapod gave Chicago customers three options: paying $24.95 a month for an unlimited number of deliveries, paying $9.95 a month plus $4.95 per delivery, or paying no monthly fee and $9.95 per delivery. Those options were eliminated in July.

In Boston, Peapod used to deliver orders of $60 or more for free and smaller orders for $7.50, with no minimum -- options that were eliminated last month.

Peapod tested the viability of store pickups as an alternative to home delivery on a limited basis last year in both Chicago and Boston, "but from the feedback we got, people didn't feel there was a convenience aspect or a real time savings if they had to go to the store to pick up orders," van Gelder said.

"And while we're not geared to store pickups, we want to test it further, and we will probably do so on a larger scale sometime next year."

Peapod's target customers are big families with children, he said. "We don't do well in wealthy neighborhoods, but we do well in middle- and upper-middle-class areas where there are a lot of families with young children."

He said 96% of orders are placed over the Internet, with 4% of orders phoned in.

Because speed of ordering is a major customer demand, Peapod plans to introduce a new version of its Web site this summer "that will speed up the ordering process by 33%," van Gelder said.

The new version will use existing technology to extract categories from memory instantly so products pop up quicker on the order screen. Peapod has been testing the new version of the Web site with employees since January.

Van Gelder said Peapod is also going to try to eliminate an ongoing problem by reducing the time it takes new customers to sign on as buyers -- a process that often takes up to an hour-and-a-half to develop a customer profile, he noted.

The company hopes to cut the time by introducing an opt-in feature through which customers who have loyalty cards at one of the Ahold chains can release their data to the on-line retailer, thereby eliminating some frustration on their first visit to Peapod "when speed is important to win customers over," he explained.

The opt-in feature is scheduled to go on-line at the end of this year or early in 2002, he said.

The new Web site will also offer more personalized promotions, van Gelder said. "Some grocers with on-line programs say Web sites should offer the same promotions customers can get at the stores, but we believe you should use the medium for more targeted promotions," he explained.

"That's the beauty of this medium -- to be able to target relevant product promotions or coupons to specific customers or demographic groups."

Van Gelder said Ahold is not concerned that Peapod could take sales away from its brick-and-mortar stores. "We believe on-line sales bring new business to the stores, and we're not afraid of cannibalization because we believe Peapod adds volume to the total Ahold entity.

"Rather than replacing store sales with on-line sales, we see it as adding new sales. And because consumers want convenience, the ability to provide such convenience enlarges the radius the stores can reach."

Peapod has helped Ahold build up customer loyalty, he said, with Peapod by Stop & Shop helping to boost Stop & Shop sales in areas of Connecticut where the bricks-and-mortar chain has poorer penetration, van Gelder said.

In terms of customer service, Peapod has expanded its delivery windows from its standard of two hours to a six-hour window or unattended delivery. "Broadening the delivery times gives us more flexibility in routing and getting transportation costs under better control," van Gelder explained.

"To incentivize customers to opt for the six-hour window and, occasionally, for unattended delivery, we offer $1 off the delivery charge."

The incentive has worked well, he added, with 50% of shoppers in the Washington area opting for the six-hour or unattended delivery options.

On-time delivery is also very important to customers, van Gelder said, and so is the company's in-stock position.

Peapod's primary advertising medium, he said, is word of mouth. "Our most important source of new customers is one customer referring a friend to us, for which we reward the customer with $20 off the next order."

The second most common form of advertising is in-store promotions, with brochures and point-of-sale signs at Stop & Shop and Giant stores reminding shoppers of the service, van Gelder said. The company also uses direct-mail marketing and some targeted radio, "but TV is too mass-oriented," he noted.

Van Gelder acknowledged how surprised he has been to observe the way customers react to Peapod. "During the period between Thanksgiving and Christmas, when we're extremely busy, we ask all the people in our office to help out with deliveries, including myself, and when I go out to people's homes, it's amazing to see how easily they let us into their kitchens and how grateful they are that we're giving them time back," he said.

PEAPOD THROUGH THE YEARS

1989

Peapod founded by brothers Andrew and Thomas Parkinson.

1990

Peapod launches partnership with Jewel in the Chicago area.

1993

Peapod launches partnership with Safeway in the San Francisco area.

1996

Peapod launches partnerships with Kroger in Columbus, Ohio, and Randall's Super Markets (including Tom Thumb Supermarkets) in Houston, Dallas and Austin, Texas.

1999

Peapod converts Chicago and San Francisco operations to centralized distribution model, ends Bay Area partnership with Safeway and switches to Andronico's Markets, Albany, Calif.; Bill Malloy, from AT&T Wireless, named president and CEO.

2000

March: Malloy resigns due to exhaustion; $120 million financing by investment group terminated.

April: Ahold purchases 51% of Peapod for $73 million, launches Peapod by Stop & Shop with first fast-pick center at Stop & Shop store in Norwalk, Conn.

2001

January: Peapod ends partnership with Jewel in the Chicago area, names founder Andrew Parkinson chief financial officer.

September: Peapod purchases distribution centers in Gaithersburg, Md., and Lake Zurich, Ill., from Streamline.com, announces plans to exit Texas and Ohio operations.

November : Company launches Peapod by Giant, says Peapod expects to achieve first operating profit in at least one division by mid-2001.

March: Peapod closes San Francisco distribution center.