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e-grocers are going hungry
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March 4, 1999: 9:05 p.m. ET
But online food merchants revamp business models in search for profit
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SAN FRANCISCO (The Red Herring) - The online grocery market is heating up.
The best-known Internet grocers have so far failed to tap a potentially lucrative market but have recently made big changes to revitalize business.
Peapod (PPOD) has revamped its delivery model, NetGrocer relaunched last month with a business model based on making money rather than losing it, and yuppie bricks-and-mortar food retailer Whole Foods is preparing to launch its own e-commerce site.
And analysts continue to have high hopes for the online grocery market, predicting that it will reach up to $10 billion by the year 2003. Ken Cassar of Jupiter Communications notes that Americans shop for food much more frequently than for books and CDs. Moreover, he suggests that only a small percentage of the population needs to adopt online grocery shopping to make it a very profitable venture.
But despite the serious efforts of the major online grocery players to access these shoppers, they have not yet been able to lure customers away from local shopping centers into their virtual stores.
One of the major reasons for the stall is the difficulty and expense of transporting perishable goods -- which make up a large portion of a grocery order -- across the nation. When people still need to go to a bricks-and-mortar store for perishables, they do not see the advantage of doing the rest of their shopping online.
Another problem is that grocery products are generally sold with very thin margins. The cost of shipping orders cannot be taken out of profits, and when delivery costs are added to a customer's bill, online grocers are no longer competitive with bricks-and-mortar retailers.
Rethinking grocery sales
This was the primary problem facing NetGrocer when it pulled its IPO and fired its CEO Daniel Nissan last year. The company was buying and delivering groceries for more than it could get selling them.
NetGrocer reopened its virtual doors last month. While continuing to sell groceries at a loss, it has expanding its product categories to include high-margin items such as books, CDs and computer products.
At the relaunched site, promotions for tinned tuna and a 3-for-$7 special on Kellogg's cereal now share prominent space with a Samsung flat-panel monitor advertisement and a TDK video tape three-pack deal.
When NetGrocer announced this strategy last year, Cassar told the Red Herring that groceries may be an effective Trojan horse for other products. "The loss-leader model might be the way to make home grocery selling work," he said.
With its own distribution center, the company can afford to stock up on products that can be sold for higher margins on the Internet, but it still has no plans for selling and delivering perishable goods.
Riding the local wave
Peapod, on the other hand, is attempting to deliver perishable goods to shoppers in local markets. It has developed a "cool-chain solution" that helps it store and deliver perishables fresh to consumers. "We aim to replace the entire trip to the grocery store," says Peapod chief operating officer John Walden.
But the nine-year-old company also has had its share of problems. Partnering with local supermarkets to deliver goods has meant charging consumers high delivery costs, up to $16 an order.
To attract more customers, Peapod has begun to dismantle the partnerships and establish its own warehouses in select markets. Because goods can be stored in low-rent warehouses, without the layout and promotion costs a supermarket bears, Peapod can boost profit margins and offer a more affordable service.
Since December 1998 it has opened warehouses in San Francisco, Chicago and Long Island, New York. The Chicago center is already profitable.
Yet introducing a direct-fulfillment model has put a strain on the company's financial growth. Peapod revenues for fourth quarter 1998 were $17.2 million, compared with $17.2 million for the same period of 1997. For the year ended December 1998, total revenues were $69.3 million, compared with $56.9 million for the year ended December 1997.
Its stock price has been floating between $2 and $13 over the past 12 months.
The company says the lack of significant growth was due to its efforts to centralize its fulfillment operations, with expenses from investments in facilities, new technologies and personnel. Peapod also cut back its marketing spending, which led to a drop in membership.
"1998 represented a period of tremendous transition for the company," said CEO John Walden. "We set out to develop a new service model designed to enhance the company's control over service quality and remove costs from the order fulfillment process.
"In 1998 we sacrificed short-term growth, but we built the foundation for an exciting and financially attractive long-term business."
Natural strategy
The difficulty in finding a successful business model for selling groceries online has not deterred bricks-and-mortar store Whole Foods from joining in the attempt.
The upscale store announced that it will launch an e-commerce site later this month, for the ordering and delivery of its natural-food products.
With storage and transport infrastructure already in place, it seems like a logical step for a bricks-and-mortar grocery seller. The products should also be less expensive than in its physical stores because of cheaper rent and lack of customer service costs.
Deliverance
Taking a slightly different approach, one Internet player, Cybermeals, has developed a lucrative business model for ordering food through the Internet.
Billing itself the nation's only restaurant take-out and delivery service online, Cybermeals allows consumers across America to find restaurants, grocery stores, and restaurant delivery services in their own neighborhoods. Through the site, hungry Web surfers can check out menus, special deals and hours of operation, and can place an order.
The service is free for consumers, although they do pay the normal delivery charge the restaurant or grocery store would charge. Participating merchants pay a one-time setup fee, as well as a nominal fee to Cybermeals for each order delivered through the service.
The two-year-old startup, led by former Walt Disney Studios president Rich Frank, will announce a second-round funding later this month. It raised $10 million from Accel Partners in May last year.
Without storage and delivery hassles, Cybermeals has found a viable business model for selling food on the Internet.
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