Online grocery retailing: success factors and potential pitfalls

Online Grocery Retailing: Success Factors and Potential Pitfalls

Hean Tat Keh and Elain Shieh

L ike the rest of e-commerce, the new format of selling groceries online has grown at a phenomenal pace and stirred up con-

siderable hype. Born and bred on the Internet, pure-play online retailers such as Peapod and Webvan are already household names-although they are still struggling to become profitable, even with steadily growing sales revenues. Meanwhile, traditional grocery giants such as Kroger and Safeway lag behind the.phenomenon, preferring to do business the bricks-and-mortar way. Others, such as Albertson’s, have taken baby steps into e- commerce and now offer limited online capabil- ity in addition to their regular stores.

There seems to be no turning back, then, in the trend toward grocery e-tailing. As the Internet continues to grow, so will e-commerce. Surveys show that consumers typically dislike grocery shopping, and those with busy schedules should increasingly find online purchasing a viable option. But in light of the industry’s low or nonex- istent profits, and with so many dot-corns going belly up, several questions need to be addressed:

1. What are the prospects of grocery e-tailing? 2. What is the profile of the online grocery

customer? 3. Can grocery e-tailers build sustainable

competitive advantages? 4. What are their key success factors? 5. What are their impediments to success?

THE GROCERY E-TAILING MARRET

A s an industry in the early stages of its life cycle, the online grocery market is currently very fragmented, with a

growing number of competitors. The reasons for this fragmentation lie in several factors: relatively

low entry barriers, high transportation costs, the perishability of grocery items, a nontradable goods and services industry, and the ability to specialize in geographic regions and reap the benefits of economies of scale. Much like traditional bricks-and-mortar supermarkets, online grocers are highly localized except for a few that operate nationally or internationally by delivering only nonperishable goods.

The growth of grocery e-tailing is a global phenomenon. Though still fairly new, it is one of the fastest growing online industries. Machlis (198) reports that online grocery sales in 1997 were $85 million-a minute fraction of overall sales of $401.7 billion-with only 10,000 U.S. households buying groceries online that year. But 6.9 million households were expected to do so in 2002. And Andersen Consulting (now Accenture) has estimated that the value of online groceries could be as high as $85 billion by year 2007, reports Dorgan (1998), with as many as 25 percent of U.S. households participating.

Nevertheless, despite such rosy forecasts for grocery e-tailing, the truth of the matter is that “no one has reported a profit yet,” says Reidy (2000). In fact, most pure-play online grocers are still trying to break even.

Because it has such different characteristics from other online businesses, grocery e-tailing

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requires a different business model. Its unique selling properties lie in convenience and time savings, which appeal to busy consumers or those who simply dislike shopping for groceries. Repeat ordering through the Internet frees up time, says Dornbusch (19971, which enables consumers to do other things or engage in more specialty shopping. For some, this makes shop-

ping more exciting and less of a chore. However, unlike other popular Internet purchases such as books, computers, and CDs, groceries are time- sensitive products. Moreover, many Net purchases require considerable thought and comparison, whereas most households buy more or less the same bundle

of groceries every week. The Net may also work better for replacement buys than for new purchases, says the Economist (“Define and Sell” 2000). And because groceries are usually “high- touch” items-that is, customers often prefer to be able to see and touch them before buying- delivery becomes more challenging.

Industry Attractiveness

Food is more than a necessity for living; it it also an important reflection of culture. Over the cen- turies, daily or weekly trips to the local market have evolved into a tradition, etched into people’s minds as the way things should be done. “Shop- ping outdoor markets for countryside produce,” notes Straziuso (ZOOO), “is as French as the ba- guette.” Preparing authentic cuisine often requires much time and careful selection of only the freshest ingredients. Many still appreciate the pleasure of shopping in bustling, old-fashioned markets. However, with the emergence of e-commerce, many shoppers around the world are being lured to the practicality of online grocery shopping, a phenomenon that could slowly erode elements of tradition.

A growing number of grocers-traditional and new entrepreneurs alike-are hastily building their own Web sites and putting their grocery business on the Net. They are trying to be quick followers in order to capitalize on the trend. Al- though results have been less than favorable so far, the success of replicating and improving the grocery shopping experience online can shift unpredictably and unexpectedly. Just how attrac- tive, then, is the online grocery business model? Factors to be considered include entry and exit

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barriers, bargaining power, growth, cost structure, and competitive rivalry.

Barriers to Entry/Exit. Compared to building traditional supermarkets, the barriers to entry in the online grocery market are relatively low, since most online grocers are localized. Set-up costs include establishing the computer system, creating logistics and warehousing capabilities, building brand awareness, and having the necessary alliances with local grocers in place. Many online grocers have already established partnerships or alliances. Peapod got its start by forging alliances with Safeway and Jewel.

Entry into the industry is currently relatively easy, because no one has inherent advantages. Innovation and competitive moves, which can be easily replicated, have not prevented new firms or substitutes from entering the market. However, entry barriers may rise in the future as consolida- tion likely occurs. In a commodity-type market such as groceries, barriers must be built on differentiation through brand recognition by achieving superior customer service and responsiveness.

One attraction for the recent surge of Internet startups in the grocery business is that online grocers require less capital and have lower variable costs than bricks-and-mortar stores. Fixed costs are high, but the potential for big returns is great if a large sales volume can be generated.

Exit barriers can be moderate to high, de- pending on the amount invested in logistics and warehousing, the Web site, computer systems, and marketing. There is also the issue of emotional attachment to a new but plunging business, which is the case for many entrepreneurs, Heavy investments, external or internal, can make exiting the industry quite costly.

Bargaining Power. Retailers have high bargaining power when they purchase a large volume of goods from their suppliers. Unlike huge supermarket chains, the smaller online grocers typically possess a lower level of bargaining power than their suppliers. But traditional grocers that decide to branch out onto the Net have the advantage in this regard, buying in bulk and enjoying established relationships with suppliers and customers. This allows them to price their goods competitively, deterring new entrants or forcing inefficient incumbents out.

The bargaining power of buyers or consumers is also very high in this industry. With many substitutes and competitors to choose from, dis- satisfied customers can simply switch to a competitor. Groceries are commodities, so consumers can be sure to purchase the exact same products elsewhere.

Growth. Grocery e-tailing has shifted rapidly from the embryonic stage to the growth stage, with sales projected to rise dramatically in com- ing years. Current online grocers reveal that their

Business Horizons /July-August 2001

customer bases are accumulating quickly, rein- forcing the growth forecasts. Although profits are currently dim, there is potential for good returns in the future if the industry keeps growing at the estimated rates. One major force that will likely push the industry forward is reduced computer prices. Access to the Net is also becoming cheaper and more widely available. Consumers who do not have access at home or at work have the option of going to the library or other public establishments to log on.

The growth and success of the online grocery industry have been widely debated. While some experts in the industry are convinced that market trends lean toward this new retail format, many others are skeptical. High sales volume does not necessarily mean the grocers will be profitable, because margins are very thin. Ex- penses and other factors involved in the cost structure must be managed carefully in order to realize profits. Moreover, there is high uncertainty regarding technology, Internet shopping adoption rates, and consumer preferences.

Cost Structure. The cost structure of an online grocer differs significantly from that of bricks-and-mortar supermarkets. Online stores using a network of local grocers have almost no inventory, resulting in an improved cash flow cycle. They also have much lower variable costs, such as payroll. Although the online format may seem to have many cost advantages, this could be illusory. Costs for online grocers stem primarily from building warehouses and buying and developing specialized software and hardware. Maney (2000) reports that it cost Webvan $35 million to build a 300,000-square-foot distribution center, while the automated system in the center is con- trolled by artificial intelligence software written and maintained by highly educated, highly paid staff members. Other costs include marketing, delivery, expansion, hiring and training of delivery personnel, and other start-up factors. As al- luded to earlier, this cost structure is very sensitive to volume. However, online grocers can cut costs at various stages of the supply chain. And certain stages in which other companies can per- form more efficiently can be outsourced.

Competitor Analysis. The environment in the online grocery industry is growing more and more competitive as new firms continue to enter. There are a variety of different business objec- tives that depend on how each company chooses its positioning strategy. For some firms, the mis- sion is to replace the grocery store altogether, offering customers one-stop shopping. Other firms intend to act as a supplement to the local grocery channel, providing weekly, nonperishable items to which consumers do not give much thought when grocery shopping. Many consumers prefer to pick and choose their own perish-

ables. Having their regular nonperishable items delivered can reduce the frequency of trips to the supermarket as well as the time spent on each trip. Then they can use the express lane for their milk, eggs, and other perishables.

In online retailing, competitors are not necessarily limited to local stores. While most online grocers are regionally focused, some operate nationally. NetGrocer, Inc., for example, has a multimillion-dollar deal with AOL to sell its nonperishables nationwide throughout the United States. Tesco aims to have online sales throughout the U.K., serving more than one million home shoppers a week.

Increasingly, traditional supermarkets are going online. These bricks-and-clicks operations offer greater competition to pure-play online stores, with the advantages of brand recognition and reputation. Safeway, the national supermarket chain, has been conducting delivery trials in certain test markets. Having been the neighbor- hood grocer for a long time, it has established customer trust and loyalty, which it will likely transfer to its online business. Its online partner, GroceryWorks, will draw from Safeway’s inventory to pick, pack, and deliver electronic orders. The partnership expects to be operating in 16 markets by the end of 2001.

Traditional supermarkets also realize significant economies of scale, as they already have the necessary warehouse and distribution infrastructure. Compared to the new online start-ups, the bricks-and-clicks supermarkets are much further along on the experience curve. Having been in the grocery business for some time, they have developed the required expertise and connec- tions to run the business smoothly. With their critical advantages in cost and bargaining power, buying in large volumes allows them to offer better prices than pure-play e-tailers.

Despite the advantages traditional grocers can gain from branching onto the Net, they also face challenges. Cannibalization, resistance to change, inexperience with the Internet format, loss of focus, and cultural flexibility are examples of problems that managers must weigh against potential advantages.

THE CONSUMERS

0 ne of the driving forces behind the growth in online grocery business is the rise in the number of time-starved

consumers. Couples with two careers, children, and above-average income want to spend their spare time with their families, so they are con- cerned more with convenience than price. As the role of women keeps changing, the rise in the number of dual-income families is expected to continue. Such households, especially those with

Online Grocery Retailing: Success Factors and Potential Pitfalls 75

young children, will be more willing to embrace the concept of having their groceries delivered directly to their doors. For them, the convenience of ordering online far outweighs the higher prices or the membership fees. Factoring in the frustra- tion of dealing with children at the supermarket, pushing carts up and down the aisles, waiting in long lines at checkout counters, and finding park- ing spaces, these consumers may even end up saving more money and time than expected.

Although these time-starved, dual-income households are expected to be the main drivers of grocery e-tailing, several other types of consumers also show a willingness to use online services. These include people who dislike grocery shopping and those with disabilities related to age and health. The former may prove to be a significant target market. Their dislike for the physical grocery shopping experience may lead to an eagerness to buy through the Net. Online grocers can take advantage of this opportunity to add value and solve the problem for them. On- line grocers put the “fun back into going to the market,” says Dornbusch, by freeing up busy consumers for more specialty shopping. By buying their regular, repeat items from the Net, they can shop for specialty items at the supermarket.

With Baby Boomers beginning to reach their senior years, e-tailers cannot afford to ignore this huge market segment-which is also one of the fastest-growing segments of the online population. Shopping on the Net provides an alternative for seniors who find it difficult to travel to the store or load groceries to and from the car. It can also help give them a sense of independence.

McGovern (1998) reports that the demo- graphics of consumers who demonstrate a willingness to use online services “cut across all income and educational levels, age groups, and locations.” People across all market segments are becoming more and more comfortable with computers and the Net, expanding the limits of shopping and buying online beyond computer experts. For example, while popular belief holds that the Net is mainly a male medium, Peapod’s customer base shows the opposite: 75 percent of its heavy users are women. With the addition of Generation Y consumers, who have grown up with computers, the grocery e-tailing industry has a strong potential to take off in the future. Con- tinued growth, however, will depend largely on the value perceived by all these consumers.

THE COMPETITIVE ADVANTAGES

A s competition grows, having a sustainable advantage becomes a major issue in terms of staying in business. To de-

velop such advantages, online grocers, like any other firm, need to analyze their internal structure

and identify their core competencies and capa bilities. One plan involves developing unique selling propositions and differentiating oneself from one’s competitors. Differentiation in the online grocery business lies mainly in superior service, the value proposition, and responsiveness to customers. Other means of differentiati include enhancing the quality of the products delivered, creating superior efficiency, and COT ing up with innovative ideas to meet consume unique needs.

The main competitive advantages of a diff entiation strategy include building customer lo alty and raising entry barriers. However, becaL of the nature of the online grocery business, s1 advantages may not last long. Competitors re- spond quickly to imitate differentiators. While tailers should always focus on cost leadership a means of protection against competition, thi: should not be the primary competitive strategy used to gain advantages. Groceries do not per much markup, so competition based on price would hurt the industry as a whole. Webvan, 1 example, expects to make profit margins of 12 percent per order, versus the industry average 8 percent. If it cut prices further, the chances c its ever being in the black would be bleak.

THE KEY SUCCESS FACTORS

W hat are some of the various succf factors a potential “e-grocer” sho pursue? The ones we will discus:

here include establishing first-mover advantag gaining access to capital, forming strategic alli antes, building the right Web site, providing s perior service, offering value-added informatic developing the warehousing and logistics stru ture, and differentiating through niching.

First-Mover Advantage

Among the many benefits to being the first mover, one of the most important is brand nal recognition. With the media attention that usu results, a first mover can gain invaluable free publicity and advertising, helping to establish well-known brand as well as gain important 11 time over competitors. Market penetration she be the main focus for online grocers during tl early stages, and being the first to market cer- tainly helps. A first mover is also farther along experience curve, enabling it to realize econo mies of scale and develop technical know-ho1 before its competitors.

As the first mover in the U.S. online groct industry, Peapod has been able to take advan of these benefits and remain an industry leads The media have followed its business model ; innovations very closely, thereby giving it con

Business Horizons / July-Augusl

erable free publicity. However, a first-mover advantage does not last forever. Watching Peapod’s moves closely, competitors have become fast followers.

Access to Capital

Until quite recently, Internet startups have been able to acquire capital with relative ease. Com- pared to traditional supermarkets, pure-play online grocers have obtained stronger financial support even when operating at a loss. HomeGrocer found a backer in Amazon.com; Webvan’s angel was Louis Borders. Such financial support is essential, especially when online grocers are still testing out their business models. Trying to sur- vive in a new industry, grocery e-tailers need adequate resources to sustain the growth and instability of the market. The need is particularly acute considering that most of them should expect to be in the red for the first few years of operation, while requiring cash injections to expand and reap economies of scale.

The common means of increasing capital are through IPOs and venture funding. In November 1999, Webvan was listed on Nasdaq, while Home- Grocer secured $100 million from Amazon.com and venture capitalists Kleiner Perkins Caulfield & Byers and Hummer Winblad Venture Partners. In March 2000, HomeGrocer raised another $245 million in its own IPO. Peapod, the first online grocer, had its IPO inJune 1997, but its share prices have since tumbled and it had to be res- cued by the Dutch grocery powerhouse Royal Ahold in April 2000.

strategic Alliances

E-grocers require strategic alliances to ensure their viability. In an industry that relies on several varied factors to operate, no one company can do everything by itself. This is particularly true for the pure-play e-tailers, who need to expand into new markets quickly in order to capitalize on any first-mover advantages. Meanwhile, many traditional supermarkets are partnering up with online grocers to enter the market without a great deal of risk and investment. By forming such partnerships or alliances, different types of synergies can be achieved, including economies of scale and scope and spillover effects that reduce the cost and time of market penetration and expansion. These synergies work to combine each alliance partner’s complementary resources and capabilities.

Peapod started out by forming arrangements with bricks-and-mortar supermarkets to fill the orders it received on the Web. Relying on Safe- way in the San Francisco market, Peapod had its delivery people pick up the customer orders

directly from the supermarket for delivery. Now it is moving toward centralized distribution and relying less on partners, thereby improving profits and lowering customer fees. Peapod has also developed an Affiliate Program whereby it com- pensates other Web sites for promoting its services. Since buying a majority stake in Peapod, Royal Ahold is providing the e-grocer with merchandising expertise and real estate.

HomeGrocer.com formed its alliance with Amazon.com in 1999. Amazon’s 35 percent stake in the e-tailer was meant to include shared delivery services to the alliance’s combined customer database. In June 2000, Webvan announced that it would acquire HomeGrocer via a stock swap. Both online grocers would operate their own distribution centers and truck fleets, with the expectation that the combined entity would allow them to serve a total of 13 metropolitan markets by the end of 2000, compared to Peapod’s nine markets. Recently, Webvan Group, Inc. signed strategic alliances with Kellogg. Nestle, Pillsbury, -

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and Quaker Oats. By . partnering with these major consumer product companies, Webvan hopes to gain “brand knowledge and resources in such critical areas as product assortment, merchandising, mar- . . 1 , . . ketmg, and supply-chain management.” In turn, its partners will “have the opportunity to test and develop virtual merchandising strategies, online marketing programs, and new consumer behavior models” (“Webvan Announces. . . ” 2000).

Several pure-play online grocers depend on third-party logistics providers to deliver the goods to customers. HomeGrocer relies on UPS to ensure same-day or next-day delivery. Roadnet Technologies, a division of UPS, provides specialized software that plans the daily routing and scheduling and tracks shipments. NetGrocer.com subcontracts delivery to FDX Corporation for orders received from anywhere in the continental U.S., all from a North Brunswick, N.J. warehouse. These e-tailers, who joined the fray later than Peapod and Webvan, hope such strategies will accelerate their business development.

Another form of strategic alliance is to form exclusive arrangements with suppliers. PDQuick (formerly known as Pink Dot) recently made Kraft Foods its exclusive provider of packaged meats, cheeses, frozen pizza, cereals, beverages, coffee, and other products. Alliances also ease the process of horizontal integration, allowing for opportunities to differentiate further. Products and services can extend beyond traditional grocery items to include destination retail items such


as books, videos, and CDs. HomeGrocer, for example, delivers fresh flowers and magazines; Streamline offered dry-cleaning and video rentals.

Many of these alliances are intended as a means to create competitive advantages. Name- brand trustworthiness adds to the synergy, such as Peapod’s alliance with Walgreen’s, the drug- store chain, and the McLane Group, a food distribution/logistics and technology specialist. Alli- ances are growing in importance due to intensi- fied competition and the fast-changing Internet environment. They can ease and speed up the implementation process of new ventures. And they offer greater flexibility and reduced risk. Nevertheless, e-tailers must bear in mind that the importance of mutual benefit and trust makes alliances delicate to manage.

The Right Web Site

A well-organized Web site that allows consumers to navigate easily and comfortably is one of the most critical factors for success in the online supermarket industry. With retailers rushing to gain a presence on the Net, sites that do not satisfy consumers or add customer value will face rapid extinction. Competition is just a click away, so if online companies do not make good first impres-

sions, there is little chance for redemption. Bad word of mouth, which travels fast and tends to be magnified on the Net, will contribute to failure. Luring consumers back to a Web site is far more difficult and costly than acquiring those customers in the first place.

Ease of navigation, up-to- date information, user-friendli- ness, security, useful links, and desirable interfaces all contribute to the formation of a good Web site. They lead to its overall attractiveness and greatly affect the online shopping experience. When consumers shop online, they do not want to feel

the burden of doing research. A positive experience will induce them to become repeat customers. Ease of navigation and up-to-date information are particularly important when trying to replicate the grocery shopping experience. The location of products is one of the most frequently asked questions of store personnel in a physical supermarket, so a well-designed Web site with advanced search engines helps take the place of these store personnel.

One advantage of a good Web site is that the e-tailer can absorb its customers’ product knowledge as well as their suggestions for improving

products. In essence, says Tosh (1998), customers become product developers. Companies can also use this knowledge to make their Web sites more appealing to customers. By allowing for a good feedback mechanism and an active dialogue, e- grocers can continually offer what their customers deem important. If health-conscious consumers want to know the nutritional value of the products they are buying, the firm can include nutritional details on its site.

Online grocers must develop their Web sites with their customers in mind. Shopping for groceries, whether online or off, is routine. Once shoppers become comfortable with a site, they are likely to stick with it rather than search around for the lowest prices. Generating repeat business is a key to success for any e-tailer.

Superior Service

As noted earlier, groceries are commodity-type goods, so grocers generally must rely on service for differentiation. By offering customers superior responsiveness and service, grocery e-tailers can build brand equity, generating repeat business and resulting in fast market penetration in this increasingly competitive industry. It is crucial not to lose sight of responsiveness while focusing on technology. Successful online relationships must incorporate the functional and the emotional, and establishing strong relationships with online customers is a key to long-term success.

Online grocers have a better opportunity to develop and foster closer relationships with consumers than regular stores do. Such relationships differ from interaction in a physical store. For example, remembering what customers previ- ously ordered online and asking if they would like to buy the same items again can create a bond between the e-tailer and the customers. An automatic calculator that tallies up the items in the virtual shopping cart also creates a form of personalized service.

Grocery e-tailers should remember that customer loyalty can be essential toward long-term survival. According to Hays (2000a), a Webvan customer who had not placed an order in a while reported that she received a postcard from the company asking, “What did we do wrong?” Web- van also gave her a $25 coupon to use on her next purchase.

Prompt and efficient delivery is a must. But online grocers must go beyond that. In its arrangement with Walgreen’s, Peapod delivers Wal- green prescriptions in selected markets and plans to eventually expand these deliveries to CDs, fresh-cut flowers, dry-cleaning, and photo developing. Streamline and Shoplink installed refrigerators in customers’ garages so the customers would not have to wait for delivery.

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Value-Added Information

To induce shoppers to buy groceries on the Net, a Web site must provide more information than physical store personnel can provide-information that shoppers will find valuable. Examples include offering recipes, cooking tips, nutritional data, and table-setting tips. As Tosh puts it, this “creatles] virtual neighborhoods where loyal audi- ences return again and again.”

It is also possible to establish chat rooms where customers are encouraged to provide tips and comments that can be shared with other online shoppers. Customers become enthusiastic about such value-added information and personalized services, bookmarking the Web sites and providing the online grocer with repeat business. Here again, the importance of building strong relationships with customers can be seen. Provid- ing value-added information is an important way to make the online shopping experience more personal-something that many Web sites lack.

Warehouse/Logistics Structure

Although a storefront can be virtual, backroom operations cannot. Online grocers must have an efficient warehousing and logistics system in place to handle their “one-to-many” distribution problem: delivering groceries to all their indi- vidual customers in a timely manner. This situation is compounded by a continual fluctuating demand from customers, the perishability of produce, and the need to order supplies in advance. Factors to consider when designing warehouses and logistical structures include geography, land availability, and population density.

One aspect of grocery shopping that e-tailers cannot replicate exactly is immediate delivery. However, as they experiment with and develop more efficient storage and distribution systems, they can more closely meet the demands of consumers for speedy delivery. PDQuick, a small grocery chain based in Los Angeles, realizes that good logistics is essential for coping with LA’s notorious traffic congestion. It claims to be able to deliver within 30 minutes. In an aggressive expansion strategy, Webvan has engaged Bechtel, the engineering and construction company, to build distribution and delivery centers in 26 markets within two years--a deal worth $1 billion. “Infrastructure is everything,” reports Fisher (1999). “To do online sales the right way rather than the rush-to-market way, [Webvanl needs to develop a very complex distribution system.”

Differentiation Through Niching

Differentiation efforts have resulted in a number of niche players attempting to satisfy segments of

the market with unmet needs. Examples include kosher, vegetarian, and organic foods. Kosher Grocer, Inc. caters to observant Jews who require special foods not easily found in areas without large Jewish communities. GlobalGrocer.com, a Singapore-based e-tailer, enables Singaporeans and other Asians to order regional foods and spices worldwide. NetGrocer.com has created a virtual store that caters to the needs of diabetics. The one-stop virtual shopping center will include a wide range of nonprescription medical and nonperishable food products. Whole Foods, in its e-tailing venture, enables customers to purchase natural foods that are nonperishable.

THE PoTENTL4LPITFALLs

H aving reviewed the key success factors, we now turn to the possible pitfalls of online grocery retailing. There are sev-

eral major and minor factors to consider, including the use of the senses in grocery shopping as well as delivery, financing, technology, security, Internet privacy, and seasonal influences.

Seeing, Touching, and Smelling Products

Many grocery items, such as fruits and vegetables, belong in the see/touch/smell category. Customers may want to see the ripeness of a bunch of bananas, feel the firmness of a melon, smell the aroma of a peach or a tangerine. Some online grocers pride themselves on having special pickers who choose the freshest fruits and vegetables with the utmost care. But although customers can be assured of receiving quality produce, it is difficult to change their mindset of wanting to personally choose their own fruits and vegetables. In this regard, consumers cannot experience the ambience of a traditional supermarket. For some shoppers, says Dornbusch, “looking at and smelling and touching food is a very basic part of [their] lives.” As revealed in Ernst & Young’s second annual Internet shopping study (19991, preferring to see products prior to purchasing was the second most popular reason for not buying online, after security issues.

Delivery

Another reason consumers are reluctant to shop on the Net is delivery time. In a recent BCG study reported by Burton (20001, 19 percent of online customers said their orders were delivered either much later than they expected or not at all. As more grocery e-tailers enter the marketplace, this will be an area of intense competition. Consum- ers expect speedy delivery because they do not always plan their meals ahead of time. Daily schedules are hard to predict, especially for time-


starved families or households with children. Sandoval and Wolverton (1999) note that the need for speed in delivering Internet goods is growing. A large percentage of people would like to buy online, but do not because they cannot get their order immediately. Many “spoiled” consumers have come to expect instant gratification.

Online grocers must try to overcome slow delivery to better fulfill customer expectations. NetGrocer’s arrangement with FDX allows for delivery within only two to three days, thereby enabling the sale of only nonperishables. Com- pare this with UrbanFetchcom and PDQuick’s promise to deliver within the same day. According to Sandoval and Wolverton, “Ordering online and having someone bring merchandise to your door in under an hour is the height of convenience.”

A large part of the delivery issue is determined by the strategy of the e-tailer in terms of geographic coverage. Some, such as Webvan, serve local markets. They first earmark certain metropolitan areas, normally those that have a sizable population with Internet access, then build the infrastructure-distribution center, auto- mation systems, and truck fleet. Others are more ambitious and are attempting to serve a whole country, such as Peapod and NetGrocer. Because financing is a major problem, these companies cannot do everything by themselves, so they have to form arrangements with third-party logistics providers and local partners to operate distribution centers. Even then, consumers who do not live in major urban areas still face problems. As related by Slatalla (19991, a Long Island re- porter, getting Peapod and NetGrocer to deliver her groceries was very difficult, and even then only limited to nonperishable items.

Financing

It is not a coincidence that relatively easier access to capital, mentioned earlier as a key success factor, is also a potential hindrance. Although grocery e-tailing is less costly to set up than the traditional method, considerable investment is needed to start an online grocery business. Be- sides building warehouses, it is expensive to build competitive advantages and market share. Even though several online grocers have suc- ceeded in attracting financing, the recent spate of shutdowns by many e-tailers has been attrib- uted largely to the reluctance of financial backers to continue supporting money-losing online ventures. The ability of an e-tailer to attract investors is crucial to the company’s success. For the time being, however, major online grocers such as Webvan and Peapod have managed to secure funding through IPOs and venture capitalists. It is not certain how long these pure-play e-tailers can hang on before the funds run out.

Price competition may also turn out to be a major threat in the future as the industry becomes stagnant. Due to the commodity nature of groceries, fierce price wars may result and lead to di- minishing profits for the whole industry.

Techllology

Online grocers are capable of creating extremely sophisticated Web sites involving impressive graphics. However, graphic displays sometimes require a long download time. Many consumers do not have fast enough computers or connec- tions that allow for rapid transmission of the huge graphics files. This may change in the near future, as people improve the speed and capacity of their computers. More and more homes are using DSL lines or cable modems, allowing them quicker access to the Internet.

Security remains the top reason why consumers are reluctant to buy online. In light of all the horror stories they have heard, they want to avoid being the next statistic. The fear of credit card fraud may diminish as more secure forms of pay- ment develop. A grocer should have a privacy statement on its Web site assuring customers that all information they send is encrypted. Neverthe- less, it takes a lot of convincing to assure them that all online transactions are secure. Security measures must also be implemented, and customers must be certain of this if their fears are to be alleviated.

Occasionally the situation is reversed, and the e-grocer is unwilling to accept customer orders for a variety of reasons. As Burros (1999) reports:

One company, wholefoods.com, refused to accept my order, claiming incorrectly that I was ordering from a nonsecure server. Another, easygrocer.com, tried to deliver the order but would not leave it because I was not at home to sign the credit card receipt. A third, yourgrocer. corn, wouldn’t leave the order because there were perishables and 1 wasn’t home (it would not entrust the order to my doorman).

Privacy and Seasonal Idluences

The grocery e-tailing business offers marketers the opportunity to study consumer buying habits and target their promotions effectively. Online shopping enables manufacturers to link purchases to consumers in ways that traditional stores cannot. However, the downside is that shoppers are sensitive about revealing information regarding

Business Horizons /July-August 2001

their buying behavior and lifestyles. Many are not willing to trade convenience for privacy.

Finally, purchasing patterns during the winter months may differ drastically from the summer months. Sales may increase sharply during the winter, when people are reluctant to leave their homes. Online grocers need to consider these seasonal changes in their assortment and inventory plans.

THREE MAJOR PLAYERS

T

he last few years have seen a surge of online grocers, many of which have developed competitive advantages through

differentiation based on innovative responsiveness to customers. Responses have ranged from building such innovative features on Web sites as shopping lists and electronic coupons to the in- stallation of mini-refrigerators. By examining the attempts of three major online grocers to capture market share, we can understand some of the unique aspects of these e-tailing operations.

Peapod

Founded in 1989 by the Parkinson brothers, Peapod started as a phone and fax order service and has now expanded to become the leader in U.S. online grocery shopping. Unlike other e- grocers’ strategies, says Janoff (19991, Peapod promotes “the idea that shopping at its Web site can replace any and all visits to the local supermarket.” The e-tailer began test marketing in 1990 with about 400 households in its hometown of Evanston, Illinois. It is now serving 130,000 customers in nine major U.S. metropolitan areas and plans to expand even further.

The average Peapod customer spends about $100 every two weeks. Currently, the membership base consists of 68 percent women (75 percent among the heavy users). Members must pay a monthly fee in addition to a shopping and delivery fee for each order, which averages out to roughly 10 percent of the total bill.

When it first started its online operations, Peapod relied on supermarket partners, such as Safeway, in local markets to fulfill orders. Later, it moved toward its own distribution system. Ac- cording to cofounder Andrew Parkinson, “Al- though we have enjoyed a long relationship with Safeway, the business has been modest for several years due to a lack of marketing attention” (Reuters 1999). Peapod offers an array of both perishable and nonperishable grocery items, with local same-day delivery service. Shoppers can navigate easily and use unique features such as Shopping by Personal List, Shopping by Aisle, Find Item, and Shop from Last Order. The software has several clever features, such as sorting

products by price or nutritional value. The move from having employees fill orders by picking items from local groceries to using centralized warehouses has enabled Peapod to lower prices and speed up order filling. Warehouse workers carry handheld devices that receive data from the back-end database.

In 1998, Peapod realized sales of $69 million, which rose to $73 million the following year. However, in 1999 it incurred losses amounting to $29 million. More recently, the company’s future began to look more uncertain-first, when it lost its CEO, Bill Malloy, who quit due to health reasons, and second, when key investors refused to inject another $120 million, as they had promised

Webvan

Webvan, which was founded by Louis Borders (a cofounder of Borders Books), began operations in the San Francisco bay area in 1999. It has been able to expand quickly by forming strategic business alliances and, as mentioned earlier, has recently merged operations with HomeGrocer.com.

As a quick follower, Webvan “offers conve- nient delivery of consumer products through an innovative propriety business design that inte- grates its Web store, distribution center, and delivery system” (“Webvan An- nounces. . ” 2000). Howell (1999) reports that it uses a “highly automated central distribution center and spoke- and-hub delivery system featuring a fleet of drivers and local delivery sta- tions.” The hub-and- spoke system allows the trucks to reach the local centers at night, thereby avoiding traffic. It also extends the reach of the centers; for example, it can serve the Sacramento market from its Oakland distribution center.

Webvan offers about 18,000 grocery and specialty items, including perishables and already prepared meals. It provides same-day delivery within a 30-minute window, and delivery is free with purchases of more than $75. Orders below $75 are charged a delivery fee of $4.95. The average order is about $115. Although the firm currently sells mainly grocery items, it expects to move into other product categories eventually. According to then-CEO George Shaheen, “[Web- van1 is not an Internet grocery play. This is a last- mile play. Webvan has always been about delivery. That’s where it has strength. We view our-

Online Grocery Rerailing: Success Factors and Potential Pitfalls 81

selves as an Internet retail company, delivering the last mile” (Sandoval 2000~).

Since its inception, Webvan has been unprof- itable. In 2000, its net loss amounted to $413.2 million. However, the company expects to be in the black in its 10 markets by the end of 2001.

Shoplink

Incorporated in 1996, Shoplink.com began operations in 1997, offering a variety of services on top of grocery delivery to provide the utmost convenience for its customers. It eventually served more than 150 suburban communities in Massachusetts, Connecticut, and New York, and expected to expand its operations to more than 235 communities in the Northeast by the end of 2000. Shop- link focused on fresh food quality and selection at good value, offering its customers a variety of nonperishable and perishable items as well as other services, including shoe repair, film developing, video rental, and dry-cleaning. It even offered bottle and can redemption, crediting the deposit to the customer’s account.

In the rush toward market penetration, online grocers are merging with similar opera- tors-a trend that shows the likelihood of con- solidation and continued growth. It is difficult to conceive of pure-plays such as Peapod continu- ing to thrive by themselves as losses continue to build. It could also mean that bricks-and-clicks operations may be able to hold out more suc- cessfully than the pure-plays.

Could grocery e-tailing ever replace traditional shopping to any extent? It is debatable. Characteristics such as impulse purchases, brows- ing, instant gratification, and product freshness are hard to replicate online. Our view is that both channels will coexist. For consumers in general, this is good news. They will have more than one way to buy their groceries. 0

Besides offering a wide array of services, Shoplink also differed in that customers did not have to be home during delivery. For an addi- tional fee, Shoplink would set up a refrigerator/ freezer and rack in the customer’s garage and even unpack the groceries. A company called Smart Box was created to manufacture and market these secure refrigerators. In essence, Shop- link offered its customers a completely new life- style. In return, it had a very high frequency of purchase and customer retention rate. On top of its superior service, Shoplink also built a unique technological infrastructure that put it ahead of competitors. Its state-of-the art Product Consolida- tion Center (PCC) consisted of 65,000 square feet of warehouse space encompassing several different temperature and humidity zones, configured and racked for the specific purpose of high- speed piece picking-a revolutionary process compared to conventional warehouses, which are built to handle full cases on pallets.

References and Sekcted Bibliography

F. Andrews, “Regarding Customers as Business Collabo- rators,” New York Times, February 9, 2000, p. ClO.

M. Burros, “Untangling the Grocery Web,” New York Times, September 22, 1999, p. Fl.

J. Burton, “Creating Ways to Cut the Delivery Time from Mouse to House,” New York Times, June 7, 2000, p. H38.

T. Clark, “Peapod Delivers More than Groceries,” news.cnet.com/category/O-1007-200-342456.htmL May 13, 1999.

“Define and Sell,” Economist, Special E-Commerce section, February 26, 2000, pp. 6.

T. Dorgan, “Just the FAQs, Ma’am,” Progressive Grocer, September 1998, p. 38.

Unfortunately, like the other two companies, Shoplink could not make any profits, and on November 14, 2000, it posted a message on its Web site stating that it had closed up shop.

J. Dornbusch, “Shoppers Get Online for Groceries-At Home,” Boston Herald, April 9, 1997, p. 45.

“E-Commerce May Be Hazardous to Your Wealth,” affininet.com/news.html, February 14, 2000.

T he fragmented online grocery industry is still growing at an incredible speed. Grocery shopping on the Web appeals

not only to time-pressed consumers but also to the elderly, the infirm, and those who simply dislike grocery shopping. Its attractiveness lies mainly in the newness of the industry and the low barriers to entry.

However, low bargaining power, burgeoning competition, and potentially high exit barriers are

critical factors for a potential e-grocer to consider. Whether the Internet supermarket is just a fad or is here to stay has yet to be determined. The future of pure-play online grocers is highly uncertain, particularly in light of changing technology and consumer preferences.

“eMarketer Interview: Randy Pickard,” www.emarketer. com/enews/enews_picard.html, July 27, 1998.

Ernst Cy: Young. “Second Annual Internet Shopping Study,” www.ey.com/global/gcr.nsf/US/1999_Internet_ Shopping_-_Retail_&onsumer_Products_--Ernst_&_ Young_LLP, April 10, 1999.

L.M. Fisher, “On-Line Grocer Is Setting Up Delivery System for $1 Billion,” New York Times, July 10, 1999, p. Cl.

H2

A. Goldberg, “Online Grocers Take Shopping Back to the Future,” Deutsche Presse-&entur, International News Section (San Francisco), June 21, 1999, np.

C.L. Hays, “New Economy,” Mew York Times, July 3, 2000(a), p. C4.

CL. Hays, “Peapod to Lose Chief and a $120 Million Investment,” New York Times, March 17, 2000(b), p. C2.

D. Howell, “National E-tailers Lead the Way,” Discount Store News, December 13, 1999, pp. 25, 61.

B. Janoff, “Point, Click, Shop,” Progressive Grocer, June 1999, pp. 31-34.

H.T. Keh and S.Y. Park, “To Market, To Market: The Changing Face of Grocery Retailing,” Long Range Plan- ning, December 1997, pp. 836-846.

S. Machlis, “Filling Up Grocery Carts Online,” Com- puterworld, July 27, 1998, p. 4.

K. Maney, “Webvan Lugs a Big Dream,” USA Today, June 27, 2000, p. Bl.

C.E. Mayer, “Supermarkets Feel Webs Bite,” Washing- ton Post, March 10, 2000, p. El.

M.J. McGovern, “One-Stop Shopping,” Transportation &Distribution, May 1998, pp. 39-42.

K. McNaughton, “Whole Foods Bites into Web Com- merce,” cnet.com/category/O-1007-200-339017.htm1, February 22, 1999.

“Netgrocercom Announces Grand Opening of Diabetic Solution Store in Recognition of National Diabetes Month,” PR Newswire, November 1, 1999.

S. Olsen, “Safeway Makes Online Move with $30 million Deal,” cnet.com/news/O-1007-200-1708446.htm1, April 17, 2000.

C. Reidy, “$lOOm Buys Control of HomeRuns,” Boston Globe, January 14, 2000, p. Cl.

Reuters, “Peapod Cuts Out the Middleman,” www.news. com/News/Item/0,4,32922,00.html, February 25, 1999.

M. Richtel, “For New Online Grocer, High-Tech Ware- house Is Key,” New York Times, June 3, 1999, np.

G. Sandoval, “Online Grocers Don’t Deliver the Goods,” cnet.com/category/O-1007-200-1472747.htm1, Novem- ber 26, 1999.

G. Sandoval, “UPS Helps Online Grocers Cart Goods,” cnet.com/category/O-1007-2OC-1512614.htm1, January 4, 2000(a).

G. Sandoval, “Pink Dot Takes Grocery Web Site Na- tional,” cnet.com/category/O-1007-200-156977l.html, March 10, 2000(b).

G. Sandoval, “Webvan Bags HomeGrocer for $1.2 Billion,” cnet.com/category/O-1007-200-215218l.htmI, June 26, 2000(c).

G. Sandoval, “Webvan Defends Business Model Despite Woes,” cnet.com/news/O-1007-202-3662541.htm1, No- vember 13, 2000(d).

G. Sandoval and T. Wolverton. “Net Retailers Use Same- Day Dehvery to Compete,” cnet.com/category/O-1007- 200-1420426.htm1, October 27, 1999.

E.I. Schwartz, “Technology (An Online Grocer Bets Against Bananas and Meat),” New York Times, May 4, 1998, p. D4.

M. Slatalla, “Buying Groceries Online? Forget About Lamb Shanks,” New York Times, November 4, 1999, p. G4.

Jason Straziuso, “French Warm to Online Grocery Stores,” Associated Press Online, May 29, 2000.

“Tearaway Tesco,” Economist, February 5, 2000, p. 62.

M. Tosh, “Packaging Deal,” Progressive Groceq Sep- tember 1998, pp. 119+.

“Webvan Announces Strategic Alliances With Four Major Food and Consumer Products Companies,” Busi- ness Wire, January 25, 2000.

A. Wee, “Buy Groceries Online Soon,” Business Times (Singapore), December 27, 1999, p. 17.

T. Wolverton, “HomeGrocer.com Raises $245 Million in IPO,” cnet.com/category/O-1007-200-1569073.htmI, March 9, 2000.

Hean Tat Keh is an assistant professor of marketing at the National University of Singapore. Elclin Shieh is a sales executive at ABX Logistics in Taipei, Taiwan.


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Online grocery retailing: success factors and potential pitfalls