Strategic Management. Final Term paper. Webvan: On-Line Grocer or Last Mile Solution?

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1 Strategic Management Final Term paper Webvan: On-Line Grocer or Last Mile Solution? Submitted by: Bill Baillie Sloan Fellows Class of 2001 Submitted: December 12, William S. Baillie. All rights reserved.

2 Webvan: On-Line Grocer or Last Mile Solution? Company Overview Webvan, a California based on-line grocer, was founded in 1996 by Louis Borders (one of the two Borders Bookstore brothers) to sell groceries over the World Wide Web. Louis was able to attract George Shaheen, a managing partner and CEO of Anderson Consulting, to join as CEO. Webvan s unique strategy, at least as advertised, was to build massive, state of the art distribution centers (DC s) from which the home deliveries would be centered. Their plans called for 26 such DC s throughout the US by In order to achieve this aggressive business goal, they partnered with a major construction firm, Bechtel Corporation, and raised capital through private equity investors such as Sequoia Capital, Goldman-Sachs and Softbank. In November 1999, Webvan had a successful IPO that raised $8 Billion. Currently, Webvan is only offering service in Atlanta, Chicago, Sacramento and the San Francisco Bay area although they recently acquired a competitor, Homegrocer.com that will add 6 major cities located primarily on the west coast and Texas. The general business model is to provide on-line purchase of groceries and many other goods, then deliver at a prescheduled time within a 30 minute window (a recent press release on Dec. 4 has just changed this to 60 minutes!). Industry Analysis The On-Line Grocery industry is very new. The earliest player, Peapod, started business in 1990 with the majority of the players coming along after Webvan has a dozen significant pure play competitors in the US and, of course, the bricks and mortar (B&M) grocery and convenience store chains. In the traditional retail grocery environment, it is important to note that most B&M chains are regional in nature with few, if any present on a national level. Some of the B&M chains have ventured into the on-line space to complement their physical presence. (See Appendix A for list of competitors) The market demand is extremely stable and growth opportunities exist in the on-line market. The food at home market was estimated to be $550 billion at the end of 1998 and this would be magnified to close to $1 trillion by adding prepared meals, cleaning supplies, personal care products and retail drug sales to the product offerings. Certainly, the market opportunity looks promising; however, the industry is extremely competitive with products and services that could be described as commodities or staples. In the traditional grocery industry margins are very tight throughout the value chain with the representative supermarket chain netting 2% before tax (Oster, page 24 indicates 1996 data of 6% return on sales for Food and Drug stores this may be higher due to the Drug sales component). Needless to say, margins are negative for Webvan and in the on-line space and can be expected to remain there for some time. Webvan 2 12/17/01

3 Now that we have a quick overview of the industry, let s use our favorite (and I do mean that, I think it s great!) analytical tool, Porter s Five Forces Model, to gain a more detailed understanding of the threats and opportunities that Webvan may be facing. Rivalry Among Existing Firms Medium to High As described above, the competition abounds, price competition is strong, profits are very low and there is little room to differentiate to gain premium prices. All competitors have access to the same suppliers and products. These are all strong indicators of a mature, highly competitive industry. I allowed the medium end of the rating range only because of the somewhat fragmented regional nature of the industry. This could allow for some reduced levels of major competition in select regions. Major urban centers, however, will have high rivalry from corner stores to supermarkets to warehouse superstores. The numerous convenience store chains also provide direct competition, especially in the convenience space. Potential Entrants Medium to High New entrants will come from several areas. More traditional B&M grocery chains will start offering online services as extensions to their existing channels. For years, many grocery stores have provided some form of home delivery, especially in major city cores. There could also be new, pure play on-line competitors although this will probably slow with the recent pummeling that dot-coms have been taking in the marketplace and the souring of venture capital for technology start-ups. I see a major threat of entry on the horizon from superstores such as Wal-Mart and even from an Internet player such as Amazon (although Amazon has equity in Webvan now after Homegrocer.com was acquired. Amazon owned 35% of Homegrocer.com). Threat of entry will be significantly harder to do at a national level; a regional entrant is more likely. Threat of Substitutes Medium There is not much possibility of the products being replaced. This would have to come in the form of futuristic home meal replacement products that are totally non-perishable and could be mailed to the home. Quality is the limiting factor there. Substitute services are much more likely. This would be primarily in the form of a new competitor with a better delivery model or pricing structure. One could certainly imagine the day that UPS, FedEx or the USPS could be delivering groceries and consumer products to the home. Creating customer stickiness to Webvan s site and services will be important to minimize switching. Webvan 3 12/17/01

4 Supplier Power Low to Medium Webvan purchases wholesale from major branded food companies like Kraft, General Mills, Nestle and Coke. They also need to purchase perishables from local distributors. Their supply chain is, in effect, the same as any grocery chain. The main bargaining power comes from volume, store location and grocery store chain brand recognition. These three points determine how hard the suppliers want to play for Webvan s business. In traditional stores, the food companies fight for preferred shelfspace and location in the store. They will actually pay the store for the best locations; this is called trade costs in the industry. Based on discussions I have recently had with Kraftfoods, Webvan is the only on-line grocer that has approached the on-line business from a trade standpoint. They are trying to negotiate trade types of revenues from the food companies, betting on the Webvan brand name and service quality as reasons why a food company would want to look at trade costs. In general, because Webvan is new and is still building volume and brand recognition, I feel that supplier power is closer to medium. This may weaken if Webvan is successful. Buyer Power Low to Medium I would normally consider the buyer s power to be low but we need to look at the effect of the Internet to see if there is a subtle shift in this balance. Individually, buyers cannot exert any pressure on Webvan or grocery prices. Collectively they could be more powerful. In the traditional industry, it is difficult for consumers to aggregate to be able to exert any pressure on the price of a can of soup. However, the Internet has offered the consumer more power. They can compare price and service features, virtually, in real-time and the general consumer behavior on the Internet is one of searching for the lowest price. The very channel that Webvan uses is causing pricing pressures and higher buyer power. Another issue is that consumers do not factor in the cost of gas and their personal time when comparing prices for on-line groceries, again, leading to downward pricing. (Interestingly, one of Webvan s value propositions, to be discussed later, is timesavings for the consumer.) Evidence of the effect of the Internet can be seen at convenience stores why can 7/11 openly charge higher prices for the convenience they offer yet on-line grocers cannot up-sell their convenience? As with anything to do with the Internet, consumers are expecting basic service features to be free. This behavior will ultimately drive the marginal value of the physical delivery to zero; eliminating any pricing strategies based on the delivery. It is already happening and my sources in the industry indicate that free delivery is becoming a key determinant for the consumer. Industry Attractiveness Medium to High The stable demand market, high volume sales, fragmented industry and consumer trends toward the Internet all make this, still, an attractive industry to enter. Consumers need food and ever more Webvan 4 12/17/01

5 increasingly, consumers are looking for convenience and reduced demands on their time. These are characteristics that bode well for the on-line grocery industry. Webvan s Entry and Current Strategy Webvan s strategy has been primarily one of market entry on a regional basis first. It is a streamlined organization with all operations focused directly on the final service delivery, therefore, issues such as centralized versus decentralized structure are not as complicated just yet. Because the company is new, it will be interesting to try to identify a culture, core values and core capabilities. All of the strategy, as I see it, comes from the corporate level. I can imagine that the senior management is heavily involved in all strategy decisions for the 3 DC s that currently exist. As time goes on, this trend may change, allowing the regional DC s to develop and implement more of their own strategy. Currently, given their need for growth and brand recognition, this central strategic control is probably best in order to ensure the brand image is consistent. Business Model Louis Border s original entrepreneurial insight was to leverage technology to transform and simplify the way people shop (1999 Annual Report). His vision was centered on the need for a more efficient, convenient and cost effective means to get products to consumers. He decided that groceries would be an appropriate entry strategy with future growth into delivery of other household goods. John de Figueiredo s article, Finding Sustainable Profitability in Electronic Commerce, concurs in that The best opportunities for selling one of a kind products online are products that can draw repeat business by selling inexpensive products. (See chart, page 49) How has Webvan chosen to differentiate themselves from competitors? What is their strategic intent? Webvan has positioned their value proposition to the consumer as: Convenience and time savings for the consumer Personalized customer service Scheduled delivery within a 30 minute window Delivery of high quality dry and perishable goods High level of product selection Competitive prices How are these value propositions any different from another competitor? Webvan feels they are positioned to provide the consumer with a premium shopping experience by offering a complete, single source package from product selection through fulfillment, delivery and customer service. Webvan feels Webvan 5 12/17/01

6 that they can differentiate themselves based on their back-end technology. Their strategy is to build hightech regional DC s that warehouse their inventory and facilitate highly efficient order fulfillment and staging for delivery. The model is a hub and spoke system where the DC is the central hub and local stations form the spokes. From there, the extensive army of vans delivers to the consumer household. Each of the 300, ,000 square foot DC s is estimated to cost $25 - $35million. With plans for 26 DC s, the capital costs could exceed $1 billion. Questionable, is the size and capacity of the DC s compared to traditional industry warehouses. Webvan publicizes that each DC can support inventory for the equivalent of 20 stores. In the traditional industry, this DC would be more in the order of 1,000,000 square feet. Will Webvan s state of the art technology really support the product flow that their business plan requires? As you can see, Webvan has a considerably different strategy than any other online player, rather ambitious for an on-line grocery delivery company! Revenue Model Webvan does not charge a membership fee. Delivery is FREE for orders of $75 or more and only $4.95 for orders under $75. Webvan's prices are competitive with brick-and-mortar retailers. They pass along the savings achieved through efficient procedures and lower overhead expenses gained through the DC s. Because the savings are already passed on, they do not issue buying cards or accept coupons. Webvan s entire business plan and competitive advantage hinges upon the scale of the DC s. They intend to leverage volume to drive cost efficiency in purchasing. They intend to use innovative handling and distribution technology to gain operating efficiencies beyond those of the traditional industry (at full capacity Webvan believes their fulfillment system will generate 12% operating margin versus 4% in the grocery industry). Can Webvan re-invent the age old, tried and tested distribution system to their advantage? Management Team Webvan has assembled an impressive list of executive management. Louis Borders has on-line retail experience through his bookstore chain. In September 2000 he stepped aside to allow George Shaheen to take over as CEO and Chairman. Apparently Borders will remain as a director. Shaheen comes from the consulting industry and was CEO of Anderson Consulting. He is also a director of Siebel, a software company. The remainder of the executives come from an impressive list of companies such as GE, Oracle, FedEx, P&G and Carlson Companies. Their SVP-Operations has extensive grocery chain experience. Webvan 6 12/17/01

7 It is interesting to note that at least half of the current team came from the acquisition of Homegrocer.com. This may be a sign that Webvan s previous team was not as strong and that this new team may be better able to drive performance and meet the challenges Webvan will face. Change in Strategy Whether Webvan s original vision was to deliver the Last Mile of e-commerce is unknown, but they have certainly shifted their strategy from on-line groceries. This shift may have been pre-conceived, and many industry analysts feel that Webvan s ambitious strategy for the DC s is a clear indicator that they were not going to be an on-line grocer for long. The name that was selected in 1997 also gives credence to the notion that Webvan wanted to be in the distribution space. This Last Mile delivery space presents a complete new set of strategic challenges and competition. I attempted to include aspects of this new space in my analysis above. This change in strategy is similar to that seen in our case studies. The need to be flexible and adaptive to changing environments was demonstrated by Intel, Netscape & Microsoft. In September 2000 Webvan acquired Homegrocer.com, a former competitor. The acquisition was an equity swap and this gave Amazon.com (who owned a portion of Homegrocer.com) an equity stake in Webvan. This acquisition appears to be strategically complementary both from a growth and market acquisition standpoint and also from a strategic alliance standpoint. Amazon.com will certainly bring many complementary assets to the table. The issue is whether Webvan paid too much for the acquisition. Their balance sheet now carries $900 million in purchased goodwill that will be written off over the next 5 years. Was an on-line grocer worth $900 million above its book value? (See Appendix B for Webvan s current stock price) Webvan has also been very active in developing alliances and partnerships. These range from suppliers to marketing partners. I consider this an extremely important strategy for Webvan to continue. They need to build the brand name and grow their market share and presence in order to survive. They have pursued a values based marketing campaign based around three philanthropic initiatives supporting schools, fighting hunger and helping children in need. I m not sure if these would be considered core values as Jim Collins would see them or in the same values league as J&J s credo but at least Webvan is working on marketing their brand through the community involvement channel. Future Challenges Threats and Opportunities Webvan faces many challenges that can be quickly summarized as: Webvan 7 12/17/01

8 High fixed costs and capital investment required for DC s High, negative income from operations (-$300 million in last 12 months) $200 million per year amortization of purchased goodwill from Homegrocer.com acquisition Greater competition on Last Mile space versus just groceries Continue high quality service to ensure customer satisfaction, retention and repeat order growth Will consumers really move this much economic activity away from B&M? Competition from Albertsons and others causing continued low margins and price pressures Continued fulfillment and delivery improvement pressures (real time delivery, increased selection) Lack of national presence Cultivating a consistent brand image given the shift from an on-line grocery play to the Last Mile delivery solution Ultimately, will they have enough cash or ability to raise cash in the future to support their burn rate? Execution! Can they deliver on their business plan? They have only opened 3 DC s compared to the 26 they estimated for 2001 and they recently delayed moving into the Northeast market after having publicly announced the move. Return shareholder and market confidence Strategic Recommendations It is hard to determine what Webvan s core competency and organizational capabilities are but they could certainly be: raising money, spending it and managing the buzz surrounding their company. I question whether their business model will work and I think we see signs that Webvan may be backing off of it s aggressive construction and market expansion plans. The market certainly feels that Webvan s potential is low, the stock is trading below $1, down from the IPO high of $26 just a year ago. I liken their case to that of StarMedia will they have enough cash to survive until the market is developed? Conversely, I am a firm believer that the money in the e-commerce value chain resides in the exact space that Webvan is playing in the logistics of the Last Mile delivery. I ve always said that Internet companies are truly wonderful and may change the way people shop (and interact socially) but the bottom line is that somebody still has to make the stuff and deliver the stuff that people buy over the web! I am optimistic that some company is going to solve this weak link in the value chain and exploit the rent opportunities that lay there. The question is is Webvan that company? In order for Webvan to have a chance to survive, I recommend the following tactics and strategies: Webvan 8 12/17/01

9 Scale back expansion plans and optimize what is already in place. This will reduce cash expenditures. Finish the merger of Homegrocer.com and leverage the new markets and consumer base. Continue brand marketing activities and buzz generation. Webvan seem to be able to issue press releases at least a few times per month. Don t get too broad of a product offering. This will dilute the economies of scale, purchasing department resources and customer satisfaction if they do not receive the same consistency of quality across all products. Focus on customer satisfaction, retention and repeat orders. The network effects of these satisfied customers will be worth more than advertising. The switching costs for the customer will also go up making them stickier. Continue improving the technology platform to enhance the user friendliness of the website, accuracy and efficiency of the fulfillment systems. Sell the consumer data that is available through the on-line activities. Webvan collects massive amounts of data that the branded food companies are desperate to have. In my interviews with Kraft it was clear that traditional grocery stores do not share their consumer data. I was also told that Webvan currently does not provide any data to the food companies, probably because of a lack of resources or having not identified the potential use of the data as a revenue stream. Continue to show improving operating numbers. Revenues and gross margin are growing each quarter and the customer base and the repeat customer continues a positive trend. Develop value-added features on the website that will hook customers and make it more difficult to switch. Webvan could also create features that would make it easy to transfer customer preference data from a competitor site to make switching from a competitor easier. At the end of the day I believe that a hybrid model of Internet and Bricks & Mortar companies will be the winning business model that leverages the technology of the Internet and provides the comfort and feel of the traditional stores. I see the Internet as simply another channel and if leveraged effectively it will complement the traditional channels and provide a higher level of convenience, choice, flexibility and satisfaction for the consumer s shopping experience. (See Appendix C for a model that I developed for a paper that I co-authored for Managing Services) As can be seen by Webvan s DC strategy, they must believe that a combination of on-line presence and physical assets is a winning business model as well. Is their model difficult to imitate? At the physical level, yes, for an on-line play but for an existing B&M grocery chain, they already have the DC assets. It would not take much for the Last Mile portion to be added through a strategic alliance with one of the courier companies or the USPS. Keep driving! But do so at a more efficient burn rate! Webvan 9 12/17/01

10 Appendices Appendix A Competitive Ratings from Top Internet Grocery Stores for Fall 2000 ranked by Overall Score. Firm Score 1. Webvan Albertsons ShopLink.com (Ceased Operations) Peapod HomeGrocer.com GroceryWorks NetGrocer HomeRuns.com Streamline (Ceased Operations) Groceronline 4.77 Top Internet Grocery Stores for Fall 2000 ranked by National Shipping Services. Firm Score 1. NetGrocer Peapod Groceronline 4.57 Appendix B Webvan Stock Price Trends (Dec. 8, 2000) Webvan 10 12/17/01

11 Appendix C - from Can Web Only Services Firms Survive? ( Paper by Asnan, Baillie, Bastos, Bonder, Halperin, Johansen, Kanbayashi and Lee; July 2000) Web / Bricks & Mortar Continuum and Trends Bricks & Mortar Hybrid Virtual Tradition & Stability Accessibility Established Brand Build Brand Shopping experience Human Touch Ultimate Customer Service Convenience Selection & Links Physical Locations Leverage Data & Personalize Trend New Market Segment Leverage Reputation & Experience Take Internet Seriously Logistics Warehousing Customer Service Trend Guarantees & Returns Build Reputation & Brand Seamless Networks Appendix D - Research Resources Interviews with e-commerce employees at Kraftfoods, Inc., November 2000 John M. de Figueiredo, Finding Sustainable Profitability in Electronic Commerce, Sloan Management Review Summer 2000 Webvan 1999 Annual Report HBS Case, Webvan: Groceries on the Internet Industry Transformation: Webvan class notes from Introduction to e-commerce Websites Webvan 11 12/17/01