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Online Grocery: How the Internet Is Changing the Grocery Industry

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Online Grocery: How the Internet Is Changing the Grocery Industry Graduate School of Business Administration UVA-DRAFT University of Virginia ONLINE GROCERY: HOW THE INTERNET IS CHANGING THE GROCERY INDUSTRY Online grocers ‘must create storefronts as easy to model appealing from an economic standpoint. They use as Amazon’s, build delivery infrastructure as argue that because they don’t need to pay for sound as UPS’ and pick and pack pickles and checkout clerks, display cases, or parking lots, online pineapples better than anyone ever has.’1 grocers can drop prices below those of retail stores and remain profitable.5 Key factors determining --Evie Black Dykema of Forrester Research success for the online grocery model include scalability, membership size, order frequency, and A survey by the University of Michigan order value. ranked 22 favorite household tasks, and found that grocery shopping came in next-to-last, just ahead of 2 Industry Projections and Outlook cleaning. According to the Food Marketing Institute (FMI), the average American household (HH) made Forrester Research segments the industry 2.3 trips to the grocery store a week and spent $87 3 into Full-service and Specialty online grocers (see per week on groceries. Andersen Consulting Figure 1). They predict that the full-service segment estimated that the average grocery trip took 47 will struggle to achieve the necessary economies of minutes, not including time to drive, park and unload 4 scale and to overcome hard-to-change consumer groceries. buying behaviors. Economic factors of the online grocery Full-service online grocers are located in model urban centers where critical volumes can be realized. Streamline.com estimates that the top twenty markets Proponents of the online grocery model point to numerous factors that they say makes the Figure 1: Projected electronic grocery spending of approximately $500 billion total industry (Source: Forrester Research) 1 David Henry, “Online grocers must change buyer habits, keep costs down,” USA Today, March 30, $12,000 2000, p. 3B. $10,000 2 Bill Richards, “Technology (a special report): Let $8,000 the buying begin. How big a bite?” The Wall Street Full-Service $6,000 Journal, June 17, 1996, p. R10. Specialty 3 Sharon Linstedt, “How food shopping is changing $4,000 Americans visiting markets more often to prepare (billions) Dollars $2,000 ‘quickie’ meals,” Buffalo News, August 4, 1998, p. $- D1. 1998 1999 2000 2001 2002 2003 4 Victor J. Orler and David H. Friedman, “The consumers behind consumer-direct,” Progressive Grocer, Feb. 1, 1998, p.39. This case was prepared by Research Assistants Richard R. Johnson and Lauren Killgallon, and Kimberly Lockhart (Darden ’00), under the supervision of Paul Farris, Landmark Communications Professor of Business Administration. This case was written as a basis for discussion rather than to illustrate effective or ineffective handling of an administrative situation. Copyright 2000 by the University of Virginia Darden School Foundation, Charlottesville, VA. All rights reserved. To order copies, send an e-mail to [email protected]. No part of this publication may be reproduced, stored in a retrieval system, used in a spreadsheet or transmitted in any form or by any means-electronic, mechanical, photocopying, recording or otherwise without the permission of the Darden School Foundation. -2- UVA-DRAFT provide access to 40 percent of the United States Hickory Farms have sold directly to consumers. population. The number of families that meet the Well-established fulfillment practices are already in criteria of an urban HH with annual income over place. $35,000 limits their target audience. In 1998, only eleven million HHs met this criterion. By 2003, however, this number is expected to increase to Competing Full-service Players and nineteen million HHs. Strategies According to Forrester Research, specialty There are several competing strategies and online grocery sales will surpass that of full-service business models in the full-service online grocery online groceries in 2000 because their customer base sector. Exhibit 1 provides a categorical comparison is more dependent upon the number of people with between the leading full-service online grocers. Internet access, rather than a specific customer demographic. This segment is not seen as a replacement service for weekly grocery shopping. Instead, it merely supplements gift and specialty shopping needs. In most cases, the products offered in this segment cannot easily be found elsewhere. Peapod—the Company Table 1 provides insight into how these two market “Smart shopping for busy people.” segments differ. Founded in 1989 in Skokie, Illinois, Peapod is the oldest online grocer. Peapod went public in Table 1: A Comparison of the Full-Service and June 1997 at $16 per share. As of December 1999, Specialty Online Segments Peapod employed 1020 people. By May of 2000, Peapod Peapod operated in eight metro markets (see Table Example Godiva Streamline 2). Companies Hickory Farms Webvan Service Gifts Table 2: Peapod’s Markets, Spring 2000 Providers Hard-to-find Product All, including Market Operations Format items Selection perishables Bulk Chicago CDC (70,000 sq.ft) replenishment San Francisco CDC (50,000 sq.ft) 80% female, 35% female, & San Jose 20% male 65% male Columbus 2 Kroger stores Demographics Average age: Average age: 40 35 Boston 4 Stop-n-Shop and a small CDC 36% with kids 65% with kids (20K sq.ft.) Buyers Urban areas: > Nationwide / Location Houston 5 Randall’s/Tom Thumb stores 1 million worldwide Austin 2 Randall’s/Tom Thumb stores Convenience Primary Dallas 5 Randall’s/Tom Thumb stores Convenience Impulse / Motivation Seasonal buy Long Island Small CDC (20K sq.ft.) $50 - $60 Cost per order $105 average average Items per Peapod—Operations +/- 60 1-2 Purchase order Peapod’s original model of distribution Behaviors # purchases 25-30 average 2-3 sourced products from local supermarkets with an per year army of personal shoppers. Peapod received a 6 Membership / $10 - $30 per $5 - $10 per percent discount from supermarket partners, yet it Delivery fee month order still cost the company about $40 to fill a $100 order.6 These specialty grocers also typically face In 1998, the firm shifted to a strategy of centralized less channel conflict. Historically, companies like distribution centers (CDCs), the first of which was 6 Catherine Trevison, “Grocers scan online 5 Don Tapscott, “Online grocer gives shoppers strategies,” Portland Oregonian, July 27, 1999, p. choices,” Financial Post, October 2, 1999, p. D6. D1. -3- UVA-DRAFT opened in December of 1998. Peapod planned to use retailers. New members ordered one or two times per the CDC model for all future markets, while existing month, and the company forecast that, over the long operations would be gradually converted to term, this frequency would increase to twice per centralized order fulfillment (see Table 2). See month. Exhibit 2 for an example of a leader in order fulfillment. Peapod—Online Customer Experience Peapod’s Web site featured a virtual Peapod’s CDC model allowed the supermarket with electronic aisles. company to serve an entire metro Customers could create personal lists market out of one facility. Each for frequently purchased items. The CDC carried approximately site also offered the opportunity to 12,000 SKUs. Under the old input specific shopping instructions: model, eleven Jewel supermarkets i.e., only very ripe bananas. were required to serve the firm’s Chicago customer base; this Peopod has established a Table 3: Peapod profitability comparison, traditional number of agreements with leading Internet sites. retailer model vs. CDC model One such partnership involves a three-year agreement In-store Warehouse with Excite.com to be the only food retailer to Grocery Sales $ 115.00 $ 115.00 advertise on their site. Consumer Fees $ 15.75 $ 8.85 Total Revenue $ 130.75 $ 123.85 In October of 1999, Peapod announced the COGS $ 102.95 $ 85.85 national rollout of a program called Peapod Gross Profit $ 27.80 $ 38.00 Packages. The service made 7,000 non-perishable Picking, Packing, and Delivery $ 14.25 $ 19.05 grocery items, health- and beauty-care products, pet Other* $ 4.60 $ 8.40 merchandise and other household goods available for Variable Operating Expenses $ 18.85 $ 27.45 shipping to customers in the lower 48 states. Fullfillment Center OH $ 5.85 $ 2.65 Customers could send themed packages like “Late City OH $ 1.80 $ 2.60 Night Study Buddy” and “New Baby Welcome,” or Net Contribution $ 1.30 $ 5.30 they could send their own customized packages. Shipments were sent via UPS ground service at a flat required Peapod to have eleven groups of employees rate of $7.95 per package. to staff each location. The switch to the CDC model improved margins by 308 percent (see Table 3). Peapod—Market Research However, opening a new CDC required a capital Peapod tracked member profiles, shopping expenditure of $1.5 million. behavior, and purchase history, and offered this information to its suppliers for a fee through a Under Peapod’s “old” model, customers marketing program called Consumer Directions. paid a $5 monthly fee in addition to a five percent Approximately eighteen consumer packaged goods charge on their total order value. With the CDC companies (CPGs) subscribed to this service, model, however, customers had three options: including Colgate-Palmolive, Kraft, Nestle, and • $0 monthly fee and $9.99 per delivery Frito-Lay. Subscription fees varied, but typically ran • $5 monthly fee and $5 per delivery less than $250,000 per year. • $19.95 monthly fee and free delivery The Consumer Directions center provided With this system, the average order fee was $8.50 market data and also ran individual tests for without the monthly charge. manufacturers. As Peapod’s senior vice president of product management and marketing Mike Brennan Customers choose two-hour delivery explained, “Do discounts get sales? Recipes? windows with twelve hours lead-time.
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