Case 4 Homegrocer.com: Anatomy of a Failure Terry Drayton, the co-founder and original CEO of the Drayton had learned a great deal from his experi- now defunct HomeGrocer.com, left the meeting with ence at HomeGrocer. He strongly believed that he and his original management team and co-founders feeling his team had done many things right, and come close to charged and hopeful. They had met to discuss the pos- cracking the online grocery model. As he drove home sibility of reviving the online grocery business. Although from meeting with his former partners, he wondered the company had been the victim of the dot.com bust, what he might do differently if given the chance. Reflect- and an unsuccessful merger with Webvan, it was attract- ing on his experience in founding HomeGrocer, Drayton ing interest from investors looking to fund an online gro- tried to isolate what critical mistakes he and his team cery venture. would avoid the second time around. This time he was Drayton and his Seattle-based team had started Home- confident that he could pull it off. Grocer back in 1997. They raised over $440 million in venture capital, opened eight distribution centers, and in a relatively short time had established operations in six locations along the West Coast. They made plans for more THE COMPANY locations and were in midst of a fast rollout at the time of BACKGROUND HomeGrocer’s IPO on March 9, 2000. One month later, the NASDAQ dropped 35% from its high of 5,132, and Terry Drayton and Mike MacDonald founded HomeGrocer, the opportunity for a secondary round of funding disap- an Internet-based grocer, in 1994. Drayton had just sold peared. Lacking cash to deliver on the growth plans laid Crystal Springs Water Company, which delivered bottled out in their IPO prospectus, HomeGrocer tried to weather water to businesses in and around Vancouver, B.C., and the financial crisis by merging with Webvan, a California- was looking for something new. One cold winter day, based online grocer that was launched in 1999. Drayton’s wife remarked that he ought to deliver grocer- Webvan, with its larger capital base (at its 1999 peak ies instead of water; that way busy moms wouldn’t have it had a market capitalization of $8.8 billion compared to brave a snowstorm just to go to the store. The idea stuck with HomeGrocer $725.5 million at IPO), took control and Drayton found himself discussing it with his friend of the merged entity. To the chagrin of HomeGrocer MacDonald, president of the largest food broker in the executives, Webvan’s managers transitioned all of the Canadian province of British Columbia. MacDonald was distribution centers to Webvan technology and created intrigued and agreed to put up some initial capital while a single Webvan brand. However, despite all their ef- forts, they burned through cash quickly and their share price plummeted, from $26 in December 1999 to $4 at Research Associate Greg Fisher and Professor Suresh Kotha, Olesen/ the time of the merger (August 2000). By January 2001 Battelle Chaired Professor, the University of Washington’s Foster School of Business prepared this case. The case was developed solely the price of shares was a mere 5 cents. In June 2001, as a basis for class discussion. Cases are not intended as endorsements, less than a year after the merger was announced, Webvan sources of primary data, or illustrations of effective or ineffective filed for bankruptcy. management. C-59 84487_case-4_ptg01_hr_C059-C076.indd 59 28/10/13 1:29 PM C-60 Case 4 Homegrocer.com: Anatomy of a Failure Drayton wrote the business plan. MacDonald’s friend, more capital. But we were attracted by Terry’s Ken Deering, with computer and technology expertise idea of doing it in a relatively low-capital way. soon joined them as vice president of systems. The new venture would be called HomeGrocer.com. Four months later, the HomeGrocer team raised an- other $6 million in Series B funding, with the legendary Silicon Valley VC firm of Kleiner Perkins Caufield & Initial Funding. By April 1997, Drayton had raised Byers as lead investor. This was followed by a series C $350,000 in seed capital funding, primarily from friends funding round. By this time the market was abuzz with and family. In search of money, he targeted venture capital hopes for the Internet grocery business, and HomeGrocer (VC) firms in Vancouver, even as the team moved its op- had attracted the attention of some heavy hitters: erations to Seattle, deemed a more “techno-friendly” city. Amazon.com; Jim Barksdale, an early executive with This came at a time when respected Wall Street analysts Netscape and former senior executive with Federal and investment bankers were touting the Internet’s poten- Express; and John Malone, the legendary cable TV tial to fundamentally “disintermediate” incumbents in a operator and Liberty Media Investor. Notes Drayton: number of industry supply chains. To many, this meant cutting the need for a middleman in the supply chain. [W]e actually went out to raise $20 million, but Mary Meeker, the Morgan Stanley stock analyst, notes: everybody wanted to own more of the company, so the round kept going up. And it was just the math. [I]t is important to understand the drivers of sup- Amazon.com insisted on owning 35% and so we ply and demand, and therefore how Internet based had a valuation in mind and so we just had to raise distribution may affect this chain and whether way more money—actually $52.5 million—than there will be disintermediation . For example, we ever intended. Amazon.com would be classified as a disinter- mediary, as it removes the inventory chain to A Series D financing round followed in April 1999 the bookstore (e.g., brick-and-mortar Barnes & with HomeGrocer raising another $110 million. The pri- Noble stores) and potentially creates better unit mary investors during this round of financing were CBS, pricing (than the traditional stores), better service, Inc., the Knight-Ridder Company, Softbank Co. of Japan, and so forth, while reducing the capital tied up Benchmark Capital, Sequoia Capital, and others. in inventory. [It is] pretty simple—less overhead, With the frenzy over Internet-based ventures in full more efficiency, better prices for consumers.1 swing, Drayton raised a considerable amount from U.S. investors, $172 million, even though his original busi- Such comments excited investors, fueling the fund- ness plan had only called for $15 million in funding ing of many online ventures by a buoyant venture capi- from venture capitalists, followed by an IPO to secure tal industry. In May 1998, Drayton raised $4 million in another $50 million in capital. Terry had also assembled Series A (first round) funding. Tom Alberg of Seattle’s an impressive board of advisors that included Jeff Bezos, Madrona Ventures, an early VC investor in HomeGrocer, the founder of Amazon.com, the legendary John Doerr remembers: of Kleiner Perkins Caufield & Byers, Jim Barksdale, We had already invested in Amazon.com so we Martha Stewart, and others. were beginning to see that online commerce could work. This [venture] was much different Going Live in Seattle and Expanding. According [in] everything from the delivery to the inven- to the business plan, the company would spend the first tory to a whole lot of issues . nonetheless, lots 12–15 months establishing a distribution center in Seattle, of people are frustrated with the regular grocery and then roll out new facilities every three months. The stores and the lack of inventory sometimes and idea was to learn as much as possible from the launch and having to carry [grocery] bags out, and parking management of the first distribution center so they could and everything else. So we thought there was perfect the model before replicating it in other regions. In an opportunity and that it could be a really big May 1998, its website went “live,” and commercial opera- business. Unlike Amazon.com, though, you can’t tions were officially underway with a staff of 60. During its serve the whole country from one warehouse ini- first month HomeGrocer attracted 300 customers; they tially. You’ve got to start by building out in cities. found that on average, each customer ordered three times So we really realized it was going to take a lot a month with an order value of $75 per order. According 84487_case-4_ptg01_hr_C059-C076.indd 60 28/10/13 1:29 PM Case 4 Homegrocer.com: Anatomy of a Failure C-61 to Drayton’s plan, the Seattle facility should break even at second one in Seattle, two in Los Angeles, and one in San 1,100 orders per day (See Exhibit 1 and 2). Diego. In fact, the company opened eight new distribution A year later, in May 1999, HomeGrocer entered the centers, at a rate much faster than the original business Portland, Oregon market with a distribution site similar plan had called for. Drayton himself pointed out: to Seattle’s. By September 1999, it had build a distribu- The biggest consequence of raising a lot of tion center in Orange County, California, where the com- venture capital was [that] with all this money, pany employed a more automated system. Items were everyone expects you to grow that much faster. picked in zones and batches, and conveyors were used That’s very difficult to do in a logistics inten- instead of having people walk around to do the picking. sive business like HomeGrocer, especialiy when Instead of its usual 50,000-square feet facility, its Orange your business is not yet fully baked.