Photographs by Brad Wilson Brad by Photographs

other other same-day transporters.

they they won’t deliver for long.

to

Investors have Investors risked billions

Silas Byrne, and Martha Anand Turner, Devendran The economics, though, show

on Webvan, Urbanfetch, on and Webvan, The by Tim Laseter, Pat Houston, Anne Chung,

Flaws & in Fallacies Internet Home-Delivery Schemes

LastMile Nowhere

content business models 40

Tim Laseter Pat Houston Silas Byrne Anand Devendran ([email protected]) is ([email protected]), a prin- ([email protected]) is an ([email protected]) is a partner in Booz-Allen & cipal in Booz-Allen & Hamilton’s associate in Booz-Allen & a consultant in Booz-Allen & Hamilton’s Operations Practice Cleveland office and a member Hamilton’s New York office Hamilton’s New York office and serves on the firm’s of the Consumer and Health focusing on operational and focusing on operational and e-business core team. He is Group, focuses on strategic organizational issues across a growth strategies across a wide the author of Balanced Sourcing: supply-chain transformation, broad range of industries. range of industries. Cooperation and Competition in particularly as related to Supplier Relationships (Jossey- e-business issues. Martha Turner Bass, 1998). ([email protected]) is an Anne Chung associate in Booz-Allen & ([email protected]), a Hamilton’s New York office Cleveland-based principal of focusing on operations and Booz-Allen & Hamilton, focuses supply-chain management on e-business and supply-chain issues in a variety of industries, strategy as a member of the with particular emphasis on e- firm's Operations Practice. business.

Amazon.com’s launch in July 1995 ushered in online sales potential; high cost of delivery; a selection–

content an era with a fundamentally new value proposition to the variety trade-off; and existing, entrenched competition. consumer: easy access to convenient ordering with seem- Before presenting our supporting evidence, we will ingly infinite selection. Rather than dropping by the local first briefly profile the new dot-com competitors for the

business models business Barnes & Noble superstore and physically sifting through last mile. (Save this scorecard; the game may be a no- the 150,000 titles, ’s online shopper browses hitter.) more than 4 million titles from a personal computer. Amazon also simplifies the selection process through its Overview of the Players search engines and databases loaded with information on Most of the major e-tailers offering same-day delivery millions of consumers. Over the past few years, a host of tend to focus on a mix of two broad product categories, “category killers” replicated Amazon’s “limitless shelf immediate gratification/impulse items (e.g., videos, space” model in categories from music, to toys, to home music, books, magazines, snacks) and routine necessities furnishings — while Amazon in turn extended its brand like grocery and household items, for which many con- to such categories, and others, as well. sumers seek to minimize shopping time and effort. (See Unfortunately, the online advantage is undermined Exhibit 1.) All offer thousands of items, but order sizes by a benefit only bricks-and-mortar retailers can offer: the vary dramatically. Not surprisingly, the companies 42 ability to walk out of a local store with product in hand. focused on instant gratification/impulse items tend to As a result, a new breed of Internet service has emerged: have the smallest orders. retailers, such as Webvan, Kozmo.com, Urbanfetch, and All offer extended delivery hours and 24/7 ordering Pink Dot, that offer same-day delivery. These new e-tail- — not surprising in the wired world. Distribution/ ers have staked out the “last mile” delivery to consumers fulfillment centers range from simple 4,500-square-foot as their basis of competition. By combining the conven- spaces filled with rack shelving, to highly automated, ience of online ordering with nearly instant gratification, multimillion-dollar, 300,000-square-foot facilities. Deliv- they offer a new — and potentially superior — value ery vehicles range from bikes, to scooters, to small cars, to proposition. No one doubts that competition will be vans — often sporting striking colors and images to mar- fierce. As George Shaheen, CEO of Webvan Group Inc., ket the brand. Although most offer free delivery, some puts it, “One or two companies will legitimately earn the price their offerings to discourage small orders. Also, to right to cross into a person’s home. We intend to be one ensure that consumers receive truly free delivery, some, at of those. I don’t believe there will be a multiplicity of least for the time being, discourage tipping. companies doing this successfully.” Although each company offers a slightly different issue 20 Unlike Mr. Shaheen, we believe the last mile may business proposition, all offer the convenience of online lead to the gallows rather than to the promised land. Our ordering and same-day delivery, thus addressing the time- analysis of the race for Internet-ordered home-delivery lag problem encountered in the category-killer e-tailing

services uncovered four fundamental challenges: limited model pioneered by Amazon. These local deliverers hope strategy+business Exhibit 1: Local-Deliverer Overviews

Company Kozmo Pink Dot SameDay Urbanfetch Webvan

Started 1997 1987 1999 1999 1996

Atlanta, Boston, , *, *, New York, Atlanta, Chicago*, Chicago, Houston, Orange County Dallas*, Memphis*, London Dallas*, Denver*, Los Angeles, New York*, Newark*, Coverage New York, Portland, Los Angeles, Philadelphia*, San Francisco, San Francisco, Sacramento, San *announced , San Jose, Seattle*, Francisco, Seattle*, expansion Washington, D.C. Washington, D.C.* Washington, D.C.*

Offering: Videos/DVDs Games/Toys Music Electronics Books/Magazines Snacks/Food Grocery Items content Health & Body Household Items Gifts business models business

Stocked Items 15,000+ ~2,000 Not Published 50,000 15,000+

Average $15 Not Published Not Published $40-50 $90 Order Size

Hours 10 AM to 1 AM 6 AM to 3 AM 6 AM to 3 AM 24 Hours a Day 7 AM to 10 PM of Delivery All offer delivery 7 days a week, 365 days a year, and 24/7 ordering 4 Distribution 1 Distribution Center 13 Distribution 12 Fulfillment 1 Distribution Center Fulfillment Centers with an of 336,000 sq.ft. Centers in 6 Locations Plus “Several” Average Size of Plus 12 Small Centers markets (4,500 sq.ft.) Fulfillment Centers 100,000 sq.ft. Transfer Hubs (SF)

Under an Hour: Same Day Under an Hour: 30-Minute Window Delivery Under 30 Can Specify (within 2 Hours) Can Specify Specified by Response Time Minutes Delivery Time & Next Day Delivery Time the Shopper 43

Delivery Van, Car, Scooter, Blue VW Bug Van, Scooter, Beige-and- Not Published Method Bicycle, and Foot with Pink Dots Bicycle, and Foot White Van

Free> $50 Order Delivery $2.95 Flat, No Free, $10 Free> $50 Order Free $6.95< $50 Order Minimum Order Minimum Order $4.95< $50 Order Charge (Within Zone)

Tipping Optional Optional No Tipping No Tipping No Tipping Policy that gaining control of the last mile will ensure success. home-delivery business. We’re not so sure — for a variety of reasons. To start, we ran a few numbers. Forrester Research Inc., the most frequently cited forecaster of online sales, Limited Online Sales suggests the U.S. online-consumer market will exceed Given the well-publicized reports about the explosive $184 billion by 2004 — whopping growth over last year’s growth of , our assertion of limited sales $20 billion to $30 billion estimate. (No one has exact fig- may seem unbelievable. We draw this conclusion by ures; the government only recently began tracking this examining how online sales should affect the volume of new phenomenon.) But according to Forrester, only 60

su 20 issue strategy+business New York ‘04 New York increase in user density for increase New York ‘99 New York tenfold $15,000,000 Sales per Square Mile per Square $15,000,000 Sales Mile per Square $5,000,000 Sales Mile per Square $1,000,000 Sales Mile per Square $500,000 Sales Mile per Square $100,000 Sales Los Angeles ‘04 Chicago ‘04 For those not familiar with the consultant’s perennial with the consultant’s those not familiar For (and in some cases decline) and growth Population Los Angeles ‘99 Los Angeles Denver ‘04 Denver key cities, population and median income data from the data from key cities, population and median income one constant: the land area and the U.S. Census Bureau, of the cities. (See Exhibit 2.) information graphic — the bubble chartfavorite — axis The horizontal explanation. 2 warrants more Exhibit mile in users per square indicates the number of Internet the logarith- that each city on a logarithmic scale. (Note a mic scale represents typ- along the scale, rather than the more each increment linear amount.) of a fixed ical increase the migration to the right penetration rates drive Internet example, in 1999 an esti- 1999 and 2004. For between of the 4.4 million inhabitants of the mated 60 percent had Internet area metropolitan D.C. greater Washington, Since access — the highest penetration of any U.S. city. nearly 3,500 square covers D.C. area Washington, the Chicago ‘99 Denver ‘99 Denver Boston ‘04 Boston Cleveland ‘04 Cleveland Boston ‘99 Boston Washington, D.C. ‘04 D.C. Washington, Cleveland ‘99 Cleveland Washington, D.C. ‘99 D.C. Washington, 100 1,000 10,000 100,000 Circle Size Relative to Revenue Size Relative Circle Internet Users per Square Mile per Square Internet Users Internet Sales-Density Internet Analysis Sales-Density $0 $800 $600 $400 $200

$1,400 $1,200 $1,000 Internet Sales of Physical Product per User per Product Physical of Sales Internet Exhibit Exhibit 2: The physically delivered categories contribute much The physically delivered model that built a forecast further we perspective For of the future growth and account for $132 billion of growth of the future that’s put this in perspective, To 2004 forecast. Forrester’s spend 2.3 times the $57 billion that consumers currently That is enormous growth annually on catalog purchases. worry we in a short that period of time. But that even enough much home-delivery will not provide volume sales density to alter fundamental delivery economics. local delivery of highlights the two key drivers economics: Specifically, sales concentration and population density. by selected a range of U.S. cities — many covered we the key local deliverers announced expansion plans from sales 1 — and examined both current listed in Exhibit model builds on for 2004. Our density and a forecast published data from sales forecasts, Internet Forrester’s penetration rates in on Internet Research Scarborough percent of the 1999 total required physical delivery physical of of the 1999 total required percent airline and event goods, such as delivered goods. Digitally and banking services,tickets, online brokerage plus a sepa- which have like automobiles, goods” “researched rate delivery other 40 percent. accounted for the network,

content business models 44 Even if online consumer sales volume grows to twice that of catalog sales today, it won’t provide enough sales density to alter fundamental delivery economics.

miles, those 2.6 million users produce a user density of enue potential totals more than $39,000 per day per

about 750 per square mile. By 2004, increasing Internet square mile. content penetration and population growth will drive the user Unfortunately, after New York, the potential to deliv- density to more than 1,300 users per square mile. er goods economically in cities falls quickly. Most major

The vertical axis estimates the Internet purchases of cities offer approximately $1 million per square mile in models business those users. Again using Washington, D.C. as the exam- sales each year — equal to less than $3,000 per day. And ple, and looking ahead to 2004, we adjusted the average that’s the total for all online sales of physical goods, not online sales per person to reflect the above-average afflu- just the fraction that people want delivered instanta- ence in the district. This yields a projection of annual neously. Worse yet, that fraction may have to be shared by online physical-product sales of nearly $700 per user in several local deliverers. four years — well above the overall 1999 U.S. average of around $125. High Last-Mile Costs The size of the circle captures an Not only are the sales spread across lots important third variable: market size. of “last miles,” it costs a lot of money Although high user density and high to get there. To demonstrate, we con- sales per user drive sales density, the ducted top-down analyses of one low- overall market size also plays an impor- cost player and built a bottom-up cost 45 tant role. For example, Denver, with a model for a local delivery business. user density of nearly 1,300 per square Extracting from publicly availa- mile and projected 2004 sales per user ble information, we estimate that of $800, will have $1.3 million of sales Kozmo.com Inc., absent overhead costs per square mile per year. Washington, such as advertising, currently spends D.C. fares worse, with sales per square about $10 to make a delivery. Even this mile of only $900,000 — but offers a cost estimate reflects a heavy bias for its bigger prize due to the greater total original Manhattan-based operations population. — the densest delivery area in the The curved lines on the chart high- country, and thus probably its lowest- light different combinations of sales lev- cost market. With an average order size els and user density that yield the criti- of about $15, it’s little surprise that cal value of sales per square mile. The Kozmo is losing money and in trouble. $14 million in sales per square mile in In June, the company fired 24 workers, New York City offers an attractive mar- or 5 percent of its sales force, and ket; even dividing by 365 days per year slowed down plans for its IPO. Kozmo for the 24/7 Internet economy, the rev- is also considering requiring a mini- Variable Operating Costs Labor Costs Fixed Costs Total 18% 19% 63% $220 64% Local Delivery 18% Center Aggregator Distribution Even applying the Pareto Even 6% Freight Inbound New Trade-off: Speed Variety New Vs. Trade-off: models, the local under current fundamentally, More at the the issue of instant gratification resolves deliverer the response, fast achieve To expense of limitless offerings. in rather than locally, must hold product local deliverer categorylarge national distribution centers, as killers and gained the speed advantage So do. large catalog retailers variety means a Inc. and Urbanfetch.com Kozmo.com by offers about 15,000 loss. Kozmo than more items in total, versus 10 million total items at Amazon. of principle — that 80 percent 20 the sales dollars come from of the items stocked — percent will be able to the local deliverer steal only a fraction of the total a category from sales volume high- by killer: that represented though, Typically, items. volume the items provide high-volume per unit because of least profit heavy price competition. Fur- the cate- at least today, thermore, line product broader gory killer’s in negotiating leverage provides though even with suppliers. So greatest emphasis on rapid delivery emphasis on the greatest tend to have size. smallest order 12% Breakdown of Total Distribution Costs of Breakdown Total Center National Distribution Note: Note: Based on 1 cubic foot shipment size in D.C. Washington, 0 50

200 150 100 $250 Dollars of Millions Exhibit Exhibit 3: cost per delivery — but absolute cost per delivery. For a $100 package, a local a $100 package, For cost per delivery. As any New Economy entre- Economy As any New course, the impact of the deliveryOf on cost depends Unfortunately, average online orders typically run in online orders average Unfortunately, relative preneur knows, scale offers the scale knows, preneur unfortunate- solution. But obvious physical delivery the network does not benefit from ly, Economy effect that supports of Information other types labor variable businesses. As our cost model demonstrates, economics, with the driv- local-deliverer costs undergird packages comprising the bulk of the cost. ers who deliver (See Exhibit gets some deliverer 3.) A van-based space, but a bicy- fully utilizing the vehicle economies by cle courier can carry only a limited number of items. trips. bicycle customers simply means more More to According of the package being delivered. the value of $100 incurs an an online purchase Sachs, Goldman for shipping and handling. charge of 8 percent average an 11 percent reported the research $50 orders, For shipment den- 4, increasing in Exhibit charge. As shown the sity slightly reduces mum dollar value on orders. mum dollar value deliverer comes close to breaking even with the current even comes close to breaking deliverer That means a goods. cost for shipping Internet average shipping and han- that charges standard local deliverer dling fees could offer same-day delivery for the same price a category shipment from as the delayed killer — clearly an opportunity to gain an advantage. fact, larger orders In the $50 to $100 range, not higher. seem antithetical to the notion of instant gratification, than about impulse videotape rentals which is more on And our research VCRs. of the purchase about, say, delivery the companies with the the current firms shows changing the value of the package dramatically changes changing the value the

content business models 46 content business models 47 The U.S. Postal Service appears rea- The U.S. Postal $100 shipment Express Corporation retained the 10 per- Corporation retained Express in the catalog it also holds cent share world. gov- the federal Unless sonably secure. of ernment pursues the unlikely path the sole legal it retains privatization, authority to place items in mailboxes, of thus monopolizing the base business after investing Moreover, mail delivery. in a delivery than $200 million more its tracking and confirmation system for Postal the U.S. product, Mail Priority gap on a key closed the Service has now $50 shipment $50 Shipment $100 Shipment $200 Shipment Traditional Delivery Package Local Delivery Whether the U.S. Postal Service can rise to the chal- Whether the U.S. Postal opportunityUPS, for its part, than threat faces more issue limiting its competitiveness with UPS. issue limiting its competitiveness lenge of same-day delivery to be seen, but nation- remains Mail The Royal al mail services in other countries do so. throughout same-day delivery for Amazon.co.uk provides the con- noon typically reach by received London; orders the end of the day. sumer before ubiquitous the sales. Despite consumer Internet from trucks in suburbia, business-to- of its brown presence Only business (B2B) delivery still supports the company. home comes from revenue of UPS’s about 10 percent of the upside, UPS has announced aware Well delivery. complete logistics services, ware- from plans to provide fulfillment, to small- and medium-sized housing to order startups its UPS eLogistics business. e-commerce through discussions with major e-tailers, UPS has also informal In services aggregator in described a possible plan to provide indicate a clear the U.S. Both moves 60 cities across unwillingness to concede the last mile to the startups. 40 30 New York New Washington, D.C. Washington, 20 Chicago (Shipments per day per square mile) (Shipments per day per square Boston 10 Denver Cleveland Delivery Delivery Costs as of a Shipment Percentage Value 050 Shipment Density UPS and the U.S. Postal Service the most to lose have UPS and the U.S. Postal

8% 6% 4% 2% 0%

20% 18% 16% 14% 12% 10% Percentage of Shipment Value Shipment of Percentage Entrenched Competitors Entrenched may be com- The biggest challenge to the local deliverers traditional package deliverypetition from services — Service Parcel Service and United notably the U.S. Postal like as bricks-and-mortar — as well (UPS) retailers Inc. grocery stores. find a way to make a business out should local deliverers of catalog products 85 percent Today, of same-day service. shipped via one of these two services;are a little more the than half of consumer catalog shipments go through date, business-to-consumer To Service alone. U.S. Postal to be falling to the same du- appears commerce Internet of online UPS made 55 percent albeit in reverse: opoly, while Inc., Research to Zona according deliveries, order Federal 32 percent. Service garnered the U.S. Postal the local deliverer addresses the instant gratification need, the addresses the local deliverer a new trade-off of a limited selection. Nothing it presents comes free. Exhibit Exhibit 4:

business models business 48 content greatest numberofphysical outletscouldbethemost Inroute totheairport. suchamodel,retailers withthe for curbsidepickupatthemost convenient store onher Us Web giftand placestheorder site,shefindstheperfect gift totakeherkidsbackhome. Searching the Toys “R” Imagine anout-of-town businesstraveler lookingfora determined by aGlobal Positioning System signal. using ahandhelddeviceforpickupatthenearest store as Provocateur,” p. 74.)Aconsumercouldplaceanorder tional players. (See “Pattie Maes andHer Agents shiftthebalance backtothetradi- devices mightfurther killers. more suchannouncements from category Amazon.com. ahead ofthestill-virtual You canexpect its physicalstores andonlinepresence, thereby leaping capability ofKozmo andUrbanfetch, andfinallylinking in Manhattan ofbooksordered online,matchingthe In May, Barnes &Noble Inc. launchedsame-daydelivery players areclicks-and-mortar alsogettinginonthegame. requirements network. Nongrocery ofahome-delivery checkout lines,andthegrocer avoids thehighinvestment advantages ofefficient24/7onlineordering withno store. up atthelocalgrocery The consumergainsthe Carolina, now offeronlineordering withcurbsidepick- chains,likeLowe’scery Food Stores Inc., basedinNorth using groceries astheirbase-loadbusiness.Leadinggro- challenge tothelocalInternet deliverer, especiallythose them. e-tailers,insteadofcompetingagainst category-killer with dable competitor—onewell positionedtopartner ume, UPSappearsaformi- ture andtheB2Bbasevol- With anexistinginfrastruc- The rapidevolution andspread ofwireless Web retailersExisting bricks-and-mortar alsoposeamajor mass, densityoverextremely highdelivery arelatively smallland model hasalreadyferent evolved. delivery Thanks to meet consumerneeds.In Japan, dif- forexample,avery as companiesattempttofindtheoptimaltrade-offs high as1.5billioninonlyfive years. handheld Web devicestoday, forecasts suggestatotalas advantaged. Andalthoughonly25millionusersemploy that works —butmanyotherswillfailalongtheway. scape. Eventually, someonewillfindavalue proposition tinuously tonavigatetheever-changing competitive land- commitment torefine andadaptthebusinessmodelcon- penetrationandsmallermailboxes inthatcountry. card featuresoption topaycash—important given low credit- ery, offeringconvenient neighborhood pickupandthe venience stores provide anoptionallinkinlast-miledeliv- tomostJapanesedelivery consumers.Also,Japanese con- strategy+business For e-businessmodels,visitthe more discussiononlocaldelivery Kozmo.com Inc.: www.kozmo.com Urbanfetch.com Inc.: www.urbanfetch.com Sameday.com: www.sameday.com Pink Dot Inc.: www.pinkdot.com Webvan Group Inc.: www.webvan.com 2000: www.strategy-business.com/creative_mind/00108/page4.html Victoria Griffith, “Focus: Online Grocers,” Observer Christopher Byron, “Kozmo Investors Back Boys onBikes,” Resources We modelswillemerge alsofeelconfidentthatnew Winning intoday’s dynamiceconomyrequires a , April 3,2000:www.newyorkobserver.com/pages/story.asp?ID=2527 takuhai-bin daEcag twww.strategy-business.com/ideaexchange/ at Exchange Idea — andavalue —totheconsumer. hasacost more explicitlythatdelivery the companiesmayneedtoexpress explicit chargeforthat.In thefuture, delivery. Today, toavoid an mosttry cus ontheincremental value ofrapid evolve theirvalue proposition andfo- nies, we dobelieve theymustfurther to ringadeathknellforthesecompa- competitors. Althoughwe’re notready expensive, andexposedtoentrenched consists ofsometoughterrain:lonely, As theanalysisindicates,lastmile Ahead Models New services canoffersame-ornext-day services strategy+business , First Quarter Reprint No.00304 The New York +

strategy+business issue 20