Peapod

(PPOD)

, the grizzled veteran of the online grocery business, finds itself in a tight spot: CEO Bill Malloy quit because of health issues, and investors pulled their planned $120 million investment. With very little cash left, Peapod is now looking for alternative financing or for an outright buyer. Its shares lost more than half of their value Thursday, closing off 4 3/32, or 52%, at 3 23/32.

How did the first mover in a potentially big market end up in this mess?

In part, Peapod was a victim of some truly atrocious luck. But its story also illustrates the perils of being first into the petri dish of a new online market.

No Efficiencies

Peapod was founded in 1989, when the Internet was just a twinkle in

Al Gore's

eyes. It operated on the poetic sounding "pick and pack" model: Peapod workers or supermarket employees actually picked goods right off the grocery store shelves, then packed them and delivered them to customers. The weaknesses of that strategy were clear from the start: There were no operating efficiencies from additional customers because the retailer still gets a chunk of every piece of the action, and there were quality-control issues due to out-of-stock merchandise.

Analysts and investors, however, say that Peapod played it safe, using a model appropriate to its small scale. "Why build a super-large warehouse when there aren't many customers?" asks Andrew Mann, a fund manager with

Eureka Capital

, which owns Peapod shares. "It would be like building a skyscraper in a small town. They were very careful to match their capital expenditure to where the market is."

Peaks and Valleys
Peapod shares fail to sustain the high points

Source: BigCharts

But along came rivals like

Webvan

(WBVN)

,

Netgrocer.com

,

Streamline

(SLNE)

and

HomeGrocer

(HOMG)

, full of all these expensive, ridiculous-sounding ways to deliver food.

FedEx

it! Spend $1 billion to make huge distribution centers! Heck, give out freezers!

And what's more, the capital markets changed to make all this stuff possible.

Losing Ground

Those rivals gained ground on Peapod. "Being the first mover is not important. Being the first good mover is important," says Anthony Noto, analyst with

Goldman Sachs

. (He doesn't cover Peapod, but gives Webvan his highest rating. His firm has a banking relationship with Webvan.) To successfully capitalize on the first-mover advantage, a company has to have something -- technology, an established brand name, strategic alliances or a proprietary system -- to open a gap with the next wave of competitors, he says. "Peapod never created that gap." (

TSC

examined the supposed

first-mover advantage in a story last year.)

Seeing the way the tide was turning, Peapod decided to change its model and hopefully get a little cash, too. "The plan was to bring in a high-powered executive and work on a centralized model, then go raise capital," says Barry Stouffer, an analyst with

J.C. Bradford

in Nashville, Tenn. (He rates Peapod shares neutral; his firm hasn't done banking for the company.)

They got the executive. In September, Malloy, formerly at

AT&T's

(T) - Get Report

wireless division, joined Peapod as president and CEO.

"Malloy was the spark plug to build the brand and create some more enthusiasm," says George Dahlman, an analyst with

U.S. Bancorp Piper Jaffray

, which hasn't underwritten for Peapod. "He was doing just that." Peapod shifted to a centralized fulfillment model, which would require a higher initial investment but would eventually improve margins.

Things began to look up. In November, Peapod said Drayton McLane Jr., the former vice chairman of

Wal-Mart

(WMT) - Get Report

, would make a personal investment in the company and join its board. Peapod also forged a partnership with McLane's distribution-management company,

McLane Group

, to help improve logistics. And in February, the company quelled some cash-crunch fears when it said it would sell $120 million in convertible preferred stock to a group of investors.

Blast, Blast, Blast

The terms weren't all that great -- high yield on the convertible and significant dilution for current shareholders -- but at least the company had some breathing room. And it could expand into new markets.

Then came Thursday's announcement. Now, with just $3 million in cash left, the company is under the gun. That means the terms of further financing are likely to be more onerous than the investment that just fell apart. McLane may be able to pull in some investors, analysts say. If not, it could be lights out.

"It was very unfortunate timing for the company," says Stouffer. "It's like getting a mortgage and showing up at the closing to find that the lender has backed out." Or it could be like picking one business model, only to find that everyone else was headed in the opposite direction.