Net Grocers' Shopping List Includes Customers

Internet companies are rushing into the online grocer business -- far ahead of actual demand. Their chances for success are hard to gauge.
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SAN FRANCISCO -- If they build it, you will shop.

That seems to be the belief behind the recent frenzied activity among Net grocery stores. Since

Webvan

said in July that it planned to spend $1 billion building a nationwide distribution network, there's been one big event after another.

Just this week, Webvan lured George Shaheen away from powerhouse

Andersen Consulting

to become its chief executive.

priceline.com

(PCLN)

decided this infant market looked awfully tasty, too, so it decided to start offering groceries, though you have to pick them up yourself.

Of course, there's big money behind these companies, too.

HomeGrocer.com

, just 2 years old, has attracted millions from the likes of

Amazon.com

(AMZN) - Get Report

,

Kleiner Perkins Caufield & Byers

and former

Netscape

chieftain James Barksdale.

But in the midst of everyone being very, very busy, having important meetings and cutting really big deals, there's one thing folks seem to have forgotten: There's precious little evidence that this concept works.

"I love the concept," says Ted Gomoll, senior vice president at investment company

Sporl & Co.

, who sat in on HomeGrocer's presentation at a

Hambrecht & Quist

conference earlier this year. "It's great for the customer, but it remains to be seen if they save money and if it's reliable."

"It's not a slam-dunk one way or another," adds Andrew Mann, a fund manager at

Eureka Capital

, which is long Net grocer

Peapod

(PPOD)

. "It's easy to become obsessed with a winner-take-all mentality."

Peapod is perhaps one of the best indicators of this market. For 10 years, the company has been trying to get people to buy groceries online. But at June 30, its customer base actually fell 14% to 89,900 from 104,000 a year earlier. Revenue also declined.

Sure, Peapod started with what apparently is the wrong approach, filling orders by shopping at local grocery stores and then delivering the goods. Most of the rest, including Peapod now, are building their own warehouses. Peapod says the transition to this approach, along with a marketing cutback, attributed to its numbers sliding.

But

Streamline

(SLNE)

, which runs its service only in the Boston area so far, hasn't done much better. Customer figures hit just 3,000 at June 30, up only 1,000 from a year earlier.

Webvan just opened its

Netstore

in June and had 16,000 customers in the San Francisco area at the end of August, while HomeGrocer had about 30,000 in Seattle and Portland as of earlier this month.

So then what's all the hoopla about? Potential, of course -- the Internet mantra.

Research house

Jupiter Communications

expects Internet shopping to account for about 1.5% or $7.5 billion of all grocery purchases by 2003. (By comparison, Internet book buying is expected to be about $4.9 billion by then.) And how hard can it be to get to a measly figure like 1.5%? Webvan talks about building 26 highly automated distribution centers around the country over the next three years. HomeGrocer plans to move into at least 20 new markets over the next year.

And so the frantic race continues.

Two high-profile names it has lured in are Webvan's Shaheen and HomeGrocer's Mary Alice Taylor, who two weeks ago joined the company as chairwoman and chief executive.

Shaheen is leaving a firm with 65,000 people for one with 414, as of June 30. Of course, according to

Securities and Exchange Commission

documents, he's getting options that amount to a 5.1% stake in the company, which would have a total value of $195 million if the company goes public at 12 per share, the middle of its expected range.

"He's incredibly savvy about what's going on with the Internet and is in general a brilliant leader," says Christine Ferrusi Ross, a technology services and outsourcing analyst at

Forrester Research

. "Having said that, his experience is in running a labor-intensive business. So his ability to make the leap to a company that's labor-averse -- given the mega-investment in automated distribution centers -- will need to be watched."

Taylor's strengths seem to fit more with what Internet grocery stores need -- perfect customer service. She previously was executive vice president of global operations at

Citigroup

(C) - Get Report

. But her real strength for this new job came from 16-year career with

Federal Express

, an

FDX

(FDX) - Get Report

unit.

"Is this an Internet company? A grocery company? A logistics company? Or a customer service company?" asks Mark Gorenberg, a partner at HomeGrocer investor

Hummer Winblad Venture Partners

. He also sits on the HomeGrocer board. "At the end of the day, this is clearly a customer service company."

Taylor says she figures the concept will work because people are so busy these days that they'd much rather order online and have their groceries delivered than spend their timing combing the aisles. She also says HomeGrocer is moving rapidly to establish locations, giving it an advantage in gaining customers in new market.

But it'll also take doing all the seemingly simple things like getting still-frozen ice cream to someone's house to make it work. The logistics of making an Internet grocer's business work without glitches will likely be the biggest challenge for all of the companies, says Gorenberg.

And the company that accomplishes this will bring customers back. "It's all about repeat business," says Craig Cohen, president and CEO of

Waiter.com

and a Peapod user.

Indeed, but for now the first challenge is getting people to decide they need the service the first time.