Back in 1913,
magazine published an article entitled "Dinners by Parcel Post" detailing a grand new idea: shipping food by mail to arrive directly at the doors of consumers.
Sound familiar? It should. Companies -- most recently the online grocers -- have been trying to figure out how to sell food directly to households ever since. Unfortunately, they've found it incredibly difficult, if not impossible, to make money doing so. And that means that while
planned purchase of
may give the company some extra breathing room, it does little to address what critics call the fundamental problems of the industry. That concern seemed to be shared by investors today; Webvan's shares fell more than 15% to 7 3/8, while HomeGrocer's shares fell 14% to 7. (
also wrote a
story about the deal earlier Monday.)
At the heart of all the criticism about Webvan, HomeGrocer and other contenders like
is that the grocery business is mature and has very thin margins -- on the face of it, not exactly a fount of opportunity for new entrants. Online grocers said that they could boost margins by removing the storefront from the equation, then taking orders over the Web, automating packing to some degree and delivering to consumers' homes in a set time window.
The problem with that is that it takes a heck of a lot of money. Webvan's mammoth distribution centers cost $25 million to $35 million apiece. And home delivery is a hard game, particularly outside of dense urban areas. "What it comes down to is how many stops there are on a route and how many dollars per stop," says David Donnan, a vice president with consulting firm
. (Kearney hasn't performed consulting for either company.)
More Than Groceries
To be sure, Webvan has never been only about groceries; it hopes to boost margins by delivering other goods like home electronics. But more goods means more complexity. And making delivery profitable hinges in large part on achieving sufficient scale. That, in turn, depends on the capital markets to keep anteing up money for expansion, which they've been loath to do lately. In essence, online grocers are asking investors to help them get from zero to where
is in a fraction of the time. Webvan and HomeGrocer, unlike other e-tailers, haven't predicted when they will be profitable. Instead, they've said that they can stop expanding if they become cash-constrained.
Donnan also notes that the idea that these companies are worth billions for the data they possess about their customers is losing some steam. First, privacy concerns mean this information isn't going to be easy to capitalize on. Second, its entire value is coming into question.
, the British grocer (no relation to the American chain), recently abandoned its loyalty card program, saying the value of the information collected didn't warrant the costs of administering the program.
So what does this merger do? Several things, according to Webvan's conference call. First, it cuts out the company's biggest competitor.
"Without the merger, both companies had to expend monies to win the customer from the brick and mortar alternative, and then they each had to spend money to win the customer from each other," said George Shaheen, Webvan's president and CEO. That, plus leverage in dealing with suppliers, will improve margins: by some two to three percentage points in gross margins, and between five and six percentage points in operating margins. It never made sense for these guys to waste money going at each other's throats; now they won't have to.
The purchase also reduces Webvan's capital needs by 50%, the company said, since HomeGrocer is already in several key markets, including Seattle and Los Angeles. Webvan instantly vaults from two markets (three, including Sacramento as separate from San Francisco) to nine, and expects to be in 13 markets by the end of this year and 15 by mid-2001.
A Better Balance Sheet
And, it improves its balance sheet, the company says. According to its most recent
filing, HomeGrocer had about $275 million in cash ($16 million of which is restricted) on April 1. That infusion gives Webvan some breathing room -- one could even consider its purchase as a sort of back-door secondary offering. But it certainly doesn't solve all its problems; even with a combined $650 million at the end of May, the new company most likely will still have to raise another $275 million in order to reach its 15-city goal.
Webvan also says the merger will provide a chance to combine the best practices of both companies. Their practices are pretty far apart, though, and while the companies are lovey-dovey now, they've spent a lot of time talking about why the other guy's model sucks. HomeGrocer uses smaller distribution centers that cost about $5 million each to build. They're far less automated than Webvan's, and in fact, the company has tried to build a warm and fuzzy image around the idea of a real live human picking and packing produce (hence its peach logo). Webvan delivers within a 30-minute window; HomeGrocer, within 90 minutes. And the tech systems are different. Webvan didn't say which model it would continue with.
Having said it will swallow HomeGrocer, Shaheen said he's turned his sights on the competition: brick and mortar. However, they've not yet begun to fight, he figures.
"If it becomes economically viable, the
will get into it," says Donnan, who predicts that independent companies like Webvan will only account for 4% of the grocery market by 2005.
Pure-play e-tailers in other fields have seen a threat from the bricks-and-mortar dudes -- even those that are ostensibly late to the game. Is there any reason to think the grocery business won't shake out the same way?
As originally published, this story contained an error. Please see
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