Why Webvan may eventually sputter

As Webvan's stock goes on sale Friday, it will be one of the more closely watched IPOs of the last few months. If all goes well as the stock goes public, the company will be worth more than a whopping $4 billion.

What's even more amazing, though, is that the Foster City, Calif., startup could achieve such gargantuan valuation in the face of equally goliath negatives -- the market for online groceries isn't that big, and no one knows how long it will take demand for such a service to develop. What's more, delivering groceries is far different from books or computers -- by some accounts, fulfilling a weekly grocery order is nothing less than a logistical nightmare, especially in a business with paper thin margins.

There's no doubt Webvan has sizzle. It managed to raise $122 million from from a group of blue-chip partners whose ranks include Benchmark Capital, Sequoia Capital, CBS and Softbank. (Softbank is a majority shareholder of Ziff-Davis Inc., which publishes ZDNet News.) Webvan's backers also include Louis Borders, the former chairman of Borders Books. George Shaheen, former Andersen Consulting CEO, is the online grocer's chief executive.

"These are name plate venture groups that have been involved in very successful IPOs and Web companies," said Peony Kao, analyst for IPO Plus Fund (Nasdaq: IPOSX) at Renaissance Capital in Greenwich Connecticut. "I think a large part (of the valuation) is simply the management."

And Webvan isn't just attracting money. It's spending it as well. Earlier this year, the company signed a $1 billion, three-year deal with construction giant Bechtel Group Inc. to build 26 distribution centers around the country.

This approach -- distributing from big centralized warehouses rather than local grocery stores -- represents the twist that may have kick-started investor interest in online groceries. It also represents the same argument that's rocketed other online e-commerce pioneers, such as Amazon.com Inc. (Nasdaq:AMZN), to prominence: The costs of distribution centers are more than offset by the savings of not having to operate local stores.

Other companies had been trying out that model, including grocery store chains, including Albertson's and Kroger, and online-only players like Peapod Inc. (Nasdaq: PPOD). But those companes were moving relatively slowly.

"Peapod evolved toward localized central distribution model. They had one big warehouse with suppliers shipping in and (Peapod) shipping out from there," said Ken Cassar, analyst at Jupiter Communications in New York. "But Peapod was moving so slowly. Enter Webvan. Suddenly they have the money to build that model out everywhere. They used half of the $120 million to build a San Francisco center, and then they made the billion dollar Bechtel deal."

Consumer demand?
But even if Webvan can expand the model nationwide, the business will still be tough.

Buying groceries online today is roughly the equivalent of buying books online a few years ago -- something only a few early adopters were doing. Jupiter Communications says online grocery sales were only $115 million in 1998, not even close to 1 percent of the $450 billion overall grocery market.

"Online grocers serve half of the 30 largest cities in the US currently. And coverage is mixed within those cities, targeting the most wealthy suburbs where they can reach the most attractive consumers," said Nick Karris, analyst at e-commerce research firm Gomez Advisors in Lincoln, Mass. "They're looking for dual income families with kids, where mom and dad are strapped for time and have income to spend on services like this."

Even if demand develops, there's no telling how fast it would grow. While shopping online sounds like a good idea to a growing number of Web-savvy consumers, there's still a big question about how many would actually opt for it if available.

Evidence: A January survey by the Food Marketing Institute found that, while 19 percent of consumers said they'd use an online grocery shopping service, only 3 percent actually did so when it was available at their primary supermarket.

'Heavy-duty logistics'
Webvan's biggest challenge, though, may simply be in the execution. Central distribution or not, fulfilling a grocery order of dozens of items, including perishables, represents an endeavor quite different from packing and shipping books.

"Everyone forgets that online grocery shopping is a heavy-duty logistical proposition," said David Merrefield, the editor of Supermarket News, a trade publication. "There's tremendous backstage complexity -- the process of assembling orders, picking them up from distribution center putting into a truck, routing them and delivering at the time the consumer happens to be at home."

Plus, there's not much room for error. This is an industry that makes its money on volume, not the spread. It operates on margins of a mere 1 percent to 1.5 percent. That one of the reasons the big chains have moved so slowly into the online field. Kroger has two pilot programs underway, one in Columbus, Ohio and another in Huntsville, Ala.

But it's not anxious to move aggressively. "With the razor thin margins, you have to take a cautious approach," said Kroger spokesman Gary Rhodes. "We're not interested in getting into any business where we're going to lose money."

Salvation beyond groceries
In the face of such odds, Webvan's ultimate salvation may lie in an expansion beyond groceries. Webvan has said it could use the distribution system to handle other needs for time-pressed consumers.

"A lot of us believe (Webvan's) aspirations are well beyond the grocery business. They're positioning themselves to be something beyond a grocery play," Cassar said.

They won't be the only ones. Streamline.com Inc. (Nasdaq:SLNE), which currently serves customers in the Boston, Chicago and Washington markets, installs a small, locking refrigerator at the customer's home, so that they don't need to be home for deliveries. The service will also deliver things like dry cleaning, film and videos.

"That's a very attractive value proposition to many consumers," analyst Karris said. "The answer in my judgement is that grocery is only the cornerstone of the business. It's really about owning the last mile and becoming a trusted concierge for the services that take a consumer's time."

As Webvan's stock goes on sale Friday, it will be one of the more closely watched IPOs of the last few months. If all goes well as the stock goes public, the company will be worth more than a whopping $4 billion.

What's even more amazing, though, is that the Foster City, Calif., startup could achieve such gargantuan valuation in the face of equally goliath negatives -- the market for online groceries isn't that big, and no one knows how long it will take demand for such a service to develop. What's more, delivering groceries is far different from books or computers -- by some accounts, fulfilling a weekly grocery order is nothing less than a logistical nightmare, especially in a business with paper thin margins.

There's no doubt Webvan has sizzle. It managed to raise $122 million from from a group of blue-chip partners whose ranks include Benchmark Capital, Sequoia Capital, CBS and Softbank. (Softbank is a majority shareholder of Ziff-Davis Inc., which publishes ZDNet News.) Webvan's backers also include Louis Borders, the former chairman of Borders Books. George Shaheen, former Andersen Consulting CEO, is the online grocer's chief executive.

"These are name plate venture groups that have been involved in very successful IPOs and Web companies," said Peony Kao, analyst for IPO Plus Fund (Nasdaq: IPOSX) at Renaissance Capital in Greenwich Connecticut. "I think a large part (of the valuation) is simply the management."

And Webvan isn't just attracting money. It's spending it as well. Earlier this year, the company signed a $1 billion, three-year deal with construction giant Bechtel Group Inc. to build 26 distribution centers around the country.

This approach -- distributing from big centralized warehouses rather than local grocery stores -- represents the twist that may have kick-started investor interest in online groceries. It also represents the same argument that's rocketed other online e-commerce pioneers, such as Amazon.com Inc. (Nasdaq:AMZN), to prominence: The costs of distribution centers are more than offset by the savings of not having to operate local stores.

Other companies had been trying out that model, including grocery store chains, including Albertson's and Kroger, and online-only players like Peapod Inc. (Nasdaq: PPOD). But those companes were moving relatively slowly.

"Peapod evolved toward localized central distribution model. They had one big warehouse with suppliers shipping in and (Peapod) shipping out from there," said Ken Cassar, analyst at Jupiter Communications in New York. "But Peapod was moving so slowly. Enter Webvan. Suddenly they have the money to build that model out everywhere. They used half of the $120 million to build a San Francisco center, and then they made the billion dollar Bechtel deal."

Consumer demand?
But even if Webvan can expand the model nationwide, the business will still be tough.

Buying groceries online today is roughly the equivalent of buying books online a few years ago -- something only a few early adopters were doing. Jupiter Communications says online grocery sales were only $115 million in 1998, not even close to 1 percent of the $450 billion overall grocery market.

"Online grocers serve half of the 30 largest cities in the US currently. And coverage is mixed within those cities, targeting the most wealthy suburbs where they can reach the most attractive consumers," said Nick Karris, analyst at e-commerce research firm Gomez Advisors in Lincoln, Mass. "They're looking for dual income families with kids, where mom and dad are strapped for time and have income to spend on services like this."

Even if demand develops, there's no telling how fast it would grow. While shopping online sounds like a good idea to a growing number of Web-savvy consumers, there's still a big question about how many would actually opt for it if available.

Evidence: A January survey by the Food Marketing Institute found that, while 19 percent of consumers said they'd use an online grocery shopping service, only 3 percent actually did so when it was available at their primary supermarket.

'Heavy-duty logistics'
Webvan's biggest challenge, though, may simply be in the execution. Central distribution or not, fulfilling a grocery order of dozens of items, including perishables, represents an endeavor quite different from packing and shipping books.

"Everyone forgets that online grocery shopping is a heavy-duty logistical proposition," said David Merrefield, the editor of Supermarket News, a trade publication. "There's tremendous backstage complexity -- the process of assembling orders, picking them up from distribution center putting into a truck, routing them and delivering at the time the consumer happens to be at home."

Plus, there's not much room for error. This is an industry that makes its money on volume, not the spread. It operates on margins of a mere 1 percent to 1.5 percent. That one of the reasons the big chains have moved so slowly into the online field. Kroger has two pilot programs underway, one in Columbus, Ohio and another in Huntsville, Ala.

But it's not anxious to move aggressively. "With the razor thin margins, you have to take a cautious approach," said Kroger spokesman Gary Rhodes. "We're not interested in getting into any business where we're going to lose money."

Salvation beyond groceries
In the face of such odds, Webvan's ultimate salvation may lie in an expansion beyond groceries. Webvan has said it could use the distribution system to handle other needs for time-pressed consumers.

"A lot of us believe (Webvan's) aspirations are well beyond the grocery business. They're positioning themselves to be something beyond a grocery play," Cassar said.

They won't be the only ones. Streamline.com Inc. (Nasdaq:SLNE), which currently serves customers in the Boston, Chicago and Washington markets, installs a small, locking refrigerator at the customer's home, so that they don't need to be home for deliveries. The service will also deliver things like dry cleaning, film and videos.

"That's a very attractive value proposition to many consumers," analyst Karris said. "The answer in my judgement is that grocery is only the cornerstone of the business. It's really about owning the last mile and becoming a trusted concierge for the services that take a consumer's time."