Webvan, by contrast, invested heavily in technology and automation (i.e., fixed costs) to drive down labor content (i.e., variable costs) in picking and packing. According to its financial plans, Webvan's gargantuan automated distribution centers (the size of 18 regular supermarkets) would cut labor costs in half and fund the incremental costs of delivery. Unfortunately, the needed volume did not materialize because the online value proposition appealed to time-starved consumers and did not attract the core cost-conscious consumers most likely to shift allegiance to a new retailer. Without adequate volume, the high fixed costs outweighed the anticipated savings in labor cost, so Webvan unwittingly created a high-cost option rather than a new low-cost option.
By failing to offer lower prices that could attract the coupon-clippers, the pure-play online grocery model has lost all credibility. No longer threatened, traditional grocers have seized control of the surviving players: Royal Ahold has acquired Peapod; Safeway and Tesco jointly control GroceryWorks; and someone (perhaps Kroger) will scoop up Webvan's useful assets at fire-sale prices. Online grocery shopping has become the latest service offered by competing grocers, rather than a dramatic format revolution.
Hurrah for the Hybrid Model
Early on, the U.K.'s Tesco recognized the real value of online groceries, smartly building a hybrid model that combines online ordering with offline assets. Tesco's "personal shoppers," armed with a shopping cart, bar-code hardware, and routing software, pick as many as six orders simultaneously. Tesco charges a per-order fee of £5 (roughly $8), enough to cover most of the incremental cost of picking and delivery. Tesco uses the service to attract and retain high-end convenience-oriented customers who buy more expensive goods and push up margins.
Tesco claims this model is profitable, and it may well be, since by design it can gradually expand to meet growth in consumer demand: As more consumers shop online, Tesco simply adds more personal shoppers and carts.
Tesco's model recognizes that online shopping appeals to service-oriented consumers, not the core price-conscious segment. As such, Tesco's approach will never transform the industry. It will, however, become a common service adopted by the other evenly matched players in their never-ending quest for a competitive edge. Just as they incorporated deli counters, fresh seafood shops, and pharmacies, so will grocers add online ordering and delivery to eke out a fleeting advantage.
The lesson for common-goods retailers: If you've got the low-cost business model, push low prices hard to win customers and expand; if your costs are higher than competitors', forget about the price-conscious consumers and move upscale, much as Macy's did in the 1960s. Retailers — and investors — who ignore this history do so at their extreme risk.
Nicholas Hodson, firstname.lastname@example.org
Nicholas Hodson is a principal with Booz-Allen & Hamilton's Strategy Practice in San Francisco. His consulting work focuses on business strategy and implementation across a range of industries, particularly retail and oil-and-gas.
Tim Laseter, email@example.com, serves on the operations faculty at the Darden Graduate School of Business at the University of Virginia. Previously he was a a vice president with Booz Allen Hamilton in McLean, Va. Mr/ Laseter has 15 years of experience in building organizational capabilities in sourcing, supply chain management, and operations strategy in a variety of industries.