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strategy and business
 / Spring 2003 / Issue 30(originally published by Booz & Company)


What FreshDirect Learned from Dell

Not only does vertical integration shorten the supply chain to improve product quality, it also cuts out the middleman, allowing FreshDirect to garner higher margins while still offering a broad selection of fresh food, greater customization, and low prices.

Dell also eliminated the middlemen of the computer industry supply chain — the value-added resellers and retailers — by offering its own brand assembled to order from the same quality of components used by the established brands. FreshDirect applies this model to coffee beans: The grocer offers 55 standard varieties of coffee from 22 different coffee beans, which are roasted and ground to order. But if those options don’t fit the consumer’s needs, FreshDirect will prepare a customized blend by combining the 22 beans in any proportion desired. Although roasting and blending add further costs, the raw beans can be procured for as little as 70 cents per pound, leaving room for both low consumer prices and attractive margins.

Direct sourcing of ingredients also gives FreshDirect the ability to offer a selection of fresh prepared entrees, side dishes, deli salads, and the like at appealing prices. For example, a meal of rotisserie chicken, mashed potatoes, and glazed carrots that feeds three to four people costs under $14 — less, even, than the cost of the Chinese, Thai, and pizza delivery operations that flourish in food-rich Manhattan. FreshDirect expects to add more of these value-added product lines over time as demand increases and operational execution stabilizes.

FreshDirect leverages vertical integration in its operations to provide unique value propositions to its commodity suppliers, a classic example of strategic sourcing. For example, the company buys “Raised Right” branded chicken from College Hill Poultry in Fredericksburg, Penn. The Raised Right logo is featured on FreshDirect’s Web site, as are details about how the company’s antibiotic-free chickens are raised in Pennsylvania Dutch country. By helping College Hill build its brand, FreshDirect ensures its access to this high-quality product. Because FreshDirect cuts and packs the chicken to order, bypassing those normally involved in the traditional grocery supply chain, it is able to sell Raised Right chicken at a price comparable to that of unbranded poultry.

Despite its clear focus on perishables, FreshDirect does not completely ignore the standard grocery items. FreshDirect is a small operation, especially compared with Kroger Company, the leading pure grocery store chain in the United States at $50 billion in annual revenue, or even Albertsons Inc. or Safeway Inc., the number two and three chains, each with revenues well over $30 billion. So the startup faces a substantial disadvantage when it negotiates pricing with giant consumer goods companies such as Unilever PLC, Coca-Cola Company, and Procter & Gamble Company. FreshDirect compensates for its lack of conventional negotiating leverage by letting major consumer goods companies compete for exclusive positions on its Web site — a marketing advantage these companies can rarely achieve in traditional grocery stores. For example, FreshDirect offers six Coca-Cola flavors (Classic, Caffeine-Free, Vanilla, Diet, Caffeine-Free Diet, and Diet with Lemon) in three sizes (2-liter, 12-ounce/12-pack, and 12-ounce/ 6-pack) for a total of 18 different SKUs. But not a single bottle or can of Pepsi is for sale. Similarly, a search for Keebler on the FreshDirect Web site turns up 28 different snack products, whereas a search for Nabisco produces no hits.

Limited SKUs
In general, FreshDirect seeks to maximize its volume per item by limiting the number of SKUs it carries. If you are loyal to a specific brand of powdered detergent, then you might be disappointed in what FreshDirect can deliver: It offers only two brands, Tide and Ivory Snow. Tide does come in three different types — regular, unscented, and Tide with bleach — but only in the 78-ounce size. The Ivory Snow comes only in one type and a 26-ounce box. By comparison, one Manhattan grocery store offers 12 different brands in various sizes.

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