On January 12, 2001, the Webvan Group was notified that it had 90 days to bring its stock over a dollar for 10 consecutive trading days to avoid being delisted1from the Nasdaq: it had failed to meet a minimum bid price of $1 for 30 consecutive days.

In April, the company sought $25 million to stay afloat. At the end of trading on July 6, 2001, Webvan's stock stood at 6 cents a share. The following Monday, Webvan, the second best-ever-financed on-line retailer, announced that it was filing for Chapter 11 bankruptcy protection and would lay off most of its 2,000 employees. On the morning of July 9, many workers learned of their fates as they arrived at work to find the gates locked.

This fall from grace in the eyes of investors was in some ways puzzling. At one point, the company had been the best capitalized of the online grocers, with a war chest of approximately $800 million raised from private investors and the public via an initial public offering (IPO). Many customers who had used Webvan's delivery service loved it; and for three straight quarters in 2000, it had been voted the best online grocer of 12 in a survey. In some markets, the company had exceeded the average consumer order size that it had projected for itself at this point in time and in the last quarter of 2000, it had posted a gross margin of 27% that compared favorably with the 27% to 30% gross margins typically seen by large conventional grocers. It had also continued to innovate, initiating a successful program to take advantage of under utilized daytime delivery capacity.

However, Webvan had also projected in its 1999 prospectus that the expensive distribution centers (DCs) it used were likely to be operating at breakeven capacity within five quarters of being launched. At the end of fourth quarter of 2000, six quarters had passed since Webvan's flagship DC in Oakland, CA, began operation and the company had not yet hit this widely publicized target. In addition, the company had faced several unanticipated difficulties with its operations and with convincing enough consumers to purchase groceries often enough. In September 2000, George Shaheen, the company's CEO, announced that Webvan would indefinitely delay expansion into the Washington, D.C., Baltimore, and Bergen Country, NJ markets as had originally been planned although the company had already spent $45 million on the DCs to serve these areas. At the start of 2001, the company had $212 million in cash and a perilously high cash "burn rate." It chose to cutback marketing expenses stating that it would instead focus on getting current customers to order often having difficulty getting a close-in "delivery window."

Observers of Webvan had long voiced doubts about the company's viability. As news of the closedown spread, many people recalled an April 1999Wall Street Journalarticle that wondered whether the company would become the Internet era's equivalent of the movie "Waterworld," a disaster so epic it becomes American legend."11This had, in fact, come to pass, but why? Why did Webvan fail so dramatically? And why had no other company decided to purchase its assets, including elaborate nationwide physical and IT infrastructures? Were these really without values?

Company Founding

Genesis of Idea

Louis Borders, the founder of bookseller The Borders Group Inc., had an epiphany when he opened a FedEx package containing some Japanese spices and other specialty items that he had ordered from a catalog in 1997. He recalled, "I kept thinking that I would need a loading dock outside my house to use the Internet to buy things. And on top of that, I'd have to pay $10 per package."12He came to believe that online retail would never make it unless there could be a faster, cheaper and more efficient ways of delivering items to customers. Borders wanted to take advantage of the growing number of people making purchases online by creating an enterprise that would offer greater variety than conventional stores and yet provide the convenience and instant gratification that online shoppers missed.

Borders incorporated Intelligent Systems for Retail in December 1996 and in April 1999 changed its name to the Webvan Group. The mission of the new Foster City-based company was "to deliver the last mile of e-commerce," meaning the delivery of merchandise from a DC to a customer's doorstep. The last mile was also referred to as "the gilded pathway into the homes and hearts of America's consumers that everyone from Amazon.com to Wal-Mart to Fred Smith's FedEx lusts after."

The Webvan Group planned to begin by offering groceries which people shop for frequently to build critical mass, order frequency, and economies of scale. With an established customer base, it then planned to leverage its distribution system to expand to other categories, adding items such as consumer electronics and books whose profit margins were considerably greater than for groceries but were ordered less frequently. That is, they planned to attract an audience first and then "monetize those eyeballs: to bring in additional revenue and do this on a global scale.

From 1997 to May 1999, the company focused on developing the web store and constructing its first distribution and fulfillment center in the San Francisco Bay Area. Following a trial of its grocerydelivery service in May 1999 to 1,100 people, the web store was launched in June 1999 as a venture,whose mission was to deliver everything from groceries to palm pilots to consumers in a cheap and efficient manner.

Borders stated, "Intuitively, I knew I'd have a great financial model if I could eliminate store costs."18However, where he saw "a cornucopia of opportunity," there were those who wondered whether people were in fact going to migrate their purchases of groceries and many other items to the Internet, and whether the new company could crack last mile problem.

Management Team

To realize his vision, Borders recruited a management "dream team." Borders himself served as first Chairman and CEO of the company. Borders had developed the advanced information systems used by the company he had founded earlier, Borders Books, to manage inventory across the country and had also co-founded another company, Synergy Software, in 1989. He was also instrumental in designing the warehouses with intricate processes that the Webvan Group would rely on.

In September 1999, Borders recruited George Shaheen from his role as CEO of Andersen

Consulting. Shaheen, whose first job was bagging groceries and trimming beef part-time in

Elmwood, IL, had spent 32 years at Andersen and had helped create the world's largest consulting firm. He stood to collect a $10 million bonus upon retirement from Andersen Consulting in 11 months plus additional payouts from his group's venture investments. At the Webvan Group, with a salary of $500,000, a ninth of what it was at Andersen Consulting, Shaheen held 1.25 million shares of stock, in addition to 15 million options. If the company did well, Shaheen's stake would have been worth $100 million. The company also hired senior executives from Goldman Sachs & Co., Oracle Corporation, Federal Express, American Stores Company, Marriott International, and General Electric. SeeExhibit 1for more background on the company's management team.

David Beirne, a managing member of Benchmark Capital, served as a member of the board in addition to Christos Cotsakos, who was the CEO and Chairman of the Board for E*Trade. Tim Koogle, the CEO of Yahoo! Inc., and Michael Mortiz, general partner at Sequioa Capital, also sat on Webvan's board.

Funding

By April 1999, the Webvan Group had already attracted $120 million in funding from high-profile backers such as CBS Inc., Knight-Ridder Co., Softbank Co. of Japan, as well as Benchmark Capital and Sequoia Capital, two leading venture capital firms.

There had been no online grocery successes at this point in time: the best known online supermarket, Peapod Inc., had a $21 million loss on revenue of only $69 million in 1998 and another competitor, Netgrocer Inc. had laid off employees in the fall of 1998 after poor results.

The Webvan Group, however, pointed to the inability of these online

business model.

By July 1999, Webvan had garnered an additional $275 million by selling a 6.48% stake to

25

David Beirne of Benchmark Capital, one of the first to finance the company noted, "This could be the biggest company to come out of Silicon Valley."28By the time of its postponed initial public offering29on November 5, 1999 which was underwritten by Goldman Sachs & Co., the company had a only a meager operational record and had collected only $4 million in revenue. Nonetheless, the company managed to raise an additional $400 million in its IPO. On its first day of trading, the company's initial share price of $15 rose at one point to $34 giving it $15 billion capitalization before falling to $25 by the end of the day30(Exhibit 2provides a chart showing the company's stock price

Goldman Sachs & Co., Softbank Co. and Sequoia Capital.

$400 million in four rounds of venture capital financing, the most for an Internet company in 1999. Commenting on the company's valuation, Jim Barksdale, the former CEO of Netscape, observed, "I've never seen anything like it."27Webvan announced in August 1999 that it planned an initial public offering where it hoped to raise an additional $300 million.

In the end, it had raised a total of about

26

602-037 Webvan

over time). Its day-end $8 billion market capitalization was about 40% of the market value of the

31

In its prospectus filed with the Securities and Exchange Commission (SEC) in November 1999, the Webvan Group noted that the total US market for groceries, drugstore merchandise and prepared meals alone was over $650 billion in 1998,33and that International Data Corporation (IDC) estimated that the 63 million web users in the United States at the end of 1998 were projected to grow to 177

34

Noting the company's valuation, one Safeway executive whose company had a share price of $40 at that

nation's largest supermarket chain, Kroger, which had 2,200 stores and a share price of $23. point, bristled, "They have the sales of two of our stores and one fourth of our market cap."32

Size of Market

million users by the end of 2003.

Consumer purchases of goods and services online were projected

to increase from $12.4 billion in 1998 to $75 billion by 2003.

35

Specifically, online grocery purchases

that amounted to $235 million in 1998 and $519 million in 1999 were expected to grow to $3.5 billion

by 2002, $10.8 billion by 2003, and rise to $16.8 billion by 2004; they would represent 2% of the total

36

online in a few years37while Jupiter Communications forecast in 1999 that the online grocery market

38

Webvan's aim was to capture a substantial chunk of this growing market. The company noted that traditional grocery stores had to limit the number of items they carried in their stores. In addition, traditional stores had to face the costs of building and operating stores near residential areas, and had significant costs associated with personnel, store set-up and inventory. Webvan

grocery market.

Forrester Research projected that 5% of U.S. households would be buying groceries

would be worth about $3.5 billion in 2000 and $6.5 billion by 2003.

39

company's "end-game"he saw the market as $1.5 trillion, an IDC projection for 2003, which

40

Based in Foster City, CA, the Webvan Group aimed to deliver dry and perishable goods to consumers' homes, at competitive prices, within a specified 30-minute window. Customers who logged onto the Webvan Group's web site upon launch were able to choose from 15,000 grocery

41

sought to provide a more cost-effective solution.

Ultimately, Shaheen never saw groceries as the

encompassed all web-based purchases.

Original Business Model

Overview

items at prices that were initially competitive with off-line retailers.

Offerings at the company

included fresh produce, premium meats, fresh seafood, prepared-meals, bakery items, non-

perishable items found in conventional supermarkets, wines, cigars, as well as non-prescription

42

The challenge faced by the Webvan Group was the delivery of perishable and dry goods at competitive prices to consumers within a 30-minute window chosen by the customer on a scale never

Customers were able to place orders anytime, pay by credit card, and schedule deliveries

drugs.

within a 30-minute window the same day or up to four days later.

membership fees, and delivery was to be free for orders over $50 with smaller orders carrying a $4.95 surcharge. With its staff of courteous and friendly drivers who did not expect tips, the company hoped to quickly gain a large number of customers who would be happier about convenience and service than getting discounts. Thereafter, with an established customer base in one geographic area, they planned to expand across the country to other markets as well as expand their product offerings.

43

Webvan did not require any

Webvan 602-037

before attempted. The grocery category also provided a challenge because of its razor-thin margins

44

Motivating consumers to shop online was viewed as an uphill battle since many people did not

46

Shaheen saw the company's target customers as women and, more specifically, soccer moms that is, mothers in urban, two-income families with a combined income of more than $75,000 and

48 49

52

Operations

Warehousing and order managementTo tap into the online consumer market, the Webvan

Group took an approach that was capital and technology intensive. Central to Webvan's approach

was a highly automated central DC that could carry as many as 50,000 items and process 8,000 orders

55

Goods received at the distribution center were broken down immediately from cases to "eaches" (singular items) and transferred to trays, which were the containers used to store inventory. Each tray carried a unique bar code license plate, which was used to track all movement in the system. Product barcodes were scanned by workers and the number of items on each tray were entered in conjunction

56

Webvan knew that the "last mile to the consumer" posed an enormous logistical problem, especially with groceries, but as Shaheen expressed it, "two or three companies will legitimately earn the right to cross into a person's

of 1% to 1.5% and the wide product range and temperature requirements. home. We intend to be one of those."45

Customers

want to pay delivery charges and everyone demanded high service standards.

grocery store on a weekly basis was highly ingrained behavior. However, the company believed that the "market demand for high quality reliable grocery services [was] enormous and [was] very much like the pent-up demand for high quality wide-bandwidth communications."47

He noted that 1% to 3% of this target market would make the economics of the new People made an average of 2.4 trips to the grocery store per week and spent an

little spare time.

company work.

average of $4,600 annually in the process, about 10% of their income.

conducted in San Francisco to learn how many people would be likely to use an online grocer, 6% of respondents noted "absolutely," 23% said probably. Shaheen believed that 35% of the market would

51

The Webvan Group also noted that most people viewed grocery shopping as an inconvenience and that nearly 55% of all Americans considered time to be their most precious commodity. However, other studies had apparently shown that consumers

be buying groceries on the Internet by 2003-2004.

put little economic value on their time in the supermarket.

53

could serve as many people as 18 conventional supermarkets and contained cooking facilities as well

a day.

The company constructed its first DC in Oakland, CA, a 330,000 square feet warehouse that

54

carousels with a storage capacity of 107,000 locations and contained about 5 miles of conveyor belts

as multiple temperature zones to store items such as wine, cigars and ice cream.

that moved through a series of put-away and pick pods, where goods could be loaded by workers.

with each tray's barcode license. across multiple carousels.

To increase throughput, Webvan spread high-demand products

When a customer placed an order online and specified a delivery time, the information was conveyed to the central DC. There, the appropriate quantities of colored totes were assigned to the order; yellow totes were for used dry groceries, green totes for chilled products and blue totes carried frozen goods. Each tote was given a bar code license plate that linked to a specific customer's order

57

and could then be tracked throughout the fulfillment process.

A custom-written piece of software

5

50

In a survey the company

Moreover, going to a

The DC had 41

602-037 Webvan

would then devise the optimal "picking plan" for each tote, or the route it would follow through the

DC. The totes' routings were determined by the time required to pick each part of an order, the

scheduled delivery time and the existing workload. Routes were also calculated so that the biggest,

heaviest or most solidly packed items came first so that smaller, more delicate items would not be

58

crushed. A series of scanners, fixed or hand-held, read each tote's barcode as it passed through the

59

61

keep them busy", noted Gary Dahl, Webvan's vice-president for wholesale.

As a tote came to a pod, carousels would move into position to place the ordered items within

reach of the picker. A "light tree" display next to the carousel bins would then tell the picker which

items to pick and a "sort bar" display on the conveyor belts would indicate which items to put into

which tote. Once an item was placed in a tote, the picker hit a button to confirm that the pick was

complete; the next item then appeared, or a signal let the picker know that the tote was complete.

After completion, the picker would close the tote and place it on an express carousel that took it to

The Webvan Group had exclusive relationships with vendors who supplied the company with the conveyors, carousels and light displays. In fact, the company was so protective of its carousel

64

66

maintained that its produce would therefore be of higher quality. However, not everyone was

impressed with the technology. Some believed that the automation would only save the company 1%

67

analysts doubted that this would yield significant cost savings to Webvan.

DeliveryOnce at the DCs dock, orders were separated by delivery route and loaded onto

69

The Webvan courier delivered the order to a customer's home and unpacked the totes. Using a wireless hand held device the courier could print out a receipt and an itemized list of the order and

Workers known as "pickers" were stationed at the pods, and were responsible for assembling

60

that in a single hour, pickers could pack 450 grocery itemsnearly 10 times the productivity of a

orders.

Each picker could work on as many as 16 orders simultaneously and the company claimed

Pickers assembled orders from rotating carousels that carried items to them so that they would not have to walk more than 19 feet. An MIT trained mathematician, Borders reasoned that within 10-feet, not enough items could be near the "picker" while 30 feet was too long for a "picker" to walk. "You want to keep people stationary so you can

62

shopper wheeling a cart through a supermarket.

63

area at approximately the same time.

the shipping area.

The process was timed to ensure that all totes in an order arrived at the shipping

technology that it did not allow the carousels to be photographed.

felt, would allow it to increase its offerings without a proportional increase in personnel. The company also claimed that as a result of the automation, grocery products were only handled an average of 8 times as compared to an average of 14 times for a conventional supermarket; Webvan

Others noted that 40% of the company's product volume was fresh and frozen food that the company was not able to automate because of the labor-intensive nature of picking/preparing fresh food. Another 25% of the company's offerings were fulfilled from the less automated mechanized pods that were used to store heavy or fast-moving items such as soda. The remaining 35% of items were picked using the highly automated carousel pods and

68

The totes were then transported to one of 10 to 12 manned depots within a 50-mile radius of the DC (Federal Express served as the model for the company's hub and spoke delivery system). From the manned depots, individual orders were put on one of about 60 delivery vans that would then take goods to the customers. By design, van drivers, called "couriers" would not have to travel more than

10 miles in any given direction to reach a customer.

of the cost of groceries being sold.

dollies that would be wheeled onto trucks that had ambient, chilled, and frozen compartments.

Such automation, the company

65

Webvan 602-037

check items against the order list. The mobile device also gave a courier access to a customer's back orders so a customer could be immediately credited for any returns they might have. If a delay

70

occurred, customers would be informed, refunded $3, and given the option to reschedule delivery.

71

The Webvan Group spent three years and hired 80 software programmers to create the

73

Speaking of the company's couriers, Shaheen commented, "Couriers are our ambassadors of reliability and

If a customer was not home, the company added a $4.95 charge for a re-delivery attempt. they can be our saving grace if there are problems."72

Information Technology

proprietary systems linking and automating many aspects of its business process.

It spent about $15

million on this process in 1999 up from $3 million the previous year and 0.2 million in 1997.

74

In its

1999 annual report, the company claimed that it had spent 50 person-years of effort on software

75

The company also invested heavily in inventory forecasting. Forecasts incorporated expiration dates, and could be changed on a daily basis to deal with changes in demand. Webvan also relied on internal benchmarking of its inventory and distribution systems (for example, pick rates of products were monitored so that if demand lagged, the placement of products in the DC could be modified)78and claimed that it followed

79

The entire operation was supported by a warehouse management system from Optum Inc., which

allowed integration of the company's custom-designed inventory, materials handling, order tracking,

80

accounting, and transportation management systems. The design and complexity of Webvan's

system was, however, something Optum had not dealt with before and the project pushed the

81

Webvan used Descartes System's software to optimize delivery routes for a set of orders given a set of resource constraints such as number of delivery vans available. In addition, the software was used to optimize delivery schedules. When a customer placed an order, delivery slots were either marked available or unavailable. Unavailability of a slot did not necessarily mean that the slot was

82

Ultimately, the set of scalable and replicable systems used, claimed Webvan, would not require as many warehouse employees, stock personnel or cashiers seen in conventional supermarkets. That is,

83

At the launch of its Oakland DC, the company's distribution system operated five days of the

85

To stock its warehouses, the company had to establish and develop relationships with wholesalers

and suppliers. In its IPO filing with the SEC in 1999, the company noted that it offered its suppliers

an efficient supply model, which would be reflected in the discounts and pricing of goods it

86

development.

The system would be aware of the location of every stock-keeping unit or "SKU," and how many

76

suggestions from its employees, many of whom had been in "pick environments" before.

of those SKUs were on hand at a DC at any point in time.77

company to expand its ability to interface with the material handling equipment.

taken; the system could rule it out based on the time and location of other committed deliveries.

the system would allow an increase in volume without a concomitant increase in human resources. Bud Grebey, the company's spokesman proclaimed, "If you want to fly to Mars, you don't build a rocket ship to carry you halfway there. The key is software that handles the logistics."84

week although the company anticipated full-week operation in a few months post launch.

Supplier Relations

received.

For instance, Webvan noted the lower costs to suppliers who no longer had to come as

for operations in 1999, it was purchasing goods from 10 distributors and directly from 160 vendors.

often to replenish products as they had to at conventional supermarkets.

When the company opened88

Purchases were based on a combination of anticipated and actual demand. Because of the 24-hour

minimum lead-time for an online order the company had more demand-based information that it

could transmit to suppliers. To communicate this information to suppliers and to ensure just-in-time

order fulfillment and real-time drop delivery of its products, Webvan partnered with Harbinger.net,

89

suppliers in packages and forms that would make Webvan's merchandise processing more efficient. Specifically, unlike bricks-and-mortar retailers that dealt in pallets, Webvan dealt in "eaches" (singular items) and wanted its inbound shipments to arrive in a form that could be broken down quickly and moved to the pods and carousels. Shaheen noted, "We are not a pallet operation. We're working with suppliers so they can re-engineer their supply chains that come to us."92

Shaheen also wanted to avoid the costs associated with fully stocking all of Webvan's DCs. Instead, he planned to create connections with suppliers and manufacturers along the company's supply chain so that only fast-moving items would be stocked at Webvan's DCs. Webvan's partners would carry the rest and delivery them on a just-in-time basis; Webvan's DCs would include "cross docking" facilities where these supplier deliveries would be integrated with items picked from within

93

For brand name suppliers such as Pillsbury, General Mills and Proctor & Gamble, the online grocery market was uncharted territory, and one where they did not have to compete with generics;

94addition, Webvan could also provide manufacturers information such as what individual consumers

95

To entice prospective customers in the San Francisco Bay Area to try its service upon launch in

96

The company's top tier suppliers began using its system soon thereafter and the

in January 2000.

company planned to have all its suppliers linked in this fashion in the future. The company provided its suppliers with information on consumer choice and wanted merchandise sent to it by

91

In exchange for these considerations, Webvan chose not to charge manufacturers the "slotting fees" they normally had to pay to get a product on a store's

shelves.

the DC to complete each customer's order.

to them, Webvan offered to the opportunity to deliver product samples directly to consumers.

In

bought and whether a particular product made it on a customer's "re-purchase" list.

Marketing

June 1999, the company waived delivery fees regardless of order size through July 31, 1999.

In

addition, the Webvan Group advertised that its prices were 5% lower than conventional grocery

97

stores. Following the launch of its service in June 1999, Webvan planned to increase spending

98

It also planned to leverage its relationship with media investors such as CBS and Knight-Ridder.

And with the data it gathered on consumer purchasing, preferences and behavior, it planned to offer

targeted and customized services. In 1999, the company announced that it planned to spend $6 to $9

million annually in advertising for each city and a total of $200 million on advertising in the year

99

Growth and Efficiency Projections

Webvan planned a national rollout to achieve economies of scale since all of the 26 DCs the company planned would conform to a single design, and be managed with a uniform technology

substantially on its radio and newspaper advertising campaigns to build brand identity and loyalty.

2000.

90

Webvan 602-037

platform. In July 1999, the company entered an agreement with the Bechtel Group, the engineering and construction firm, to construct these DCs across the country at a total cost of $1 billion. With each DC costing around $35 million the savings were projected to be tremendous since it would cost $90 million to build the 18 supermarkets that would be the equivalent of each DC. In its prospectus the company stated that it planned to begin distribution in Atlanta, Chicago, and Seattle by the end of

100

101

2000 and that an additional 7 centers were slated to open in 2001.

The company had to contend with two big costs that a traditional grocer did not pay forpacking

carts with customers' orders and delivering the ordered items. could be assembled in less than one hour.

At the DC, the average 25-item order

The central DC proposed to service the equivalent of consumers from 18 conventional supermarkets but with less than half the labor and double the selection of items. While a conventional supermarket was constrained by the number of items it could offer customers, Webvan's DCs were

102

give the company a 10 percentage point edge on profit margins over traditional supermarkets.

With a DC operating at its designed capacity and as a consequence of the additional demand- based information in the supply chain, the company also projected that inventory would turn 24

105

And each DC, the company claimed would require only 900

designed to stock 50,000 items.

employees as opposed to the 2,700 that would be required in 18 conventional supermarkets. Ultimately, the highly automated warehouses that allowed a picker at Webvan's DCs to be nearly 10 times more efficient than a normal shopper wheeling a cart down a grocer's aisle were expected to

104

times annually as compared to the 9 to 11 times seen in traditional supermarkets.

RevenueAt full capacity with 8,000 orders a day and an average order of $103, the company

106

supermarkets which had to operate near residential areas.

The company also projected achieving operating profits of 12% of sales, triple the grocery industry average when its DCs would be operating at full capacity and after absorbing the costs of entering

At half this volume, the company expected to An average supermarket, on the other hand, typically brought in $12 million a year. And by situating its DCs in low-rent industrial zones, the company hoped to set real estate costs at 1% of revenue (generated when operating at full capacity) as opposed to the 6% seen for conventional

108

projected annual revenues of $300 million per DC.

break-even.

107

109

underwrite the cost of deliveries to customers' homes and customers could expect free delivery on

110

Borders stated that if everything went according to plan, the Oakland DC would be profitable within six to 12 months and "other Webvan warehouses might break even in as little as 60 days."111The company's prospectus filed with the SEC in November 1999 was more conservative: it stated that a DC viewed as stand-alone business unit was likely to generate significant cash flow following five quarters of operation. Analysts expected the company to have $11.9 million in sales in 1999an amount that was less than Safeway or Kroger made in a single busy afternoon but that would soon

112

Market penetrationThe company had stated that if approximately 1% of households, about 120,000 families, in the San Francisco Bay Area used its service consistently, it could achieve positive earnings (before interest, taxes, depreciation and amortization) for the Oakland DC, if the DC were

113

new markets and enlisting new customers.

The resulting savings, it claimed would then allow it to

any order over $50.

climb to $120 million in revenue in 2000 and over $500 million in 2001.

viewed as a stand-alone business unit.

In general, the company felt that it needed to achieve a 1%

602-037

Webvan

114

then in 1999, analysts sounded alarms that Webvan might expand faster than consumer demand.

to 3% penetration to achieve positive earnings on a similar basis in other markets.

However, even115

Skeptics such as Dan Rabinowitz of Peapod, a competitor online grocer, noted that the company would have to do eight times the volume of a typical store to be successful and said, "We're in 10 markets, and we've seen how difficult it is to build up scale."116Others thought that the company was "in over its head" stating that the problem with the company's delivery model was largely one of density and that "[t]ransportation should be in the hands of transportation professionals who know how to do it."117

However, speaking of the Webvan system, Shaheen said, "This is not your mother's grocery store.

It took a total reengineering of the supply chain and a total e-engineering of the business model to

put this together."118And Kevin Czinger, the company's chief financial officer insisted that the

Webvan Group would be "highly cash generative" and break even within five quarters after

119

Changes and Performance over Time

Since its launch in the San Francisco Bay Area in June 1999, sales at the company improved steadily as did its revenues (seeExhibit 3for the company's quarterly income statements). However, losses continued to mount at a high rate given the company's capital-intensive business plan. In keeping with its expansion plans, by the third quarter of 1999, the company had signed leases in

launching.

120And by the end of 1999, it had signed an additional set of leases to serve Denver, northern New

locations that would allow it to serve the Washington D.C., Dallas, Chicago and Seattle markets.

121

The Webvan Group chose the San Francisco area for its debut, citing residents' food and Web savvy. The highly automated system that the company built was, however, vulnerable to bottlenecks, misaligned totes, misread displays and Shaheen acknowledged in January 2000 that incomplete

Jersey, Philadelphia, New York City, Boston, Orange Country and Baltimore.

Early Performance in the San Francisco Area

122

delivery time was a problem for customers. To address this problem, Webvan intended to guarantee

123

One quarter after opening, at the end of September 1999, the Webvan Group was operating its 330,000 square foot flagship San Francisco Bay Area DC located in Oakland, CA, at less than 20% capacity. The DC was operating for five days a week and the company employed 630 people. Its offerings had increased since its launch in June 1999 from 15,000 items to 18,000 items at the end of September 1999. Repeat customers ordered every 10 days on average (from launch through the third

124

By the end of 1999, the company had extended its distribution operations at its Oakland DC to six days a week but it was still operating at less than 25% capacity and stated that it now dealt with 130 distributors and about 230 vendors. By January 2000, it was operating 7 days a week and orders were a challenge to overcome.

Even at this early point in its operations, getting a preferred

repeat customers the same delivery slot week after week.

And consistent with the company's claim that its produce would be of higher quality owing to lesser handling, the company reported in November 1999 that 17% of its revenue could be attributed to produce sales

125

quarter of 1999) and each customer ordered, on average, 20 items per order.

compared to the 10% seen by conventional supermarkets.

Webvan 602-037

although customer accounts continued to increase, at the end of the first quarter of 2000, it was still

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AtlantaAccording to plan, in May 2000, the Webvan Group opened its second DC in Suwanee, Georgia, to serve the greater Atlanta area with seven-day-a-week delivery service. The company had picked Atlanta since it was second only to San Francisco in terms on Internet shopping and ahead of

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maintained its plan of being online in 15 major metropolitan markets by the end of 2001.

In Atlanta, where it had brought 900 new jobs, it quickly saw orders climb to 2000 a day - four

operating at less than 35% capacity and had posted a $38.7 million loss for the quarter.

Expansion

The company had considered Seattle but found it too competitive because of HomeGrocer, another online grocer. Shaheen pronounced, "Webvan will reinvent the way Atlanta shops," and indicated that the company

other cities in terms of household income and population growth.

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a result of the increased demand and it was expected that Webvan would need about 3,600 orders per

times the volume the original Bay Area DC had in the same time.

day each averaging $100 to break even.

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solicit new customers through ice-cream giveaways at corporate partners.

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Only in October 2000,

It had to extend delivery hours as To do this, the company continued advertising and tried to

after four months of free delivery in the area did the company install a $4.95 fee for orders under

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The company also faced hurdles in Atlanta; its vans had to be outfitted with global positional

system (GPS) navigational devices so that controllers at warehouses could monitor by dispatch and

direct drivers around traffic problems. Its product mix was tailored to the region and the company

had to develop relationships with local suppliers since about 25% of its offerings were locally made

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SacramentoIn June 2000, the company began using its Oakland DC to service the Sacramento

market. The company had entered the Sacramento market from its Oakland DC saving itself the costs

of building an additional DC and it still had $410 million in cash. Large vans transported the goods

from Oakland to a Sacramento transfer station where orders were transferred to smaller vans.

Analysts estimated that it would have to capture 2% to 4%of the market to be successful in the

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and Sacramento, as did the company's revenue growth and overall gross margin.

ChicagoIn August 2000, Webvan entered the Chicago market from its third DC in Carol Stream, Illinois, where it had signed a lease in November 1999. Coincident with entry into these markets were rising sales and marketing expenses that would continue to rise as it expanded into other markets. In Chicago, where the company faced stiffer competition with Peapod, the company

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The NortheastAs part of its rollout plans, the Webvan Group intended to open its Baltimore and northern New Jersey DCs in December 2000. It had signed leases in Springfield, VA, to serve the $75 products.

However, by the end of the second quarter of 2000, the Oakland DC that also served the

region.

Sacramento area was still operating at below 40% capacity.

of the second quarter of 2000, "We showed substantial improvement across all of our key performance metrics." He noted that the customer base grew with the company's entry into Atlanta

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first order of $50 or more and gave away gift certificates for discounts on groceries. And as in

offered free delivery for the first three months to lure customers.

It also gave customers $15 off their

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Robert Swan, the company's chief operating officer, stated that the Chicago DC, like Atlanta's, was

Atlanta, the company intended to match its offerings to local consumer demands.

In October 2000,

ramping faster than the Oakland DC had.

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Nonetheless, Shaheen added at the end

602-037 Webvan

Washington D.C. area and Baltimore area and another lease in North Bergen in northern New Jersey.

However, since changes in capital markets had eliminated the possibility of procuring additional

financing, in the second quarter of 2000 the company chose to delay opening of these DCs to the

fourth quarter of 2001. At the end of June 2000, the company already had capital commitments of $90

million relating to the construction of DCs to serve the Baltimore, northern New Jersey and Seattle

markets and by the end of September 2000, the company still had $60 million in capital commitments

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Homegrocer Acquisition

In June 2000, with its stock price around $7, Webvan entered a deal to acquire HomeGrocer.com, a competitor online grocer in all-stock deal valued at $1.1 billion. The capital markets had dried up early in 2000 and the acquisition allowed the company to instantly expand its reach to Dallas, Los Angeles, San Diego, Orange County, Seattle and Portland, OR without the construction of expensive DCs. There were doubts, however, of the integration of the disparate business and operations models of the two companies. HomeGrocer, earlier one of the company's online rivals, had invested more in people than in automation and also had smaller warehouses that were less automated and cheaper to build than Webvan's:140HomeGrocer's smaller customer fulfillment centers cost about $8

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The merger would allow Webvan to gain more customers sooner and more cheaply than originally planned. Delivery density and average order size had been observed to be the two primary drivers in Webvan's business model. While the merger would have no impact on the average order size, combining market demand in a given geographic area would result in lower inventory investment with the result that the company could now offer a greater variety of products. The larger size of the company following the merger would also give it greater negotiating power with manufacturers on the cost of goods. Finally, while reports had hailed the automated carousels at Webvan's DCs as being central to the company's operational efficiency, the carousels only held the slowest moving items and did not contribute to operational efficiency. Instead, Webvan's tightly managed cross-dock operations were a strength that could be combined with the low-automation

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Concerns of the merger of the Webvan Group with HomeGrocer emanated from Wall Street. Speaking of the mergers in the industry, one portfolio manager on Wall Street noted, "I'm not a big fan of these "survival" mergers. In general, it's hard for weak companies to team up and be a success. What's often missing is a reason why the business model has improved and why there's now a chance of profitability in a clear time frame."143In September 2000, after the merger was approved, Webvan's share price stood at $3.75. The online retailer Amazon.com was a major shareholder in HomeGrocer, and Shaheen remarked, "The fact that they have now come into the Webvan sphere as an owner gives us an opportunity to talk with them about more strategic participation."144

Following the merger, the company was left with almost $600 million in cash and focused on creating a single brand identity for the latter half of 2000. It unveiled a new logo to signify the merger and worked on the transition to a single common technology platform. The conversion of the Los

In its earnings release for the last quarter of 2000, Webvan finally announced that in an attempt to conserve cash, it would indefinitely postpone the launch of its northern New Jersey, Washington, D.C. and Baltimore DCs.

for these DCs.

million to build and equip compared to the $35 million price tag for Webvan's larger DCs. HomeGrocer also offered its customers fewer options and had a 90-minute delivery window. Unlike Webvan's model that relied on a highly automated DC, orders at HomeGrocer were picked by hand and the company had been able to enter many markets quickly at lower cost.

facilities at HomeGrocer DCs.

Webvan 602-037

Angeles HomeGrocer facility to a common technology platform was to be completed by March 2001

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company's customer fulfillment center in Irvine, CA, to a cross-docking operation in the hope of

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(approximately 2,000 for a single shift) and eventually to shorten HomeGrocer's delivery window.

Later Performance in the San Francisco Area

At the end of the third quarter of 2000, the company's Oakland DC had completed its fifth quarter of operationa point in time by which the company had projected that the DC would break-even. However, in its third quarter earnings release in 2000, the company revealed that it had failed to meet its operating income break-even target in its Oakland operations though its Atlanta and Chicago

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SeeTable Afor the Oakland DC's operational metrics on a quarterly basis. The Oakland DC was operating at less than 30% capacity and would have to ramp up to 42.5% capacity for the company to realize the 3,300 to 3,500 orders per day or $29

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were insufficient delivery personnel to meet demand.

Table AChanges in Operational Metrics for Webvan's Oakland DC

with Dallas and Seattle following in May 2001.

The company also worked on converting the

increasing profitability in the Orange County/Los Angeles markets.

was converting the four HomeGrocer distribution centers to two Webvan DCs.

merger, the company hoped to move to two shifts to be able to process double the number of orders

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operations continued to track ahead of where Oakland was at the same point in time.

The company also revealed that at the end of the third quarter of 2000, its Oakland operations

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Demand appeared to be lower than expected even in this technology-savvy geographic area and analysts noted that execution was proving more difficult than anticipated. The company cited the impact of insufficient delivery personnel in its Oakland operations to meet demand as well as seasonal demand fluctuations: for instance, in July 2000, orders per day dropped at the Oakland DC and when orders increased again in August and September there

brought in $23 million in revenue at $105 per order.

to $30 million revenue needed to break-even.

Number of customer accounts Average order size

Average orders per day

*Figures not available

Source: Company and analyst reports

160,000 * $105 $116 2,350 2,160

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BAY AREA METRICS

3Q1999

22,000 $72.53 745

4Q1999

47,000 $81.31 1573

1Q2000

87,000 $90.33 2001

2Q2000

100,000 * 2,500

3Q2000

4Q2000

At the end of 2000, even after six quarters in operation, the Bay Area DC was still operating at less than 30% capacity, a far cry from 8,000 orders a day that would be needed for the company's

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operating margin target of 10% to 12%.

The Oakland DC was now stocking 37,000 items and a

customer's average order size had increased to $116 in the region at the end of the fourth quarter of

2000; however, the company averaged only 2,160 orders per day at this DC. As a result of the increase

in order size, the company revised its estimates, stating that it expected 2,900 to 3,000 orders a day to

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