HomeGrocer.

com : Anatomy of a
Failure
Characterizing HomeGrocers Approach to Competing in the Online
Grocery IndustryStrengths and Weaknesses
In the three years that HomerGrocer operated as an independent entity, from
1997 to 2000, HomeGrocers approach to competing in the Online Grocery Industry
is a story of big ideas, innovation, strategy, rising pressure, and incredibly bad
timing. At a time when the internet boom was accelerating and typical supply chain
setups where being questioned by companies such as Amazon.com, Terry Drayton
took the Amazon.com idea for books and applied it to groceriesthus building on
the idea that there are many unnecessary resources tied up in brick and mortar
establishments and the recovered value could be shared by the new startup and its
customers.
In terms of things done well, Terry Drayton was able to identify the best
period over which to pursue this opportunity, and match his concept of how value
can be created with an analysis as to his own goals, skill, and time-frame. 1 He had
already started, run, and sold a business (Crystal Springs Water Co.) so he already
had experience with business plans and startups to bring to the table. Yet, he was
also able to identify skills, resources, and relationships he was lacking and felt
would be necessary to bring this opportunity to life. He assembled his core team
with Mike MacDonald, who was the president of the largest food broker in British
Columbia and Ken Deering, a computer and technology expert. Having a powerful
person working directly in the grocery industry was a big head-start for the
company, as was having a person who knew the rapidly changing internet
landscape. Rarely does an individual entrepreneur possess or even substantially
control all of the skills, resources, and relationships that are required to pursue an
opportunity.2 Terry was able to determine his own limitations and fill in the missing
gaps. This team was the right combination for venture capital firms and obviously,
they were able to put together a strong business plan and a solid pitch as they
raised $172 million even before the IPO.
In terms of things that should have been done differently, for one, they should have
stuck to the original business plan to learn as much as possible from launching
1 Van Slyke, John and Stevenson, Howard (1985). Pre-Start Analysis. Harvard Business
School Review, 9-386-075, page 2-3.,

2 Van Slyke, John and Stevenson, Howard (1985). Pre-Start Analysis. Harvard Business
School Review, 9-386-075, page 7.

and managing the first distribution center and to perfect the model before
replicating it in other regions. 3 There is one school of thought that says founders
need to be patient with growth and impatient with achieving profitability. 4 This
would be especially true with a disruptive innovation like online grocery delivery. By
forcing the company to keep its fixed costs low, the company can better understand
its business model and make the necessary changes while the company is small
and cash burn is minor. So HomeGrocer could have delayed the shift to automated
picking systems and overall the quick expansion to eight warehouses until they saw
profitability. They put the capacity in place for very large growth, but they hadnt
quite seen the necessary throughput to justify the costs. The reasons for this will be
described below and involve changes in customer habits.
Fundamentally, even though the VCs and early investors wanted to push the
company as fast as it could grow, the market might not have necessarily been ready
for growth that fast. Buying groceries can be a personal experience, changing
habits and psychology can take some time. For many people buying groceries at a
store was just such a natural way of doing things that they struggled to move away
from the practice.3 HomeGrocer had to defeat the gallon of milk problem, had to
win people over through customer service, and had to defeat the perception that
neighbors might think [customers] have gotten so lazy as to shop online [for
groceries].3 Additionally, tastes, which are a personal preference, had to be
accounted for. Unlike buying a printer, customers cant always just read reviews on
groceries and know theyll be satisfied; its a personal taste (in the literal meaning
of the word). So the model itself may have been one that relied on slow steady
growth as opposed to an overnight switch. Given his actions with customer service,
I believe Terry understood this, but the VCs may not have had the appetite for it. So
I believe HomeGrocer made a mistake by signing up for all the growth terms in its
prospectus to obtain capital with the VCs and the IPO investors.

Aspects of the Online Grocery Industry Cause Difficulties for Profitability

As discussed in the preceding section, tastes play a large role. The online
service model was the newcomer on the block and potential customers needed to
be informed of its existence and availability. [And] then they needed to gain
enough trust to place their first order.3 Changing consumer habits is always
possible, but risky and time consuming. Additionally, the grocery industry itself has
extremely thin profit margins of around 1%-2%. By removing costs is the existing
supply chains, Terry estimated that a 7% margin could be achieved with
HomeGrocers model. But even at 7%, the volume needs to be fairly high to
overcome the fixed costs of warehouses, vans, maintenance, picking, etc.not an
insurmountable problem, just one to keep in mind with the consumer psychology
3 Fisher, Greg and Kotha, Suresh (2009). Homegrocer.com: An Anatomy of a Failure. Foster
School of Business (Yeay Foster!), page 3, 5-9.

4 Christensen, Clayton. "Six Keys to Building New Markets by Unleasing Disruptive

Innovation. http://hbswk.hbs.edu/item/3374.html March 10, 2003. Retrieved on April 18,
2011.

issue. Next, traditional retailers had significant buying power given their ability to
source products at a lower cost compared to new entrants. 3 Again, this could be
alleviated through growth and time or through strategic partnerships, but
HomeGrocer was not at that size yet. In reaction to thin profit margins many of the
grocery wholesalers and retail businesses had become deeply interwoven and
interdependent.3 So the brick and mortar competition was improving and
wholesalers had already invested considerable amounts of money and effort into
the retail-store relationships so would they want invest more with a risky venture,
online grocers? The onus was on the online retailers to prove it was worth it.
Another difficulty cited in the case was that the acquisition costs for new
customers in the online model were higher than a brick and mortars. Many
customers would repeat buy, but then stop after the forth or fifth order. The
reasoning for this was never really developed in the case, but I assume was related
to the consumer psychology issue and could be addressed, but would take time.
Not mentioned in the case is the amount of marketing dollars the brick and mortar
grocers get for auctioning off shelf space (aka slotting fees). For a new product
the standard price of admission to the shelves is a slotting feeup to $25,000 per
item for a regional cluster of stores. (A California food producer says he met with a
buyer at a chain grocer who demanded $250,000 for ten stores and wouldn't even
take a meeting until he received a $100,000 check.) 5 The online business model,
as it stands, is not eligible for this competition. It could be developed, but currently
for this in-store decision making competition the scales are certainly tipped in
favor of the brick and motar.

Investigation into the Root Causes for HomeGrocers Failure

I still believe one of the greatest causes for HomeGrocers failure is the
incompatibility between HomeGrocers business model and the high growth
demanded by the VCs and the IPO investors. However, the model presented in the
Five Stages of Small Business Growth article provides a good framework for
investigating HomeGrocers trajectory and provides more insight. Using the
framework, a case can be made that HomeGrocer certainly made it past Stage I
(existence) and then was in between Stage II (Survival) and Stage III-G (SuccessGrowth) when it was forced to merge with Webvan. HomeGrocer did demonstrate a
workable business entity due to its founders early efforts and connections. They
had achieved successes in making themselves known and even generated a strong
customer allegiance (demonstrated by the emails) as they continued to grow and
work through problems in the business model. Because HomeGrocer was not able
to prove profitability on the smaller scale they were not able to move completely
out of Stage II. In the article Churchill notes among the important tasks [for the
founders in Stage II] are to make sure the basic business stays profitable so that it
will not outrun its source of cash and to develop managers to meet the needs of the
growing business.6 The case does not develop what steps Terry took to develop
managers, but the model was not yet profitable and Terry did note that growth was
5 Copple, Brandon. "Shelf-Determination."
www.forbes.com/forbes/2002/0415/130_print.html Forbes. April 15, 2002. Retrieved on April
18, 2011.

very difficult in a logistics intensive business like HomeGrocer, especially when

your business is not yet fully baked.3 So, it can be said that the complexities of the
logistics were a problem for the company when HomeGrocer received funding from
the VCs. These operational complexities are only further complicated when VCs
desire to have the accelerator pedal on the floor the whole time. Its possible these
complexities were not fully resolved, the managers in place were not solving them
fast enough, the case for changing consumer habits was not proceeding fast
enough, and more of Terrys time was taken in expanding the company rather than
addressing the issues.
With all the capital raised, the company was stuck in Stage II yet artificially
launched into Stage IV (Delegation). Consistent with Stage IV, Terry was replaced.
But at this point the company was already huge and had many warehouses,
employees, and other overhead costs. The business model was still being dragged
down by many complexities and every day the company operated like this was now
a huge cash burn due to its size. Eventually problems were too extensive and they
needed more capital just to survive. This forced the company to drop back to the
early parts of Stage II (survival) and they merged with Webvan.

In Retrospect the Merger with Webvan was not the right approach
The merger with Webvan was certainly not the right strategic decision, but
due to its critical financial situation, the promises in the prospectus, the lack of
capital available in the markets, and the threats of lawsuits, HomeGrocer had no
other choice. The opportunity to bail out and cut loses had passed long ago. Even
if it could have avoided a lawsuit from the investors, the business model still had
problems and there were no opportunities to raise capital even with a scaled down
(Seattle/Portland only) version of HomeGrocer.
Moving on to Webvan, as a company, Webvan was going to fail no matter
what. Beyond the problems of having a broken interface that didnt work with
America Online (representing 40% of the customer base) and the company having a
near 5-to-1 ratio (Webvan-to-HomeGrocer) of employees working there, they were
not working productivelycertainly not like a scrappy startup like Homegrocer.
Webvan was run like a dotcom, but fundamentally the online grocery structure was
quite different than a typical dotcom. Incremental sales, the cost to add another
user or ship another copy of a software program, at a dotcom are typically minimal.
But in the online grocery business, Webvans incremental sales were considerably
higher, they had customer acquisition costs, inventory costs, distribution costs,
shrinkage costs, and the like. Webvan was going to fail; it was only a matter of time
until the capital ran out.

6 Churchill, Neil and Lewis, Virginia (1983). The Five Stages of Small Business Growth,
83301, page 7.

Terry Drayton Resurrect Should Not Resurrect HomeGrocer

Being of an entrepreneurial mindset, it pains me to write it, but I dont think
Terry Drayton should try to resurrect HomeGrocer. The major reason I believe this is
because the blue ocean opportunity is now red ocean. John Van Slyke in his article
Pre-Start Analysis talks extensively about finding and acting upon the right
opportunity. While Terry certainly has the skillset and experience to make the
model work, the capital markets have changed in a way that would allow steady
continued growth (versus explosive growth), and fundamentally the idea of cutting
out brick and mortar costs to increase margins has been proven; there are now
many competitors in the space and even more of a threat are big entrants like
Amazon Fresh and Walmarts Project Titan (more in next section). These
competitors have extensive resources in the way of buying power, IT infrastructure,
and supply chain logistics. The new challenge will not only be how to fix the
business model, but how to compete in red ocean against some big giants. I believe
his entrepreneurial resources would be squandered in this space and could better
serve him in another blue ocean venture.

The Amazon Fresh Projects Performance to Date and Its Likelihood for
Longterm Success
In researching Amazon Fresh, I could not find any data broken out from
Amazons 10-K or recent 10-Q filings to indicate the financial performance of
Amazon Fresh, so a financial assessment is difficult. Amazon Fresh launched in
2007 in Seattle and Seattle is still currently the only market they serve. So I think
its safe to say that they have the idea on a slow simmer right now, perhaps they
are working on the customer psychological problems HomeGrocer faced.
Interestingly, the URLs Webvan.com and Homegrocer.com are now both owned and
operated by Amazon.com. On these sites, Amazon is selling non-perishable
groceries (which further makes Terrys resurrection more difficult). Amazon.co.uk
announced in July of 2010, that it was going to take on Tesco (TSCDY), Sainsbury's
(JSAIY), and Asda (WMT) with the launch of an online grocery store offering free
delivery on thousands of great value household, niche, ethnic and international
products.7
Likelihood for success is also difficult to determine due to the fact that Amazon is
not aggressively pursuing Amazon Fresh. In fact that could be an indicator that
either Amazon is waiting for something to happen (i.e.-better business model,
better deals with suppliers, more market interest, inflation, etc) or that they are just
looking to selectively cherry-pick markets (like London). But in terms of ability to
make the model work, they have some of the most advanced consumer research
and evaluation techniques on the planet combined with enormous buying power,
consummate supply chain knowhow, and years of experience. Most interesting is
7 Clark, Nick. "Amazon to Sell Groceries Online in U.K."
http://www.businessweek.com/globalbiz/content/jul2010/gb2010078_778191.htm
Businessweek . July 8, 2010. Retrieved on April 18, 2011.

that on April 11, 2011 the worlds biggest retailer, Walmart, announced its plans to
launch an online grocery delivery service. So, Amazon Fresh would have some
serious competition considering Walmart meets or surpasses Amazon in some
implicit knowledge in supply chains. Their entry is likely Amazon Freshs biggest
threat to success. However, one must also consider the market for online grocers is
still really limited to those with more disposable income (average household income
of $75,000 or greater)not Walmarts typical customers, so Amazon Fresh may
have an upper hand. Nevertheless, the market will be exciting to watch.