April, 2000

From the Editor

Peapod's Legacy

Peapod, the granddaddy of the online grocers, is tottering on the edge of bankruptcy. Bill Malloy, the chief executive of the company, resigned due to health reasons. This led a group of big name investors, including the Yucaipa Cos. and Apollo Management, which have both been active in grocery store investments and acquisitions – Ralphs Grocery Co., Dominick’s Finer Foods, The Kroger Co. and Fred Meyer – to abandon a plan to put $120 million into the company.

Following the announcement, Peapod’s stock dropped by half falling from 7 13/16 to 3 23/32 in a single day. That it stays at that level is more a matter of investors’ penchant for praying than due to any particular analysis. Peapod has never shown an operating profit and has only about three million in cash. At the rate the company burns money, Peapod could close down by the time you read this.

Well, so much for the vaunted “first mover advantage”. This gospel in the “new economy”, that whoever first seizes a market position will build up an almost insurmountable advantage over any newcomer competitors. Yet Peapod, which was accepting consumer orders via computer when most of its on-line competitors were not yet incorporated, hasn’t seemed to benefit much from its early mover status.

When Peapod went down for the count, other online grocers, such as Webvan and HomeGrocer, also saw their stocks tumble to all time lows. It is as if all at once, the scales fell from investors’ eyes and they began to question the real business prospects for these companies.

Webvan, for example, soared to a market capitalization of more than $10 billion based on its assertions that “at a minimum” it could boost the grocery industry’s standard profits of 1 to 2 percent of sales to 10 to 12 percent of sales. But talk is cheap and despite spiffy technology and access to lots of cheap capital, Webvan shows no prospect of achieving these eye-popping grocery margins.

Up till now, it seemed possible that the online grocers could triumph. Why? For the same reason that AOL could buy Time-Warner, with a $10 billion based market valuation Webvan could, for stock, buy most supermarket chains in the country. But now it is down to $3 billion, and it is not clear if the valuation will be sustained if profits don’t start appearing. Without access to cheap capital and the ability to do acquisitions with high priced stock, the prospects for the online grocers are much weaker; they are much more likely to be subsumed either through acquisition by conventional grocers or by competition.

Of course, companies like Webvan and HomeGrocer vigorously protest any comparison to Peapod. Peapod started out with a high-tech front end – that is to say consumers ordered on the computer in a manner similar to what Webvan and HomeGrocer offer, but Peapod elected to use a decidedly low-tech back end. Basically Peapod aligned with a supermarket and sent in employees to manually shop its customers’ orders. In a sense, Peapod was an ordering and delivery service, not a true grocer.

Webvan and HomeGrocer, by contrast, build high-tech warehouses, order their own groceries and, more basically, compete with grocers as opposed to working with them as customers.

Still, this is a protest without much of a point. When Peapod started, modems and what not were sufficiently rare that it was clear that a critical mass of business – a volume necessary to support a warehouse – could not be assembled. Peapod figured to seize the first mover advantage by building its customer database, its customer contacts and its delivery infrastructure. When a market justified Peapod’s ownership of a complete warehouse, Peapod could rather seamlessly change its back end to a more cost efficient model without customers even knowing. And, in fact, Peapod had begun to move in that direction, building new distribution centers in Chicago and San Francisco and planning on more.

In one sense, it is sad. Peapod spent 10 years garnering customer support and, barring a last-minute infusion of funds, it will have all been for naught.

Investors certainly could do well to take a lesson from all this and insist on more than theories before putting their hard-earned money at risk. Webvan’s stock is now trading at a price not only below its IPO price, but even below what venture capitalists paid in its last financing round.

Yet, with all these troubles, it would be a horrible mistake for conventional brick-and-mortar retailers to write off the threat of Internet competition. Indeed, prudent retailers would step up to the plate now and make prudent investments.

The world is going to change as technology changes, and what today is really nothing more than an old-time delivery boy souped up on the Internet, will one day be indispensable.

Imagine a world where one scans a jar of mustard before throwing it in the garbage or recycling bin, thus triggering a reorder. Or perhaps the refrigerator itself will sense the small chip on the quart of Greek salad, and when the salad is missing for a few hours, the refrigerator consults its list of “automatic reorders” and reorders based on the list.

It may sound far-fetched, but it is really very doable. It will change everything for the food industry. How sad that Peapod – that saw this future more clearly than any of us – might, like Moses, be denied the chance to enter the Promised Land.  DB