March 31, 2003, 12:00 AM

A new chief has big plans for Safeway’s dot-coms

Mitchell Rhodes confidently predicts the web will account for 3-6% of Safeway’s sales–soon.

Safeway Inc.’s online grocery business is at a turning point: The company says it’s got an effective infrastructure and a proven business model. All it needs is a big marketing push to expand its reach and hit its goal of $1 billion or more in annual sales. “That’s ambitious but not impossible,” says David Kathman, an analyst who follows Safeway with investment research firm Morningstar Inc.

That’s doable, says Mitchell Rhodes, new president of GroceryWorks, the subsidiary that runs the online business of the $32 billion-a-year Safeway. In fact, $1 billion is at the low end of his expectations. “Over the long haul, I think we can be 3-6% of Safeway’s business,” he says.

While that number does strike some as ambitious, given that Safeway’s online expansion is less than a year old, it’s in only five metropolitan areas and Rhodes is GroceryWorks’ third president in less than a year, Rhodes points out he’s been there before. Rhodes, who took over GroceryWorks in January, launched OldNavy.com and BananaRepublic.com while serving as general manager and vice president of marketing for Gap Inc.’s online division. In those spots, he rode out wild swings a few years ago between having the right mixture of customer demand and a ready infrastructure.

“We experienced both having not enough customers, and having too many,” he recalls. “In the early days, Gap’s challenge was to generate order volume, because we felt we offered great service and just wanted customers to come. But by the fourth quarter of 2000-when we did 40% of our annual business in December-we couldn’t satisfy customer demand and had to shut down portions of our sites.”

Gap moved onto smoother operations, Rhodes adds, because it was able to devise a formula that balanced infrastructure investments with growth in customer activity. “Gap was shrewd-and lucky-that it was not caught up in big e-commerce costs,” he says. Ditto for Safeway: It is addressing the balance issue through controlled geographic expansion and marketing and by leveraging its store infrastructure for order fulfillment and delivery, he says.

But while it makes sense to use stores to fulfill orders, Safeway still has to get those orders to customers and that’s where real challenges could lie, Kathman says. Unlike other online retailers who rely on UPS, FedEx and the Post Office to be their delivery arms, online grocers must manage their own delivery fleets. And the problem then becomes compounded by the multiple markets that Safeway is in. Kathman notes that e-grocer Webvan Group Inc. failed partly because it was unable to match its sales with its number of delivery drivers. “So they had drivers sitting around and getting paid for it,” he says.

Kathman notes that Safeway and its partners have invested at least $65 million in GroceryWorks since June 2000, with about half of that from Safeway itself. Interestingly, in 2001, as the online grocery business began to falter, Safeway posted a $30 million impairment charge for the value it calculated it had lost in GroceryWorks. “At that time, everyone thought the online grocery business was dying,” Kathman says. “But now presumably the value is back up.”

So far, while not revealing details about online sales, GroceryWorks reports remarkable success as it has entered new markets. Safeway last year expanded into Portland, Ore., San Francisco, Sacramento, San Diego and Las Vegas with Safeway.com and Vons.com. It says customers in new markets are signing up faster than expected. It now serves 330 communities.

Rhodes is the first GroceryWorks chief hired from outside Safeway and the first with direct e-commerce experience. The former McKinsey & Co. consultant says he’s excited about taking his marketing and online experience from the trendy apparel world to the meat-and-potatoes realm of Safeway. But don’t try to tell Rhodes that selling food isn’t as cool as selling fashion. “Online grocery can be a lot bigger in the long run than online apparel,” he says. “People spend a lot more on groceries and buy from grocers a lot more frequently.”

Having fun

Rhodes should know because before directing online operations for Gap he served in executive positions at major grocery suppliers Kraft Foods and Procter & Gamble Co. “This is my new challenge and I’m expecting it to be a lot fun,” he says. “I have no problem seeing this as a $1 billion business.”

At Safeway, he expects to build on a strategy that has already produced online growth on top of Safeway’s existing supermarket infrastructure and the proven online selling techniques it learned from Tesco plc, its U.K.-based associate, which owns 35% of GroceryWorks. Safeway owns 50% and the remaining 15% is owned by investment groups, including The Sprout Group of New York, Accel-KKR of Palo Alto, Calif., and Enterprise Partners Venture Capital of La Jolla, Calif. “Now that we’re more than a year old, we’re ready to go out and promote our service aggressively,” Rhodes says.

The key to success in selling online, he says, is finding a business’s critical touch points with customers and perfecting them. At Gap, that meant excelling primarily in three areas: ease of site navigation, reliable service through fulfillment and call centers and quality of products.

Rhodes says his experience with site navigation, making online shopping as easy as possible, directly applies to the online grocery world. But online grocery’s version of fulfillment and product quality offers new challenges-and opportunities, he says.

For instance, he says, Safeway has implemented a fulfillment policy called “Would You Buy It?” The professional store shoppers who fulfill customer orders from within Safeway and Vons supermarkets are instructed not to pick anything that is not in good condition. “We want to make sure our pickers choose the best quality,” Rhodes says. Safeway’s online customers are able to customize their orders with special requests, such as asking for ripe tomatoes or firm avocados.

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