Right Now Is Not Too Soon

While analysts are not ready to write off the category, they’re highly skeptical. In a report critical of online home delivery retailers, “Last Mile to Nowhere,” Booz, Allen & Hamilton Partner Tim Laseter writes: “We believe the last mile may lead to the gallows rather than to the promised land.” He cites four major challenges:

— limited sales density which drives profitability;

— high delivery costs;

— product selection; and

— competition from the U.S. Postal Service and UPS.

But some say the opportunity is too large to ignore. “There’s a huge demand for improved distribution,” says venture capitalist Theresa Gouw Renzetta, whose firm Accel Partners has poured millions into Sameday.com’s logistics service technology. “Someone will solve the last mile problem and find a way to make money,” she says. “The key is finding where the pain is and tackling the most economically advantaged layer first.”

In July, Kozmo’s board urged Park to step down from the top slot at the company he co-founded with Yong Kang in a Greenwich Village storefront. He was replaced by Chief Financial Officer Gerry Burdo, former finance director at Ethan Allen who was recruited in February. Park is no longer responsible for day-to-day management, but remains chairman of the board. Kozmo says the decision was mutual. Replacing a young, inexperienced founder with a seasoned executive is par in Internet start-ups. The move was, however, interpreted as an attempt to demonstrate to Wall Street that Kozmo is cleaning up its act in preparation for its $150 million IPO. Originally planned for May, the IPO was postponed until September but will likely come next year—if it comes at all.

Fred Smith also was kicked upstairs when FedEx was still losing money and hungry for cash. He also had unbelievers eager to predict his doom. Business Week’s 1974 forecast predicted the company would not continue to grow; Smith proved otherwise. FedEx burned through $84 million, a huge sum in pre-dot-com dollars, before turning its first profit in February 1975, four years after Smith started the company.

The most daunting indictment is that almost no one believes Kozmo’s free delivery model will work—a huge liability now that path-to-profitability has become Wall Street’s new mantra. Many view it as an opportunity to heap on abuse. An executive at a Kozmo’s competitor boasts of ordering a Coke from the service every afternoon to hasten the company’s demise. Others have ordered single boxes of candy multiple times as a way to prove the Kozmo model is not working.

“Kozmo’s system is designed to be abused,” says Forrester analyst Evie Black Dykema, who orders frequent lunches from Kozmo. “They need to charge a premium like a convenience store if they’re going to make their business plan work.”

Kozmo mitigates some of its delivery costs by it not having expensive retail outlets. But, the service is labor intensive, even though it laid off 300 employees in mid-August as a result of improvements in its automation software. Many of the company’s 3,000 employees work in warehouses packing orders or ride around on bicycles, in cars or vans delivering them. Kozmo delivers goods from its central warehouses where it stocks select items from manufacturers and retailers. It maintains drop boxes at several sites including Starbuck’s, one of Kozmo’s strategic investors.

According to its Securities and Exchange Commission filing, Kozmo’s average order is running at $15, however, its delivery costs average more than $14. But, Park says costs will fall as the company increases its delivery density—the number of drops a driver makes per hour. “FedEx and UPS drivers average 12 deliveries per hour. Our challenge is to get as close to 12 as possible, though we don’t need to be at that number to make money,” says Park, declining to say how many deliveries an hour they now make.

A typical carry-out from Domino’s pizza costs $15, while delivery costs run $2 or $3 representing 15-20% of the pie. Drivers average four to five deliveries per hour. In addition, Kozmo plans to raise its average order size under Burdo’s regime by offering office supplies, wine, beer and gourmet food, and by bundling items.

However, analysts say Kozmo will have a hard time balancing its books. “They’re set up to lose money,” says Rebecca Nidositko, senior retail analyst at the Yankee Group. “They need a huge number of orders of the right products in concentrated markets to make it work. Conversely, if they move into larger items to boost their margins, their bike messengers won’t be able to carry them. They’re counting on too many ifs to become profitable. Free delivery is not going to work.”

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But the beleaguered executive is sticking to his story. In the worst case, Park told Vanity Fair, Kozmo will make a good case study for his business school application. Park earned his BS degree in journalism and political science before seeking his fortune on Wall Street. Smith, also a political science major, got a C on his Yale term paper which outlined FedEx’s hub-and-spoke model. His professor doubted that the concept would work.

Unlike Kozmo or Webvan which own inventory, warehouses and delivery fleets (read: massive capital requirements), these Bay-area start-ups could be described as a delivery infomediaries—they owned none of the above. Instead, the companies planned to broker deliveries between web retailers and local couriers which serve most metropolitan areas. DNet’s CEO Chris Moore describes the service as the “revenge of the brick-and-mortars.”

DNet’s service was designed to work like this. When a consumer selected same-day delivery, the retailer would pass the information electronically to DNet’s servers, which would route the order to one of the company’s courier partners. A driver would pick up the goods at the local merchant’s store and deliver them. By aggregating volume, the company was able to negotiate a standard rate that was less than the cost of an overnight shipment. Their negotiated rates on a four-hour delivery start at $10 delivered within four miles of the merchant’s store and increase with weight and distance. DNet planned to make money by taking a cut of each delivery charge. By piggybacking on existing couriers it would presumably avoid the density problems plaguing Kozmo.

Local couriers—the vast majority of which are small, low-tech, privately held and specialize in time-sensitive legal papers, parts, and donor organs—stood to benefit from the incremental business. Retailers in turn could better leverage local inventories. “It doesn’t make sense for retailers to ship goods across the country from a central warehouse if they are sitting in a store a few miles away from the customer,” Moore says.

Moore says his company pulled the plug because it was in the right place at the wrong time. “The delivery space is in the dumps—the courier companies are awful financial investments, and the new guys like Kozmo and Webvan are getting crushed,” he explains. “We have a great model that avoids the pitfalls but there is a legitimate fear of the category. Our strong ties to the legacy courier industry was a two-sided sword.” Board members did not believe they could finance the company through the public market, Moore says. The company took in more than $1 million in founder and was reportedly working with several large retailers.

However, Roger MacDonell, founder and CEO of Redwood City, Calif.-based DeliverEtoday, which has conducted tests with at least one major retailer, contends that both DNet’s and GetToday’s point-to-point delivery models were flawed. DeliverEtoday plans to build a series of local hub-and-spoke sorting centers, similar to FedEx or UPS, and then deliver packages with its own fleet of brightly painted vans in order to maintain quality control. The sorting centers enable drivers to pack their routes, increasing delivery density.

As a result, the company claims that with sufficient volume it makes money while charging less than $10 per delivery. “Our model takes into account both the density and quality issue,” explains MacDonell. “We’re a supershuttle not a taxi cab.” The company is currently seeking additional funding.

One reason retailers have been slow to adopt same-day delivery is the lack of in-store infrastructure to support rapid delivery. To offer same-day delivery, retailers require a real-time inventory system that is integrated with their web site. Most retailers rely on a batch inventory system. They also must be set up to pick and pack customer’s orders at a local store. Few retailers meet these criteria. “There’s no doubt it would give retailers a powerful new service option if they had the back office infrastructure and culture to support it. Unfortunately those are big ifs,” says the president of the online division of a national luxury goods retailer that worked with DNet.

While distributing consumer goods out of local stores has a certain logical appeal, not everyone is convinced it offers a workable solution for retailers.

The problem, says Andrew Krainin, co-founder and senior vice president of marketing at Sameday.com which helps retailers and b2b companies improve their distribution networks to support rapid deliveries, is that in-store inventories are difficult to pin down on a real-time basis. Inventory is sitting in customer’s shopping carts. Items get stolen and sales are recorded with the wrong SKUs. “Even if they have an integrated point-of-sale system, it’s not going to be 99% accurate,” he says. “Our belief is that retailers want a high degree of certainty and control over their orders.”

In addition, he says the in-store labor required for checking shelves and staffing a pick-and-pack operation is an expensive way to distribute goods. And creates conflicts with in-store processes—the higher the volume, the greater the disruption. Pickers would end up competing with shoppers.

“If you’re a mom-and-pop, it’s probably OK, but it’s not a viable solution for major national chains who want to maintain their brand at a high service level,” Krainin says. “If they start seeing significant volume, it will create conflict with their in-store processes.”

Barnes & Noble plans to take advantage of its inventory, buy in a different way. In a test of same-day service launched last May in New York, books ordered from bn.com by 11 a.m. are delivered by 7 p.m. at standard ground rates. Fulfillment is handled out of the company’s 800,000-title distribution center in Dayton, N.J., through City Sprint, a local courier service.

According to Vice President Gus Carlson, the giant bookseller hopes to gain valuable experience while gauging consumer demand. Though deliveries are reportedly strong and growing, he is quick to point out that Manhattan is a unique, high-density market where everyone delivers.

“We’re still not sure if the technology is transferable to our entire market,” Carlson says. But then that’s what they said about online book selling. Amazon has got $60 million riding on Kozmo, and they’ve got history on their side.