Pricey and perishable, online supermarkets struggle to deliver on their retail promise

One of the great perceived differences between American and European cultures is that Americans spend less time than Europeans shopping for food. While Europeans go to the market several times a week, goes the conventional thinking, Americans make one mega-trip every seven days.

Yeah, right.

Figures from A.C. Nielsen reveal that the average American household makes 94 trips a year to supermarkets and nine to warehouse clubs—and that’s not counting trips to the convenience store. Andersen Consulting reports that the average shopper spends 47 minutes at the supermarket. Assume 20 minutes of travel time to and from the store, that adds up to more than an hour a trip, twice a week. And that doesn’t count the time spent at convenience stores or warehouse clubs.

The future would seem bright, then, for online supermarkets. Customers could order groceries from home or office any time of day, arranging for delivery when it’s convenient for them. But Internet grocery shopping has been a slow starter, and even the most optimistic projections indicate it will be no more than a drop in the basket of overall grocery sales for at least the next five years.

The obstacles to overcome are related directly to the product and not to the technology: Unless the customer lives relatively close to the distribution center, the Internet grocer will have a hard time delivering perishables before they perish. And home delivery systems are expensive, jacking up the cost of products that consumers have traditionally bought based on price, observes Willard R. Bishop of Willard Bishop Consulting Ltd., a leading supermarket consultant based in Barrington, Ill.

Long time coming

But while online grocery sales may be a slow starter in the short term, most are predicting that sales will begin to increase at a much faster rate early in the next century. Andersen Consulting reports that 30% of consumers would pay a fee for more convenient grocery shopping and predicts that by 2007, 15% of U.S. households will prefer to shop for groceries online. And new online merchants will doubtless emerge to chase after the market.

In fact, the trend is already under way. WebVan Group Inc., an Oakland, Calif.-based Internet retailing company headed up by Louis Borders, the founder of Borders Books, has ambitious plans to build a multimillion-dollar online grocery business in just a few short years. WebVan already has its own warehouse and distribution plan in place and expects to start selling online this summer.

“There’s no question that the Internet will play a role in grocery sales in the future,” agrees Bishop, “but it will take a long time because the costs associated with delivery are quite substantial.”

In terms of demand, there is incredible growth potential for this category, says Geoffrey Ramsey, statistics manager at eMarketer, a New York-based aggregator of Internet news, information and statistics. “Food and beverages are something everyone needs, and one of the biggest issues with grocery shopping is convenience,” he says, adding that dual-income families are looking for quicker and faster ways to do things.

Online grocery shopping fits into the trend toward a speedier completion of household chores. First companies shortened cooking and cleaning times. Now they are working on shortening shopping. But while the pent-up demand is there, the supply is not, says Ramsey, because none of the current online grocers has figured out how to overcome the logistical problems of delivering perishable and bulky grocery items outside of major urban areas.

Internet grocery shopping for the most part is still available only in certain large urban markets, and the companies that do deliver nationally, like North Brunswick, N.J.-based NetGrocer Inc., use outside delivery firms, which makes buying groceries online cost-prohibitive for the average household. “Nobody has figured out how to do it so that it makes sense for the retailer,” says Ramsey. “It’s the retailers who are slowing up the pace of growth of the market because they haven’t figured out how to make it cost-effective for them.”

The U.S. retail grocery market rings up $430 billion in sales each year, with another $40 billion being spent on gourmet/specialty foods. According to Forrester Research Inc., Cambridge, Mass., e-commerce grocery sales totaled only $235 million in 1998—less than one-tenth of 1%—so there is an enormous amount of growth potential. While Forrester predicts that online grocery sales will reach $10.8 billion by 2003, even that will represent only 2% of total industry dollars.

Frozen in time

The biggest logistical problem that Internet grocers will have to overcome prior to their services becoming popular is delivery. Delivery of perishable foods such as frozen foods, meats, dairy products and fresh vegetables is extremely time sensitive, and e-grocers still have not found a way to cost-effectively meet consumers’ need for on-time deliveries to a broad range of geographical areas.

Many of the current crop of online grocery services work with local supermarkets. The customer orders online, then either shoppers from the online service go to a local supermarket, fill the order, and deliver it to the customer’s home, or the local supermarket both fills and delivers the order.

Other online grocers use delivery services such as Federal Express and United Parcel Service to make deliveries from centralized distribution centers. But that approach severely limits the kinds of food that are likely to be delivered and significantly raises the price. Costs vary, but Federal Express shipping costs for NetGrocer range from $5.99 an order for orders under $60 delivered to the Northeast and $13.99 for a delivery west of the Mississippi to $56.99 for an order more than $800 shipped to the Northeast and $78.99 for delivery west of the Mississippi. But, says NetGrocer CEO and President Fred Horowitz, when people figure out their actual expenses for going back and forth to the store, they often find that ordering from NetGrocer and paying the delivery fee is cheaper.

Peapod Inc., Skokie, Ill., was one of the original virtual grocers, beginning with a telephone ordering and delivery service in 1989. By the following year, it served 400 households in Chicago; today it’s the largest online grocery service with more than 98,000 customers. The company offers full-service grocery shopping and can deliver a wide variety of meats, vegetables, fruits and dairy products to customers. Even so, the service is available only in eight metro markets: Boston; Chicago; Dallas; Houston; San Francisco; Austin, Texas; Columbus, Ohio; and Long Island, N.Y.

But retailers will resolve these problems in the next several years, Forrester predicts. Establishment of new distribution centers will expand the markets where Internet shopping is available. For example, Peapod is converting to a centralized warehouse distribution system from one that depended on local markets to fill orders. Thus far, Peapod has established centralized distribution centers in San Francisco, Chicago and Long Island. Peapod predicts the new warehouses will improve the quality and salability of its service, along with improving gross margins for the company allowing it to further lower fees, which will further enhance consumer demand.

Besides logistics, the small market for selling groceries on the Web is also limiting growth. Consumers are currently paying premium pricing for the convenience of at-home delivery.

IRCE 2008 Conference Multi-Media CD-ROM

The price isn’t right

There are usually delivery or membership fees for the service and prices tend to be higher on many items than those found at the local supermarket, says Ramsey. John Furton, chief information officer for Peapod, agrees that the fairly high prices that most services charge are a barrier to growth. And it is necessary to have access to a computer and the Internet. So the current potential market is still limited to high-income individuals willing to pay a premium for convenience.

“It’s a business impossibility to make this appealing to the average household in the next five to 10 years,” says Bishop. “The delivery cost raises the price of items significantly and only a small number of households have the money and desire to pay for the service.”

But experts predict that cheaper PCs and Web-enabled phones and televisions will increase the number of middle-income shoppers who will have access to online shopping sites. And as sales grow and volumes increase, Internet retailers will begin to have the clout to negotiate better supplier deals, and will drop fees to further spur growth.

Peapod’s fees have already dropped from an average of $15 an order last year to between $5-10 an order this year, because increased volumes allowed them to lower costs.

Another issue that must be resolved before Internet grocery shopping can truly take off is paying for online groceries. While Peapod accepts checks and debit cards for its service, most online retailers accept only credit cards. While some consumers are fearful of security issues with divulging credit card information online, a bigger issue is that grocery shoppers aren’t accustomed to charging their purchases. Credit card purchases in traditional supermarkets today account for only about 6% of all purchases. Meanwhile, 99% of all online sales are transacted with credit cards. Unless consumers become less resistant to using their Visa to buy Bounty, e-commerce grocers will have to find another method for their customers to pay for their weekly groceries—and most other e-payment systems are fairly cumbersome.

Largely because of the problems currently limiting the growth of online grocery shopping, many industry watchers believe traditional retail supermarkets will largely ignore the online market until at least 2003. “Currently, no major traditional mass market supermarket chain has an Internet commerce presence equivalent to that of Internet pure plays,” says Forrester analyst Evie Dykema. But, adds Bishop, although only a small percentage of buyers will be attracted to online grocery shopping, losing 3% to 5% of customers to the Internet can still have a significant impact on supermarket profitability.

Some major chains such as Safeway and Marsh offer limited shopping online. Safeway sells only flowers and gift items on its Web site, and Marsh delivers groceries ordered over the Internet only to customers who live within a few miles of its stores in Indiana and Ohio. No major grocery chain has any significant presence on the Internet.

But once Internet grocery sales surpass the $10 billion mark, the major players will take note. “Traditional retailers won’t feel the need to invest in the Internet until 2003,” predicts Dykema. “Internet sales are not keeping traditional supermarket retailers awake at night because they represent such an insignificant percentage of total grocery sales.”

Waiting for Bezos

Once sales do take off, however, she predicts that traditional grocers will buy their way onto the Internet via acquisitions to get up and running immediately. Ramsey agrees: “The biggest threat to Safeway is not the supermarket across the street, but a smart entrepreneur like Jeff Bezos of Amazon.com. Once someone finds a way to quickly and cost effectively deliver groceries ordered over the Web, traditional supermarkets will have a new formidable competitor.”

One traditional supermarket chain dipping its toe into the waters of Internet selling is Whole Foods Market Inc., Austin, Texas. Whole Foods is the leader in natural and organic foods in the bricks-and-mortar world, operating 88 stores in 19 states and the District of Columbia under the names Whole Foods, Fresh Fields and Wellspring Grocery. The company launched its Internet counterpart in March, shipping non-perishable items from a central warehouse via UPS. Shipping is 25 cents per pound plus a $4.99 shipping and handling charge that is waved for grocery orders of $70 or more.

Once the non-perishable business takes root, the company will explore shipping perishable items as well, according to John Fischer, interactive marketing director at WholeFoods.com. The company is making a concerted effort to promote the new business. Prices online will be as much as 35% cheaper than prices in the stores, and the company is sponsoring an incentive program for employees to promote the site in its stores.

Fischer believes that moving onto the Internet is a good move for Whole Foods for a number of reasons, including the unique demographics of its customers, who tend to be highly educated and affluent and who generate higher profit margins. “Our product mix is unique,” he says. “We don’t have to price-compete on a can of Pringles.”

Dykema believes that WholeFoods.com will be among the winners in e-grocery sales along with other retailers selling high-priced niche products. “Their customers are high-income, highly educated and likely to buy online—and their products are unique and hard to find,” she says, pegging likely losers online to include anybody fighting for a small market.

For example, four players are currently duking it out in Boston, and unless sales grow significantly, only one will ultimately prevail. And one Internet grocer has already folded—OnCart, which sold groceries online through agreements with local supermarkets.

NetGrocer is generally perceived as a company with complex problems to overcome, according to Dykema, because its delivery costs are excessive, prices too high, and market demand too small. The company recently reinvented itself, however, changing its business model to offer a variety of items, such as books and software, in which it is trying to compete on the basis of price.

“But they’re not what you’d go to NetGrocer to buy,” says Dykema, who remains pessimistic about the company’s fortunes. “Not only is the product offering confusing, the way in which they display it is confusing as well.” NetGrocer’s Horowitz disagrees. “We had our difficulties in this business related to operational and execution issues,” he admits, but he says those problems are a thing of the past, pointing to NetGrocer’s customer-retention rate of 60% and calling the potential for the online grocery market enormous.

But despite the current problems, there is a consensus that e-grocery shopping will one day be headed for the express lane with a large number of households. “There are many obstacles limiting the potential of online grocery sales,” says Dykema, “and whoever solves them will be economically rewarded.”