Case: Webvan – A cautionary tale about breakeven analysis & the misguided use of “if you build it, they will come.”

Background

Founded in 1996 by Louis Borders, co-founder of Borders Bookstores, Webvan was an online grocery delivery business that went bankrupt in 2001. At the time, there were no other major pure-play providers in the online grocery space.  Competitors such as Peapod, HomeRuns, and Albertsons were around; however, they only dabbled in the online space and/or utilized strategic alliances and joint ventures with traditional bricks-and-mortars grocers.  The goal of Webvan was to provide shopping convenience to customers through a convenient and reliable online website backed by a state-of-the-art order fulfillment infrastructure.  Grocery consumption was expected to continue growing with the population, and Internet commerce seemed to have limitless potential.  This, combined with numerous surveys indicating that grocery shopping was one of the least liked household-related chores, gave strength to the notion that online grocery shopping was the way of the future.

Webvan was backed by a host of vaunted VC investors, including Sequoia Capital and Goldman Sachs. In its IPO, Webvan raised nearly $400 million.  Yet, after only a few years of operations, Webvan went “belly-up”, having never come close to breaking even.  In 2008, CNET published an article ranking what they considered to be the ‘top ten biggest dot-com flops.’  Ranked at number one, was Webvan.  The following three specific factors, ranked in order of impact, contributed most strongly to Webvan’s failure:

  • Financial Mismanagement – an initial massive investment in IT infrastructure, which raised Webvan’s breakeven to an unattainable level given that it was a start-up with small economies of scale;
  • Weak Market Research – a lack of consumer understanding, leading to a decision to cut costs by dropping its product quality and propagating a general lack of customer focus in its decision making;
  • Inexperienced Management – a leadership team with no grocery industry experience, leading to unrealistic cost structures and general strategic oversights.

Financial Mismanagement

Successful online grocers such as Tesco and Peapod began their online ventures with conservative investments in small, local test markets in conjunction with other established industry partners.  In contrast, having never tested its business model, Webvan decided to build its own hub-and-spoke distribution system that would span the country.  Investing close to a billion dollars in state-of-the-art logistics (warehousing, inventory control, order fulfillment, and delivery), Webvan built up a colossal distribution capability which, while impressive, could only be profitable at a very large scale.  As their costs were rising and their margins were shrinking, Webvan continued to enter new markets in 2000 and also acquired competitor, HomeGrocer.com, in a $1.2 billion all-stock deal.

These high initial fixed costs and relatively small initial customer base meant that Webvan’s state-of-the-art distribution system was operating at less than half-capacity and every delivery being made was resulting in a loss.  Adding insult to injury, when Webvan acquired HomeGrocer.com, Webvan management chose to replace HomeGrocer’s website with their own, expecting the change to be transparent to HomeGrocer’s customers.  However, the customers did not identify with Webvan’s website, leading to a one-third drop in demand for their products.  Webvan underestimated the switching costs of learning a new website, and were never able to recapture those lost customers as it filed for bankruptcy a year later.

Weak Market Research

What Webvan failed to realize was that their target customers, who were primarily women of dual-income households, who could afford to pay extra for the convenience of home delivery, highly valued a product quality level comparable to in-store product. Meeting this minimum expectation of baseline quality was the lynchpin to customer loyalty.  If the quality wasn’t there, then the convenience factor was negated and economic utility would go to zero from the customer’s perspective.  As the pressure on Webvan to cover their high initial fixed costs was rising, and their underestimation of operating costs was becoming apparent, management decided to cut costs by lowering the quality of their suppliers.  This drop in quality contributed to the disappointment of Webvan’s customers who were experiencing rapidly rising delivery fees and declining product quality.

Originally, Webvan charged no delivery fees.  Realizing that they had underestimated their operating costs and that home delivery was the biggest expense by far, they decided to implement a delivery fee schedule.  In less than one year, they raised these delivery fees twice.  This lack of consistency signaled to both customers and investors that the company was unstable.  New customers, who were not yet repeat buyers, were deterred from making future purchases as they lacked confidence in Webvan’s sustainability.

In addition, Webvan had also underestimated delivery times and was unable to fulfill an aggressive 30-minute delivery guarantee.  In contrast, other online grocers like Tesco and Peapod used much more conservative estimates that allowed them to guarantee delivery by 10pm in the night for orders received by noon that day.  Not only were these delivery time estimates more feasible from a logistical standpoint, they also mirrored their customers’ lives more closely.  Most of the online shoppers worked during the day and could not be around to receive grocery deliveries at their homes during business hours.  As well, when given the choice to either receive their deliveries in person, or to have their deliveries dropped off, most of these same shoppers preferred to receive the deliveries in person.  Batching nighttime deliveries, as Tesco and Peapod had done, made more sense given their target customers’ preferences and lifestyles.  Webvan did not apply this type of marketing insight to their plans.  Their fulfillment operations were solely focused on procurement and warehousing, rather than website development and delivery logistics.  Put another way, Webvan invested in technical efficiency, while Peapod & Tesco invested in flexible operations and consumer research.

To handle route planning, Webvan utilized a software system that would allow customers to see when other deliveries to their area were already scheduled and would give them the option to choose these windows of time for enhanced efficiency.  However, Webvan gave no incentives to promote this option and as a result, customers did not opt to coordinate their deliveries with existing deliveries to their area.  Peapod, focusing heavily on the delivery problem, provided the same option to their customers but also gave them financial incentives for strategically timing their windows of delivery.[1] As a result, Peapods evening deliveries proved financially effective.

Inexperienced Management

“What I didn’t calculate was the stupidity of some management decisions.  Here’s one: Last December, right after I made my last purchase of its shares, at a time when Webvan had just two quarters’ worth of cash in the bank, the company started repainting all of its brightly colored vans. After less than two years of operations, Webvan decided to launch a rebranding campaign.

Re-branding?  The company’s brand was barely established in the minds of its few customers!  The company was running out of money, and raising more money was getting harder every day, yet management decided to get the vans repainted.

I’m sure the amount was small, perhaps less than $100,000.  But that was cash out the door, cash that could never be used for any other purpose.  Which illustrates one reason Webvan failed–there were no real entrepreneurs running this company.  Real entrepreneurs never let money out the door for any reason that doesn’t strictly advance the business of the company.”[2]

In the fall of 1999, George Shaheen, former CEO of Andersen Consulting, joined Webvan as its new CEO.  None of the top management at Webvan were web-savvy grocery industry veterans.  This was in stark contrast to Peapod’s leadership team. Founders Andrew and Thomas Parkinson (still the top managers at Peapod) had experience as a brand manager at P&G and Kraft, and as a software company founder, respectively, prior to starting Peapod.  Webvan’s lack of experience led to poor inventory management and cost forecasting.  Their cost estimates for delivery were in the realm of $15 per delivery, which did not include the cost to operate the distribution centers.  This unrealistic cost structure made it impossible for Webvan to be competitive with grocers such as Wal-Mart and Kroger, who enjoyed large economies of scale.  “They never understood the value chain of the grocery business.”[3]  Thin margins in the grocery business essentially translate to commoditized goods.  In a commoditized industry, the ability to win business is earned through a focus on understanding customer needs and providing the best experience. Webvan’s executives simply did not understand the importance of customer focus and market research in the grocery business.  They had convinced themselves that technical efficiency in order fulfillment was the key to success.  They failed to ask themselves how they were going to get the customers in the first place, and once they were attracted, how they would be retained.  Webvan assumed too much for having no industry experience.

Summary

Although these failure points could be classified separately, they were highly interrelated and were part of a cascade of issues triggered by the initial overinvestment into a large-scale IT fulfillment network.  Management’s overall lack of understanding of the grocery business and their overly ambitious plans to grow quickly, fueled by myopic VCs, led to poor investment decisions which exacerbated existing financial pressures typical in start-ups.  The damage inflicted by Webvan’s over-reliance on logistics and under-reliance on consumer research was only made worse by these factors.  

~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~
[1] Lunce, S. (2006). Success and Failure of Pure-Play Organizations: Webvan versus Peapod, a Comparative Analysis.
[2] Alsop, S. (2001, Aug. 13). The Tragedy of Webvan. FORTUNE magazine.
[3] Rizzo, T. (2001, Aug. 1). Web Observatory: The death of Webvan. Internet World, 7, 4.
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