Entrepreneurship, Venture financing, Online grocery

Electronic copy available at: http://ssrn.com/abstract=2585183
TEACHING CASE
HomeGrocer.com: Anatomy of a failure
Greg Fisher a,
*, Suresh Kotha b
a Kelley School of Business, Indiana University, 1309 E. Tenth Street, Bloomington, IN 47405-1701, U.S.A.
b Michael G. Foster School of Business, University of Washington, Box 353226, Seattle, WA 98115, U.S.A.
1. Learning from the past?
Terry Drayton, co-founder and first CEO of the now
defunct HomeGrocer.com, left the meeting with his
original managementteam feeling chargedand hopeful. They had gathered to discuss the possibility of
reviving the online grocery business. Although the
initial iteration of HomeGrocer.com had fallen victim
to a failed merger with Webvan, a potential reincarnation was now attracting interest from investors.
The HomeGrocer.com saga began in 1998, when
Drayton and his Seattle-based team launched the
service. They raised over $440 million in capital
in multiple rounds of financing and opened eight
distribution centers in six locations throughout the
western United States. They made plans for more
locations and were in the midst of a fast rollout at
the time of HomeGrocer.com’s initial public offering
(IPO) on March 9, 2000. One month later, the
NASDAQ dropped 35% from its high of 5,132 and
the opportunity for a secondary round of funding
disappeared. Lacking cash to deliver on the growth
plans laid out in its IPO prospectus, HomeGrocer.
com tried to weather the financial crisis by merging
with Webvan, a California-based online grocer that
was launched in 1999.
Webvan, with its larger capital base1
, took control of the merged company. To the chagrin of
HomeGrocer.com executives, Webvan’s managers
transitioned all of the distribution centers to the
Business Horizons (2014) 57, 289—300
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KEYWORDS
Business models;
Entrepreneurship;
Venture financing;
Online grocery;
Merger;
Bankruptcy;
Teaching case
Abstract This case study examines the initiation, financing, development, and
failed merger of an ambitious online grocery retail venture: HomeGrocer.com. It
highlights the risks and challenges associated with developing a revolutionary venture. Even though the HomeGrocer.com team did many things right developmentally,
some key errors and unfortunate timing resulted in them expanding too quickly and
running low on cash. It also forced them to make a tough strategic decision about
whether to scale back operations and renege on their IPO commitments or merge with
a well-funded competitor, Webvan. The case discusses lessons that can be learned
from business failure.
# 2013 Kelley School of Business, Indiana University. Published by Elsevier Inc. All
rights reserved.
* Corresponding author
E-mail addresses: [email protected] (G. Fisher),
[email protected] (S. Kotha)
1 At its 1999 peak, Webvan had a market capitalization of
$8.8 billion compared with HomeGrocer.com’s $725.5 million
at IPO.
0007-6813/$ — see front matter # 2013 Kelley School of Business, Indiana University. Published by Elsevier Inc. All rights reserved.
http://dx.doi.org/10.1016/j.bushor.2013.12.002
Electronic copy available at: http://ssrn.com/abstract=2585183
Webvan technology and created a single Webvan
brand. However, despite their efforts, the Webvan
managers burned through cash quickly while losing
money. As a result, their share price plummeted
from $26 in December 1999 to $4 at the time of the
merger (August 2000). By January 2001, the price of
Webvan shares was only 5 cents. In June 2001, less
than a year after the merger was announced,
Webvan filed for bankruptcy.
Drayton had learned a great deal from his experience at HomeGrocer.com. He strongly believed that
he and histeam had done many things right and were
close to resolving the challenge of creating an online
grocery business model. As he drove home from the
meeting with his former colleagues, he wondered
what he could do differently. Reflecting on his
experience in founding HomeGrocer.com, Drayton
thought about the start-up phase, the merger decision, and the post-merger actions to try and isolate
what critical mistakes he and his team would avoid
the second time around–—if given the chance.
2. The start-up phase
Terry Drayton and Mike MacDonald founded
HomeGrocer.com, an Internet-based grocer, in
1994. Drayton had just sold Crystal Springs Water
Company, which delivered bottled water to businessesin and around Vancouver, B.C., and waslooking
for something new. One cold winter’s day, Drayton’s
wife remarked that he ought to deliver groceries
instead of water so that busy moms wouldn’t have
to brave a snowstorm justto go to the store. The idea
stuck and Drayton found himself discussing it with his
friend MacDonald, president of the largest food broker in the Canadian province of British Columbia.
MacDonald was intrigued and agreed to put up some
initial capital while Drayton wrote the business plan.
MacDonald’sfriend, Ken Deering, who had technology
expertise, soon joined them as vice president
of systems. The new venture would be called
HomeGrocer.com.
2.1. Initial funding
By April 1997, Drayton had raised $350,000 in seed
capital from friends and family. In search of more
funding, he and the team moved their operations to
Seattle to be in a more ‘techno-friendly’ city. This
came at a time when respected Wall Street analysts
and investment bankers were touting the Internet’s
potential ‘disintermediate’ incumbents in a number
of industry supply chains. Mary Meeker, the Morgan
Stanley stock analyst, noted (Meeker, Pearson, &
Roach, 1997, pp. 10—14):
It’simportantto understand the drivers ofsupply
and demand, and therefore how Internetbased distribution may affect this chain and
whether there will be disintermediation. . . .
For example, Amazon.com would be classified
as a disintermediary, asitremovesthe inventory
chain to the bookstore (e.g., brick-and-mortar
Barnes & Noble stores) and potentially creates
better unit pricing (than the traditional stores),
better service, and so forth, while reducing the
capital tied up in inventory. It’s pretty simple–—
less overhead, more efficiency and better prices
for consumers.
These comments excited investors, fueling the
funding of many online ventures via a buoyant
venture capital (VC) industry. In May 1998, Drayton
raised $4 million in a ‘Series A’ funding round. Tom
Alberg (personal communication, November 10,
2007) of Seattle’s Madrona Ventures, an early VC
investor in HomeGrocer.com, recalled:
We had already invested in Amazon.com, so we
were beginning to see that online commerce
could work. This [venture] was much different
[in] everything from the delivery to the inventory to a whole lot of issues. . . .Nonetheless,
lots of people were frustrated with the regular
grocery stores. . .the lack of inventory sometimes and having to carry [grocery] bags out,
and parking and everything else. We thought
there was an opportunity and that it could
be a really big business. Unlike Amazon.com,
though, you can’t serve the whole country from
one warehouse initially. You’ve got to start by
building out in cities. We realized it was going
to take a lot more capital. But we were attracted by Terry’s idea of doing it in a relatively
low-capital way.
Four months later, the HomeGrocer.com team
raised another $6 million in a ‘Series B’ funding
round, with the high-profile Silicon Valley VC firm
of Kleiner Perkins Caufield & Byers as the lead investor. This was followed by a ‘Series C’ funding round.
By thistime,the market was abuzz with hopesforthe
Internet grocery business, and HomeGrocer.com had
attracted the attention of some well-known individuals andorganizations asinvestors: Amazon.com; Jim
Barksdale, an early executive with Netscape and
former senior executive with Federal Express;
and John Malone, the legendary cable TV operator
and Liberty Media investor. Terry Drayton (personal
communication, February 29, 2008) recalled the dynamics of the ‘Series C’ funding round:
We went out to raise $20 million, but everybody
wanted to own more of the company, so the
290 G. Fisher, S. Kotha
round kept going up. Amazon.com insisted on
owning 35% and we had a valuation in mind so
we just had to raise way more money than we
ever intended: $52.5 million in total.
A ‘Series D’ financing round followed in April 1999
with HomeGrocer.com raising another $110 million.
Primary investors during this round of financing
included CBS Inc., the Knight-Ridder Company, Softbank Co. of Japan, and Sequoia Capital. With the
frenzy over Internet-based ventures in full swing,
Drayton raised a total of $172 million from VC
investors, even though his original business plan
only called for $15 million in VC funding followed
by an IPO to secure another $50 million in capital.
Drayton also assembled an impressive board
of advisors including Jeff Bezos, the founder of
Amazon.com; John Doerr, the high-profile VC from
Kleiner Perkins Caufield & Byers; Jim Barksdale; and
Martha Stewart.
2.2. The grocery industry
In the late 1990s, the United States grocery industry
was mature and extremely competitive; Table 1
provides an overview. In 1998, retail supermarket
sales totaled approximately $449 billion. Grocery
retailing had experienced growth in real sales during
only 4 ofthe previous 10 years, and net profit margins
remained thin at 1% of sales. The industry was, and
continues to be, highly fragmented.
According to 1998 reports, the United States
population growth was expected to decline. Survival
of the grocery industry would rely on cost-containment efforts, increases in economies of scale and
scope, heavy penetration of existing markets, and
greater-than-average consumer expenditures. To
increase revenues, grocers had to increase the
breadth and depth of fresh produce, meat offerings,
and organically grown items while relying on private-label products with higher margins.
2.3. The market for online groceries
Forrester Research (www.forrester.com) forecast
that the total United States Internet-retail commerce would grow from approximately $20.3 billion
in 1999 to approximately $184.5 billion in 2004,
representing a compound average growth rate
(CAGR) of over 55%. It estimated that online grocery
spending would increase at a CAGR of over 100%
during the next 5 years, from $513 million in 1999 to
$10.8 billion by 2003. Despite its size in absolute
terms, this spending was expected to represent less
Table 1. Grocery industry overview, 1998
Number of employees 3.5 million
Number of grocery stores 126,000
Total grocery store sales $449 billion
Total supermarket sales $346.1 billion
Number of supermarkets ($2 million+ in annual sales) 30,700
Net profit after taxes, 4/98-3/99 1.03%
Typical supermarket size 40,483 sq. ft.
Number of items in a supermarket 40,333
Labor as a % of operating expense 57.5%
Average effective income tax rate (fed, state, local) 4/96-3/97 39%
Percentage of disposable income spent on food
! food-at-home
! food away-from-home
6.6%
4.2%
Weekly sales per supermarket $331,411
Weekly sales per square foot of selling area $9.45
Sales per customer transaction $10.16
Sales per labor hour $113.21
Average # of trips per week consumers make to the supermarket, 1/98 2.2
Food basket costs, % of weekly income spent on food
! Unites States
! Canada
! Japan
8.8%
10.3%
17.6%
Sources: U.S. Department of Labor, U.S. Department of Agriculture, Progressive Grocer magazine, and U.S. Census Bureau
TEACHING CASE–—HomeGrocer.com: Anatomy of a failure 291
than 2% ofthe total United States marketfor grocery
products in 2003.
Forrester categorized the online grocery industry
into two segments: full-service retailers and specialty stores. Full-service retailers are those selling
a complete range of grocery products, including
perishables. Specialty stores, in contrast, offer a
limited selection of gifts, hard-to-find items, or bulk
replenishment products via the Internet. Table 2
provides a detailed breakdown of predicted electronic grocery spending in the U.S. from 1999—2003.
At that time, Forrester Research estimated that by
2003, 16 million households would buy groceries
online.
Traditional brick-and-mortar retailers were slow
to embrace the Internet as a medium for selling
groceries. Albertson’s and Hannaford Brothers were
among the few traditional grocers that experimented with an online model. A major uncertainty
for those launching online grocery ventures was if,
or when, other major chains might enter the online
space. Given their buying power, traditional retailers had the ability to source products at a lower
cost compared to new entrants. While some detractors of online grocery retailing cited many downsides to the online model–—including supply chain
complexities, consumer distrust, and technology
and payment challenges–—others were much more
positive about the prospects of selling groceries
online due to potential cost savings of the model.
Tom Alberg (personal communication, November 10,
2007) noted:
I think there have always been people who have
said, ‘‘[Online markets] will never work for
groceries. Margins are too low. How can you
purchase atthe same competitive prices?’’ A lot
of which is true, but there are also online
advantages. You don’t have to have the expensive space, parking lots, and as many employees. These are huge advantages.
At the time, online grocers were not responding to
pent-up demand. Demand had to be created. Because this kind of service was so novel, potential
customers had to be educated. Many questions
about the transaction process had to be answered.
Despite these concerns, a number of online grocers
began to sell over the Internet and deliver to customers’ homes. Initially there was little head-tohead competition among new entrants, since each
focused on a specific geographic region.
2.4. Launching in Seattle
The HomeGrocer.com business plan dictated that
the company would spend its first 12—15 months
establishing a distribution center in Seattle and then
roll out new facilities every 3 months in other U.S.
cities. The idea centered on learning as much as
possible from the launch of the first distribution
Table 2. The emerging online grocer industry forecasts
1999 2000 2001 2002 2003
Online Grocery Sales
Specialty $248 $659 $1,548 $3,058 $6,291
Full Service $265 $473 $911 $1,951 $4,545
Total Revenues $513 $1,132 $2,459 $5,009 $10,836
Percentage of Industry Total 0.11% 0.23% 0.49% 0.98% 2.05%
Total Number of Households Buying Groceries Electronically (000s)
PC-Based 920 1,839 3,678 6,252 10,628
Specialty Other Net Devices 35 106 318 1,114 4,454
Total Specialty 955 1,945 3,996 7,366 15,082
PC-Based 187 327 621 1,242 2,546
Full-Service Other Net Devices 6 12 35 124 495
Phone/Fax 42 42 38 34 31
Total Full Service 235 381 694 1,400 3,072
Total Households doing both 59 115 243 630 1,536
Total participating households 1,131 2,211 4,447 8,136 16,618
Source: Forrester Research, Inc. (www.forrester.com)
292 G. Fisher, S. Kotha
center to perfect the model before replicating it in
other regions. The HomeGrocer.com website went
‘live’ in May 1998, and commercial operations were
officially underway in Seattle with a staff of 60.
During its first month, HomeGrocer.com attracted
300 customers; on average, each placed three $75
orders per month. According to Drayton’s business
projections (Tables 3 and 4), the Seattle facility
would break even at 1,100 orders per day.
2.5. Expanding beyond Seattle
A year later, in May 1999, HomeGrocer.com entered
Portland, Oregon, with a distribution site. However,
the company had not yet broken even. By September
1999, it built another distribution center–—this one in
Orange County, California, where HomeGrocer.com
employed a more automated system. Items were
picked in zones and batches, and conveyors were
used instead of having people walk around to make
selections. Rather than its usual 50,000-square-foot
facility, the Orange County center was double that
size. The number of employees also increased rapidly, doubling every 5 or 6 months. By November 1999,
the payroll reached over 1,000 employees.
Over the next few months, HomeGrocer.com
opened five new distribution centers: second facilities in Orange County and Seattle, two in Los Angeles, and one in San Diego. The new distribution
centers were opened at a rate much faster than
originally called for in the business plan. Drayton
(personal communication, February 29, 2008)
pointed out:
The biggest consequence of raising a lot of venture capital was [that] with all this money, everyone expects you to grow that much faster.
That’s very difficult to do in a logistics-intensive
business like HomeGrocer, especially when your
business is not yet fully baked. If you’re the
entrepreneur, what you’d love to do is stuff
the money in the bank and take your time,
knowing that you don’t actually have to go spend
more time raising money. Then you can focus on
perfecting the venture.Venture capitalists don’t
like that. They want you to go full speed all the
time with the gas pedal pegged to the floor.
2.6. The HomeGrocer.com approach
HomeGrocer.com was established as a full-service
online grocer offering perishable and nonperishable items. The company enabled customers
living within a designated region to buy groceries via
its website and then have the purchases delivered to
their homes. The company invested heavily in creating a website that replicated many aspects of the
shopping experience for customers used to buying
Table 3. Financial projections for HomeGrocer.com from the business plan ($ 000s)
CORPORATE FINANCIAL PERFORMANCE ($ Thousands)
Year 1998 1999 2000 2001 2002 2003
Number of Centers 1 3 7 15 31 31
Revenue 11,199 49,960 125,718 291,816 634,333 1,125,123
Gross Margin (%) 19.4% 16.7% 15.3% 15.0% 14.7% 12.0%
Net Income Before Tax (1,349) (2,901) (2,821) (1,065) 2,685 12,467
Net Income (%) (12.0%) (6.2%) (2.2%) 0.4% 0.4% 1.1%
Members 7,700 27,600 69,700 157,000 336,400 547,200
Working Capital 9,622 4,606 44,377 34,289 18,980 25,415
Total Assets 12,149 10,557 57,506 62,185 76,672 92,810
Employees 95 323 800 1,771 3,753 5,684
PROTOTYPE CENTER FINANCIAL PERFORMANCE ($ Thousands)
Year 1 2 3 4 5
Revenue 12,960 30,948 47,108 60,309 72,152
Gross Margin (%) 18.5% 13.4% 13.0% 12.8% 12.7%
Net Income Before Tax (629) 618 1,962 2,931 3,903
Net Income (%) (4.9%) 2.0% 4.2% 4.9% 5.4%
Members 8,400 15,600 21,600 26,400 31,200
Employees 91 313 784 1,753 3,733
Working Capital 532 918 2,666 5,616 9,656
Total Assets 2,122 3,215 5,572 8,819 13,038
Source: Extracted directly from the HomeGrocer.com business plan dated December 31, 1997
TEACHING CASE–—HomeGrocer.com: Anatomy of a failure 293
goodsin a traditional grocery store. The website was
user friendly, time efficient, and featured 9,000—
12,000 items2 via an intuitively organized list. The
customer could either browse the shelves or use the
search function to locate items. Customers would go
online, order groceries, and select a 90-minute
window of time between 1 p.m. and 9 p.m. the
following day to have the items delivered. Orders
over $75 had no delivery charge, while orders under
$75 accrued a $10 delivery charge.
2.7. The ‘online’ value proposition
The key advantages to the consumer were convenience, quality, and service. HomeGrocer.com
customers could shop 24/7 from the comfort of
their couch, and goods were delivered directly to
their homes; they no longer needed to carry heavy
grocery bags to and from their cars. Because the
perishable items sold online hadn’t been put out
for display or handled by other shoppers, they
were of higher quality and lasted longer than
those purchased in a traditional grocery store. John
Landers (personal communication, March 6, 2008),
Table 4. Break-even analysis for HomeGrocer.com from the business plan: Analysis per center
These projections assume an average order size of $100 with members shopping twice per month. Only 15% of orders
are assumed to be less than $75 requiring a $9.95 delivery fee. A membership of $35 is collected from 90% of members.
Hence an average member purchases $2,467 per year in products from HomeGrocer.com as shown below:
Amount % of average
grocery sales
Average Sale $2,400.00 100.0%
Average Delivery Fee 35.82 1.5%
Average Membership Fee 31.50 1.3%
2,467.32 102.8%
Average Cost of Sales
Groceries/shrinkage 1,735.20 72.3%
Delivery 223.20 9.3%
Picking 208.80 8.7%
Transaction 19.20 0.8%
Subtotal 2,186.40 91.0%
Annual Gross Margin per member $280.92 11.8%
The above analysis uses costs at the end of 1 year and excludes all revenues forecast from manufacturer programs.
Revenues from these activities are forecast at $1,740,000 in the first year and $600,000 thereafter.
Fixed costs to operate a HomeGrocer.com site are approximately $3 million annually, which are determined asfollows:
Annual Fixed Costs to Operate a HomeGrocer.com Center
Cost Amount
Warehouse Rental $243,000
Triple Net and Utilities 102,000
Warehouse Equipment Maintenance 48,000
Insurance 24,000
Office Equipment Maintenance 12,000
Supplies 60,000
Legal and Accounting 60,000
Communications 90,000
Administration 784,700
Member Services 176,229
Sales & Marketing 1,236,000
Depreciation 137,550
Miscellaneous 60,000
Total $3,033,875
As operating efficiencies improve over the year and some expenses are front-end loaded, actual monthly breakeven is forecast to
occur in month 14. So each site is forecast to achieve a break-even level of operation in just over 1 year.
Source: Extracted directly from the HomeGrocer.com business plan dated December 31, 1997
2 A traditional store carried over 100,000 items or SKUs.
294 G. Fisher, S. Kotha
vice president of marketing at HomeGrocer.com,
noted:
Clearly, our producewasfresherthan thatbought
at a traditional grocery store. We operated on
a just-in-time inventory basis and did notrequire
surplus merchandise for display. Theoretically
[in a traditional grocery store], customers could
select produce to their liking from the available
produce by touching and scrutinizing. However,
customers damage a good deal of produce by this
inspection and are limited to selecting from a
picked-over assortment. HomeGrocer.com pickers were able to select fruit to the customer’s
specifications without damaging the rest of the
produce.
HomeGrocer.com focused on quality customer service. This entailed responding to customer requests,
following up after completion of a delivery, and
training drivers to be sensitive to customer needs.
The driver was seen as a company representative
since he was the only employee the customer ever
saw. Delivery personnel were instructed to carry
groceries into the kitchen or pantry after asking
the customer whether they could enter the house.
Wearing surgical booties over their shoes was mandatory in order to leave no impact on the customer’s
home. Such attentiveness made a big impression on
HomeGrocer.com’s customers. Ken Deering (personal
communication, November 14, 2007) observed:
We’d get comments from people calling and
saying, ‘‘The best thing about your business is
I never have to pick up another 20-pound bag of
dog food in the store, and the driver putsitin the
garage. He knows that’s where we keep it.’’ Or,
‘‘I can’t believe he took the time to putthe soap
on top of my washing machine on the way outthe
door.’’
In addition, each first-time customer received a
phone call from a customer service representative
to make sure he/she was completely satisfied with
the order.
2.8. Marketing and customer acquisition
The company targeted busy middle- to upper-class
families ($75,000+ per year) with school-age children and both parents in professional occupations.
Such families were typically short on time, spent
enough on groceries to make buying online attractive, and had access to the Internet at home.
According to the company’s market research,
women made the buying decisions in these homes.
As a result, the website was designed to appeal
to them.
HomeGrocer.com’s advertising and promotion
initially focused on the convenience of buying online. After Jon Landers joined as vice president of
marketing in November 1998, the company began
promoting the freshness and quality of its products.
Landers decided to stress this advantage by sending
free sample produce bags with each order.
In addition to distributing free fresh produce bags
in targeted neighborhoods, the HomeGrocer.com
team gave away coupons to encourage customers
to buy, and eliminated delivery charges for first-time
buyers. This was a costly exercise. The company
spent approximately $300 per customerin acquisition
costs but struggled to retain these clients; many
would stop buying after just three or four purchases.
Picking up on this, Landers implemented a psychographic profiling process, using GIS (Geographic Information Systems) mapping to ensure that the team
was targeting areas with customers who had the
appropriate profile. The move helped bring down
acquisition costs and improved customer retention
rates, but did not completely solve the problem.
Because all commerce was completed via the
Internet, boosting web traffic was critical to generating sales. This was at a time before email or search
engine marketing. To drive traffic to the company
website, HomeGrocer.com used traditional media
including direct mail pamphlets and newspaper and
television ads. It also used unconventional marketing
in the form of Peach Parties, a type of Tupperware
party for early Internet users; and extensive sponsorships of local community organizations, such as donating apples and bottled water to school PTA
members who handed them out with direct mail
pamphlets that promoted a gift of $25 for the organization if people tried HomeGrocer.com. The company also entered into partnerships with AOL and
Amazon.com. Of these partnerships, Drayton (personal communication, April 18, 2008) remarked:
These were basically the big playersin the Internet, especially for customer acquisition. We had
Amazon.com as a shareholder[and so] we had to
deal with them. We signed a big AOL deal because at that stage AOL was so dominant, they
were about 40% of the overall market, but for us
they were all ourtarget customers, and so it was
probably a disproportionate share. Most people
who used AOL thought that it was the Internet
at the time.
Even though HomeGrocer.com was able to create
customer interest and get people to explore the
company’s website, it encountered barriers to firsttime and repeat orders. For many individuals, buying groceries at a store was such a natural way of
doing things that they struggled to move away from
TEACHING CASE–—HomeGrocer.com: Anatomy of a failure 295
the practice. Deering (personal communication,
November 14, 2007) called this the ‘gallon of milk’
problem:
Your spouse is on his way home and you call up
and say, ‘‘We’re out of milk. Could you please
stop and pick up some milk on your way back?’’
He stops to buy a gallon of milk. While buying
milk, he does other grocery shopping. Because
of this, this family ends up not shopping online
that week.
2.9. Operations and delivery
HomeGrocer.com opted to build its own distribution centers and purchase refrigerated delivery
trucks. The distribution centers were built close
to the neighborhoods the company served. Because
of the high upfront investment in infrastructure
and systems, each facility needed 1,100 orders per
day, at an average order value of $100, in order
to break even and become profitable. The first
55,000-square-foot facility was rented just outside
of Seattle in Bellevue, Washington.
Since small operations do not enjoy the strong
wholesaler relationships that large brick-andmortar stores typically do, Homegrocer.com generally paid more for its inventory. In spite of the
increased cost of goods sold relative to larger retailers, HomeGrocer.com’s original business plan
projected net profit margins of 7% over the long
term (compared with 1%—2% for traditional grocery
chains). These higher projections were based on its
lower location costs and not needing to build retail
displays or hire checkout clerks.
Logistically, the business concept presented the
company with significant challenges. HomeGrocer.
com’s top management agreed that the most complicated part of the business was the supply chain.
When an order came in, a picker would start at one
end ofthe facility and work his/her way to the other,
selecting all of the ordered items. If something
wasn’t in stock, an employee would have to rush
out and buy it from a local grocery store. While its
competitors would simply ship an incomplete order
if they did not have an item in stock, HomeGrocer.
com’s zeal for customer service prompted it to
ensure that customers received exactly what they
ordered. This policy had significant cost and time
implications in that pickers could spend up to 50% of
their time filling a few items on an order.
The company’s trucks featured compartments
with three different temperature settings: one for
frozen food, a cooler for produce, and room temperature for dry goods. Each truck could deliver
30—40 orders per day within a narrow geographical
area. In this respect, the online grocery business
departed from other Internet retailers like Amazon.com, which focused on a wide geographical
area. HomeGrocer.com boasted an impressive 98%
accurate delivery record. It also used a sophisticated third-party program, similar to that employed by
UPS, to route deliveries efficiently. According to
Drayton, the company was a pioneer in its technology. At the same time, software development led to
significant cost overruns; website development
alone reportedly cost $750,000.
2.10. Competitors
A number of other companies in the United States
were also attempting the online grocery retail model, including Peapod, which delivered products from
existing retail stores; Netgrocer.com, which delivered nonperishable packaged items using courier
services like FedEx and UPS; and Webvan, the grand
project of Louis Borders, co-founder of Borders
Books and Music. Webvan attracted large amounts
of capital from high-profile VCs with its promise to
revolutionize retail by creating a web-based storefront that sold ‘‘everything from groceries to Palm
Pilots.’’ With its massive 330,000-square-foot Bay
Area warehouse, fleet of trucks, and highly sophisticated automated picking system, Webvan was
considered HomeGrocer.com’s fiercest rival. Both
companies were striving hard to be first to market
in establishing a web-based retailing presence in the
biggest cities in the United States.
2.11. Going public
In 1999, the investment climate for Internet IPOs
seemed strong, and HomeGrocer.com prepared to
go public. The company’s financials revealed that it
had lost $7.9 million on $1.1 million in revenue in
1998 and $84 million on $21.6 million in revenue in
1999. Prior to its public offering, the board decided
to bring in an experienced CEO to replace Terry
Drayton, along with a new CFO. While Drayton
was not overly pleased, he remained supportive
of the plan. Board members considered candidates
with the relevant logistics, financing, and management experience. They hired Mary Alice Taylor–—
former CIO at Citigroup and, prior to that, a senior
executive of operations at Federal Express–—as CEO.
As CFO they hired Dan Lee, former CEO of Mirage
Resorts for the preceding 10 years.
HomeGrocer.com went public on March 10, 2000.
The stock opened at $12.88, reached a high
of $16.25 on the first day, and closed at $14.12.
HomeGrocer.com’s top management team had
hoped to bring in between $500 and $600 million
296 G. Fisher, S. Kotha
in capital from the IPO, yet ended the day raising a
total of just $268 million.
2.12. The stock market collapse
In April 2000, the NASDAQ index declined sharply as
the Internet bubble burst. Overnight, Wall Street’s
Internet mantra changed from ‘get big, fast’ to ‘get
to profitability.’ HomeGrocer.com had spent 18
months gearing up for a rapid rollout and slowing
it down would be tough. The company lacked the
capital needed to achieve positive operating cash
flows on its eight distribution centers. In order to
remain a viable operation, it needed between $300
and $500 million in additional capital, yet it was
unclear when–—or even if–—the financing window
would reopen. Given such uncertainty, growth plans
were put on hold. At the same time, rival companies
began to compete head-to-head in some markets.
Without additional capital, it was unlikely that
HomeGrocer.com could support its large workforce
or fund the expansion plans promised in its IPO
prospectus. Both management and the board were
concerned about lawsuits from investors if expansion plans were not carried out.
These were difficult times for HomeGrocer.com.
Although the company raised $268 million at the
IPO, financial losses were mounting. By this time,
HomeGrocer.com had over 2,300 employees and the
company’s stock was trading at $5 a month after the
IPO, representing a 64% drop in value in 1 month
since listing. Terry Drayton had recently left the
company due to differences with Mary Alice Taylor,
the new CEO. Under these trying conditions, she
began exploring ways to move forward.
3. Key decisions
The stock market meltdown that occurred days
after HomeGrocer.com’s March IPO squelched the
company’s ability to raise more capital. The top
management team, under Taylor, faced limited options. Drayton (personal communication, April 18,
2008) recalled:
We’d just gone public, and when you go public
you issue a prospectus in which you make all
sorts of commitments. We committed to opening new markets and distribution facilities. So
one of the biggest questions and hardest discussions we ever had with the investment bankers was if and when the market would ‘reopen.’
We needed more capital to meet our commitments. We asked: ‘‘Is the market going to reopen in time? Or is it ever going to reopen?’’ In
April 2000, the bankers said: ‘‘It may be a blip;
maybe by the summer it will reopen.’’ And then
by about June 2001, it was: ‘‘It’s all over. Who
knows when it will reopen.’’
One option was to scale back expansion plans and
focus on reaching profitability by improving existing
operations. At one point, company executives entertained the idea of restructuring HomeGrocer.com
under Chapter 11. However, since the company
had just gone public, declaring Chapter 11 would
almost guarantee shareholder lawsuits. The company’s board was sure to oppose that route.
Another option was merging with a wealthier
competitor like Webvan. Louis Borders founded
Webvan with the bold vision of ‘‘selling and
delivering anything and everything.’’ For him,
delivering groceries was just the beginning, a
way of getting into consumers’ homes. His plans
for Webvan were audacious, as he ‘‘sought to
outsmart the biggest players around, from Amazon.com and Wal-Mart to UPS and the U.S. Postal
Service’’ (Helft, 2001). Within months of launching
Webvan, he was able to raise over a billion dollars
through a successful IPO. One HomeGrocer.com
executive (personal communication, January 15,
2008) recalled:
[Webvan] had done a secondary offering. They
had tons of cash. We had eight operating centers and they had one. If we merged [we would
be] able to get out from most of the commitments we had made. We could say: ‘‘Now that
we’ve merged the companies, everything’s
changed and we’ve got to cut this back and
we’ll only open their facilities.’’ And so we
thought, ‘‘Here’s our way out.’’
If HomeGrocer.com merged with Webvan, the
combined company would have $500 million in cash
(Hobson, 2000)–—enough to weather the storm and
move the combined entity toward profitability. But
the two companies had very different cost structures (Drayton, personal communication, February
29, 2008):
At that stage, one of the key metrics was
average order size. You need at least a $100
orderto generate $30 in gross marginsto pay for
the picking, to pay for the shipping, and all
that. [Webvan’s] picking costs were high because they had these really automated facilities. They needed staggering numbers of orders
to cover costs. It cost them something like
$100,000 a day whether they picked anything
or not to keep the facility open, so divide that
by 500 orders and all of a sudden it’s really
expensive to pick your orders. Whereas if we
TEACHING CASE–—HomeGrocer.com: Anatomy of a failure 297
had about 500 orders a day, we were doing fine;
at 1,000 we’d break even. I think they needed
3,500 orders a day to break even. And no facility
ever, in any of the markets we were operating,
got close to 3,500. We did about 2,100 in Seattle once, which was a record for one day.
For 2 years, Webvan and HomeGrocer.com had been
fierce competitors. Merging with the enemy seemed
like a bitter pill to swallow for certain members of
the HomeGrocer.com management team. Table 5
provides a summary of HomeGrocer and Webvan’s
financial performance at the time of the merger
talks. On June 26, 2000, HomeGrocer.com announced a merger with Webvan in an all-stock
deal involving 138 million Webvan shares valued at
$1.2 billion. Webvanwasto exchange 1.076 sharesfor
each share of HomeGrocer. For Webvan, the deal
eliminated a tough competitor and gave it an immediate presence in six new markets. The combined
company projected it would save an annual $20—$30
million in redundant overhead costs.
The acquisition was completed in September
2000. By then, Webvan’s stock price stood at
$3.88. Its purchase of HomeGrocer.com was now
valued at $535 million, substantially less than its
initial offer of $1.2 billion. George Shaheen, CEO of
Webvan, remained the president and CEO of the
merged entity. At year’s end, the combined company operated in 13 markets and was set to open two
distribution centers in 2001. Its new goal was to
operate 25 facilities by the end of 2002. At the time
of the merger, Webvan had about $500 million in
cash, and HomeGrocer.com about $150 million.
4. The death spiral
Once Webvan took control, its executives exerted
influence on the merged company and things started
to quickly unravel. Webvan switched allHomeGrocer.
com facilitiesto itstechnology platform. Immediately following the change, customer ordersin San Diego
dropped from 1,000 to 500 a day, and within a week to
300 per day. The decline soon repeated itself seven
additional times at other facilities. As Terry Drayton
(personal communication, April 18, 2008) recalled:
Webvan’s technology did not work with AOL.
The ‘Buy’ buttons and the checkout on the
website did not work, so clients could not make
purchases even if they wanted to. Plus, it was
brutally slow since they only tested it on T1 and
T3 lines used by their developers. They did not
test it under the conditions that AOL soccer
moms would experience it, using a dial-up modem. We [HomeGrocer] had an in-house lab
that always tested new releases with representative users. I could forgive them for inadequate testing on the first conversion, but notfor
repeating the mistake seven more times over
the following months. Unfortunately, Webvan
management repeated this mistake with every
Table 5. HomeGrocer.com and Webvan: A summary of revenues and profits ($ 000s)
HomeGrocer Webvan
1998 1999 2000* 1998 1999 2000**
Net Sales 1,094 21,648 21,215 – 13,305 16,269
Cost of merchandise sold 1,018 19,515 17,515 – 11,289 12,138
Gross Profit 76 2,133 3,700 – 2,016 4,131
Sales, general, and marketing expenses 7,455 59,208 13,899 8,825 104,152 47,352
Technology expenses 6,466 3,010 15,237 5,523
Stock-based compensation expense 412 28,158 8,143 1,060 36,520 17,720
Customer fulfillment center expenses – – 17,644 – – –
Pre-opening expenses – – 2,015 – – –
Loss from operations -7,791 -85,233 -44,467 -12,895 -153,893 -66,464
Interest Expense -172 -384 -663 -32 -2,156 -150
Interest Income 54 2,232 1,688 923 11,480 8,799
Other income/(expense) -608 -23 – – –
Net Loss -7,909 -83,993 -43,465 -12,004 -144,569 -57,815
Unrealized Gain (Loss) on Marketable Securities 4 -729 990
Comprehensive Loss -7,909 -83,993 -43,465 -12,000 -145,298 -56,825
* 13 weeks ended April 1, 2000 ** 13 weeks ended March 31, 2000
Source: Hoovers.com
298 G. Fisher, S. Kotha
facility, with the same result. . . .The end result was a 50% immediate drop in sales, and
down to 33% of sales within a week.
In a related blunder, Webvan retained most of
HomeGrocer.com’s employees at a 50% premium
over their original salaries, but then gave them
nothing to do (Helft, 2001):
[Webvan] kept employees with identical jobs on
both sides, paying scores of workers retention
bonuses and time-and-a-half on their already
high salaries–—even as many of them had little
to do. ‘‘The last month I sat in my office answering maybe one question a day,’’ says Mike
Smith, Director of Distribution for HomeGrocer.
com. Shortly after the merger, Smith had gone
to Foster City, Calif., to meet with his counterparts. At the meeting, five Webvan employees
introduced themselves and described their responsibilities. When his turn came, Smith said:
‘‘I am director of distribution, and I do all of your
jobs.’’ It was all part of a culture where money
was no object.
By December, the media began reporting that cuts
were expected at HomeGrocer.com as Webvan
worked to establish a single brand and integrate
the two technology platforms. Even though HomeGrocer.com had six locations and Webvan had just
one, and although the HomeGrocer.com brand had
started to gain customer recognition for the peach
logo on its website and delivery trucks, a strange
switch occurred (Helft, 2001):
Blinded by their grand vision, Webvan’s execs
made a string of bad decisions. Even as it was
running out of money, the company spent millions on a rebranding campaign to avoid being
pegged as a mere grocer: The marketing push
promoted Webvan’s sterile new blue-and-green
‘‘W’’ logo. Gone were Webvan’s earthy grocery
bag and HomeGrocer’s fuzzy peach.
This move left many customers in Seattle, Portland,
and California unsure about what the change might
mean. As cash continued to run out, management
initiated cutbacks that only made matters worse.
For example, during the last quarter of 2000 they
decided to slash marketing expenses by 28%. As a
result, total orders fell 8% and orders from new
customers slid 48%. By January 2001, in order to
conserve cash, Webvan postponed planned openings
in Washington D.C., Baltimore, and New Jersey.
There was some good news: In March, the company’s Orange County facility #2 turned a profit, the
first and only standalone Internet grocer to do so.
Overshadowing this achievement, the company
released a dismal annual report in April. It included
a warning from its auditor that expressed ‘‘substantial doubt’’ the company could survive the year. The
report stated that Webvan would probably need to
raise additional capital by the fourth quarter. By this
time investors had soured on Internet-based ventures
and the company could notraise more capital. As The
Seattle Times pointed out (Liedtke, 2001):
The gloomy outlook is reflected in Webvan’s
stock, which closed this week at 12 cents, a
far cry from its all-time high of $34. The company has warned that its shares are in danger of
being delisted from the NASDAQ if the stock
doesn’t start trading above $1.
On April 13, 2001, CEO George Shaheen resigned
and the company laid off 1,150 employees. New
CEO Robert Swan was unable to stop the bleeding or
turn things around. In May, Terry Drayton made a
presentation to Swan suggesting ways to rescue the
company, including re-branding operations under
the HomeGrocer.com name and rehiring former
HomeGrocer.com executives. He even offered to
buy back the company’s facilities in Seattle and the
HomeGrocer.com name. However, nothing came of
the meeting.
On July 9, 2001, Webvan filed for bankruptcy and
ceased all operations. Over 2,500 employees lost
their jobs, while 400,000 customers in Seattle, Portland, San Francisco, Chicago, Dallas, Atlanta, and
Southern California lost their home grocery service.
A former senior technical manager at Webvan was
quoted as saying: ‘‘We bought them out, we killed
their stock, we killed their company, and then we
killed ourselves’’ (Helft, 2001). Alberg (personal
communication, November 10, 2007), the VC investor from Madrona, reflected on the merger and
everything that followed:
We [HomeGrocer] overextended ourselves by
trying to open too many markets too quickly.
Then we kind of got in this panic situation like,
‘‘Oh, we’re going to run out of capital.’’ We’d
gone public by then. ‘‘We’re going to run out of
capital, we’ve got to do this merger.’’ Management just became quite fixated that we had to
do the merger as opposed to really trying to find
other solutions like slashing expenses, cutting
back our expansion, and just letting Webvan
fail. If we hadn’t done the merger, Webvan
would have failed anyway. . . .The CEO and
the CFO were absolutely convinced this was
essential or the company would fail. Well, we
did the merger and it failed. I think once the
merger happened, there was no chance of success. I mean, it was just preordained. . . .
TEACHING CASE–—HomeGrocer.com: Anatomy of a failure 299
We invest in a lot of companies that succeed
and a lot of them fail, and sometimes it’s just
totally the wrong idea. I don’t think webgrocery sales is the wrong idea; it’s just hard
to execute. How do you figure out how to do
it, and how do you do it without spending too
much capital to get there?
5. The post-mortem
Soon after Webvan filed for bankruptcy, there was
talk about HomeGrocer employees reviving the original company. Many showed support for the original
founder, Terry Drayton, and his team. Former customers sent emails to the Seattle Post-Intelligencer
with subject lines like ‘‘Bring back the Peach’’ and
‘‘HomeGrocer.com resurrection.’’ John Cook
(2001), a reporter and columnist at the newspaper,
wrote:
To call the two-dozen e-mails I received passionate would be an understatement. These
online grocery shoppers clearly want to see
the well-polished, peach-colored HomeGrocer.com delivery trucks rumbling down their
streets again. . . .[Also] some of the venture
capitalists and angel investors I spoke to this
week–—including a few who invested in HomeGrocer.com in the early venture rounds–—didn’t
rule out the possibility of making another go
of it.
Noted David Billstrom, a managing partner at FBR
CoMotion, a VC firm in Seattle (Cook, 2001):
[I would] definitely take the meeting if Terry
knocked on my door. But he would have to look
methodically at the failure points of Webvan/
HomeGrocer.com and then he would have to
show how he would overcome those failure
points in the new incarnation. And then, most
importantly, he would have to get a track record showing that the new and improved version did not have the problems of the old.
References
Cook, J. (2001). Venture capital: Rebuilding online grocer is tall
order. Retrieved May 9, 2009, from http://www.seattlepi.
com/news/article/Venture-Capital-Rebuilding-online-groceris-tall-1059693.php
Helft, M. (2001). The end of the road. Retrieved June 10, 2009,
from http://kerchmax.tripod.com/webvan.html
Hobson, K. (2000). Out to lunch? Webvan/HomeGrocer deal
doesn’t deliver all the answers. Retrieved October 12, 2008,
from http://www.thestreet.com/tech/internet/977452.html
Liedtke, M. (2001). Webvan’s CEO resigns. Retrieved October 15,
2008, from http://archives.seattletimes.nwsource.com/
cgi-bin/texis.cgi/web/vortex/display?slug=webvan14&date=
20010414
Meeker, M., Pearson, S., & Roach, S. (1997). Internet retail: The
Internet Retailing Report. New York: Morgan Stanley.
300 G. Fisher, S. Kotha

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