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The Starting Line: Web grocer seeks stateside foothold

Online grocers have been folding up right and left in the U.S., but the U.K.'s Tesco is betting that the time is right to jump into the market.

Rap the sides of the online grocery business and you won't see too many signs of freshness.

Online grocers have been folding up right and left; where there were once at least six companies shilling soup and nuts online, there are now only about three major players. Jupiter Media Metrix recently reduced its expectations for the market, dropping its 2001 numbers by 50 percent from $2 billion to $1 billion, and its 2005 prediction from $18 billion to $7 billion.

Webvan, once the darling of the dot-com boom, has seen its stock wilt like day-old produce. The stock spiked as high as $34 on its opening day, and its IPO raised $375 million in November 1999. But the company has hit hard times since then, and the stock was recently trading at about 9 cents per share.

Peapod, the other big player in the U.S. market, had to be rescued from insolvency by Royal Ahold, an international food products company.

So, this is a great time to jump into the market, right?

Tesco seems to think so. The U.K. grocer, which runs the largest online grocer in that country, recently announced a deal with the United States' Safeway chain. Tesco bought a 35 percent stake in Safeway's GroceryWorks.com business for $35 million and other assets. According to the companies, the deal gives Safeway a cash infusion and some technological know-how, while giving Tesco a foothold into the U.S. market.

Tesco says its U.K. service, which has almost 1 million registered customers, is profitable. The stores handle 70,000 orders per week and have annualized sales of $700 million.

Executives said that by replicating its store-pick model, which involves using local stores to fulfill orders, as opposed to warehouses, it will be able to expand in the United States without running up large capital expenses.

Tesco's plan is in direct contrast to Webvan's. One of the more well-known online grocers, Webvan has publicized its warehouse model, saying that it eliminates the potential of quashing sales from existing stores.

Watch for obstacles
Tesco may be in for a struggle in the United States. According to Jupiter Media Metrix analyst Ken Cassar, the store-based model saves money in the short term and makes sense in densely populated areas where most consumers are located a short distance away from the stores, "but that hits a ceiling at some point.

"When you're taking half a dozen orders per day, that's not going to break the back of the store employees, but if it's successful, it becomes a challenge," he said.

And while a warehouse system eliminates those problems, it requires a tremendous amount of upfront capital and relies on having consumers who live near the shipping location.

But there may be an even more difficult obstacle to overcome in the United States, Cassar said.

"Grocery shopping in the U.S. is, to a large extent, not unpleasant. The aisles are wide, the food is attractively displayed and they do a good job of entertaining the consumer in the store," he said. "A bigger hurdle than the (perishable food issue) is the disruption of such an important piece of everyday lives."

And the companies acknowledge that to get people to buy groceries online requires a fundamental change in the way consumers think, even for those accustomed to buying things online.

"No matter how attractive the proposition you have for consumers, the biggest difficulty you have is breaking down generations-old patterns of behavior," said Bud Grebey, vice president of communications at Webvan. "People have been shopping the same way for generations."

For now, the key is to focus on the small set of consumers who are willing to make a change, he said.

"You're talking about a small percentage of overall market that we're looking to capture. But it's still a gigantic number," he said. "We believe that (by capturing) that low percentage of market share we can be a relatively profitable organization."

Promise of profit
Indeed, Webvan has said its goal is to be profitable on an operating basis in all of its markets by the end of 2001, and to be completely profitable, exclusive of extraordinary charges, on a companywide basis by the second half of 2002.

Tesco is also promising profitability; the company's CEO told Reuters that he expects GroceryWorks to have an operating profit by the end of next year.

What could prove essential is whether Tesco can replicate its non-grocery model in the United States. Grocery sales make up only 60 percent of Tesco's online sales; the company also offers online financial services.

"With Safeway just beginning to delve into private-label banking, we believe that Tesco and Safeway may also collaborate on this front as well," wrote Deutsche Banc Alex Brown analyst Jonathon Zeigler in a research note. "In short, we believe that the potential of this strategic relationship extends far beyond mere groceries."