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Can Peapod turn naysayers into believers?

CEO Marc van Gelder on why his formula for selling groceries over the Internet can work.

April may be the cruelest month, but a year ago it bought Peapod a little more time.

Royal Ahold, the international supermarket giant, first pumped $73 million into Peapod last April to bring it back from the brink of insolvency.

This go-around, however, looks no less stark for leading online grocers like Peapod and Webvan, which watched April claim Kozmo, a high-profile Web convenience store.

April also saw a Friday fall on the 13th, which certainly brought Webvan some bad luck: On that day, CEO George Shaheen resigned after a less than two-year tenure at the Peapod rival. In addition, after raising one of the biggest rounds of funding during the heyday of the Internet gold rush, Webvan now finds itself precariously close to being booted off the Nasdaq market--the equivalent of having a sticker with "failure" slapped on its face.

In this increasingly gloomy economic climate, Peapod is scrambling to prove it has hit upon the right approach in an unstable sector. Despite the uncertain outlook, Peapod CEO Marc van Gelder refuses to let the grocer go to seed.

It certainly helps that the company has a backer with deep pockets. After Peapod again said it would run out of money by the end of this year, Royal Ahold raised the online grocer's credit line to $50 million to resuscitate it.

What's out there is an 'embattled Peapod' or 'Peapod in difficulty,' and not that Peapod is strong, executing on a brick-and-click strategy, and has solid financial footing. Webvan raised $1.2 billion in funding up front from investors only to whittle it away at Internet speed. Peapod is raising cash in fits and starts but finds itself on the same rocky road.

The two companies have taken nearly opposite routes for bringing groceries home to consumers: Webvan relies on warehouses, while Peapod turns to Royal Ahold's far-flung supermarket chains. Investors are closely watching to see which scenario can deliver profits as well as groceries.

Van Gelder recently spoke with CNET about whether Royal Ahold's continued investments in Peapod are another case of good money thrown after a bad idea, and about how Webvan's success or failure will reflect on the sector in general.

Q: It's been one year since Peapod was given a second chance, with the help of the Royal Ahold investment. Excluding additional funding and credit lines, what has gone right for Peapod?
A: I think Peapod is in a very different situation than Peapod was a year ago. One is the advantage we have of being linked with Ahold and its purchasing power. What we see are gross margins just growing in a significant way, and we're going to be in the low 30 (percent range) for the first quarter. And that's a major piece. So on every order we save around $5 to $7. That's a major accomplishment.

The second piece is the management talent we've recruited from Ahold. So we have a team this year which is truly bricks and click. We have the key people from the technology side, from the marketing side from Peapod who we were able to retain. At the same time we were able to recruit, mainly from Ahold, a couple of key managers who are very good in operations. When I came here, I found Peapod not as strong on that front. So a year later I think we're in a much stronger position from an operational perspective.

And number three for me is the marketing, with co-branding with supermarkets: Peapod by Giant, Peapod by Stop & Shop. We've been very successful in new introductions. And actually, in the two markets we opened last year--Washington and Connecticut--we are way ahead of schedule from a sales perspective. So we see real advantages in the co-marketing or co-branding.

What has not gone quite the way you wanted in the last year?
I think the first thing is from a perspective of the stock market. Our stock is still trading around a dollar. And I expected that with all the plans we're putting in place that the market would pick up faster with the good news.

The other thing is from a communication perspective. I think a lot of people don't get yet the brick-and-click strategy, which I think has some truly strong advantages. With Ahold, we have purchasing power, marketing, branding and also operational strength from a management perspective. And that story I don't think is out there yet. What's out there is an "embattled Peapod" or "Peapod in difficulty," and not that Peapod is strong, executing on a brick-and-click strategy, and has solid financial footing.

Peapod, along with others like Kozmo and Webvan, is on the verge of being hit by a double whammy. First of all, the sector itself is still trying to gain traction. And now the economy is slowing down. Yes, everyone will still need to buy groceries, but will they be willing to pay a premium for the delivery service and the convenience?
I think there are two notions here. One is the shakeout of our industry. The second notion is what happens in a recession to our industry. Let me take each of these separately.

The shakeout of the industry I think is good for us because of what we saw in the markets. There are a lot of people coming into a marketplace with all kinds of unrealistic promotions; sometimes they were giving it away instead of selling their goods. And that's not a healthy situation.

For me it's a little bit like the car industry in the '20s. In 1920 there were 2,000 car manufacturers. And in the '30s you only had three major car manufacturers left. They were much stronger. I think that's the same thing that's happening in our industry right now.

Overall I think that the shakeout of the industry, along with the strong fundamentals of our business and the clear demand for our services, will be good for us.

Number two is the recession. We cater to busy families with kids. Those busy families are not just the upper class. We are very good at the middle class. With the middle class, what I see happening in a recession is that it's still going to be very busy for them. Most of our customers have mortgages and everything. They are going to be strained for time. And what I see right now is there is a clear need for our products. And I think if you look at the premium we ask, it's mainly a delivery fee. That's where we're charging. In New York and Connecticut, we have about a $5 delivery fee. I think people are willing to pay for that.

Still, your business is far from recession-proof. So what would you say are your plans to ride out the economic downturn and, more importantly, to expand your customer base?
I think the first thing for me is to really deliver good service. So if we don't have our operations right, which means not having a good variety of products and saying we're out of stock on groceries to the customer--that'll be a problem. If I look over the past year what happened, we've truly improved the quality of our products and service.

The second is conveying that our proposition is to bring convenience and saving time for customers. So what we try to do (is) everything possible to make our Web site easier and fast. We hope to have a new release of our Web site by the end of the year--one which is even speedier.

The third piece for me is also that we make sure that we have the right promotions for busy families. We just launched personalized coupons, online coupons, which (means) we get some great feedback from customers. You can fairly easily select your product and automatically have your coupon linked to your purchase.

When Royal Ahold took a stake in Peapod last year, what did it demand of the company, and have you been able to live up to those demands so far?
Let me first tell you what they wanted when they invested in Peapod. They demanded a new CEO for the company since Peapod did not have one.

There are a lot of people coming into a marketplace with all kinds of unrealistic promotions; sometimes they were giving it away instead of selling their goods. The second was more a discussion at Ahold about where the strategic focus should be of Peapod. They decided the strategic focus should be on the East Coast because that's where we could leverage all of the benefits from an Ahold relationship. So we assessed all the different markets we're in. We said really everything from east of the Mississippi we can get our goods from Ahold. Even in Chicago, where Ahold has no presence, we can truck it from Cleveland to Chicago. We can do that in a very inexpensive way because most of the goods are manufactured in the Midwest and transfer it to the East Coast.

They'll load empty trucks going back to the Midwest. So that's one thing. So we say everything east of the Mississippi is our market, is our territory. And we closed last year five markets. We closed San Francisco, we closed Houston, we closed Dallas, we closed Austin and we closed Columbus, Ohio. We are right now (in) less than five markets. We are also open to new markets. So as a company we had a major restructuring, which was discussed with Ahold and was just the right thing for the company. And we lived up to that.

Has Peapod not lived up to Ahold's expectations in any way?
We have a board--an outside board with our representation. And so in those board meetings we have discussions about strategy.

And our strategy is for Ahold, not just the U.S. strategy, but a worldwide strategy to really develop the e-commerce channel. Ahold also has operations in the Netherlands, Sweden, Norway and Argentina. So overall, Ahold is very supportive.

We did set the strategy and we have executed that strategy.

Your professional roots are with Ahold. Why did Ahold choose Peapod and not a company like Webvan?
Well, that's very simple. One is Peapod became available at a very attractive price last year. Peapod's stock went from $8 to $3 and had a very attractive valuation. I still think it is a very attractive evaluation. That's the price Ahold paid for it, which was $3.75.

The other thing is the logistic model at Peapod was very flexible because the company was already working with retail partners, like Stop & Shop and Edwards (now renamed Stop & Shop) in Long Island. It was easier for Ahold, which owns both those supermarkets, to extend that relationship.

And the third reason is with 10 years of history, Peapod made a lot of mistakes and they learned from their mistakes.

So let me just back up for a clarification: Peapod was already involved with click and bricks before?
No, Peapod had an operation with Stop & Shop and with Edwards. Basically the terms which we are getting now are good, but were not as strong at that time. And with the acquisition of the stakes in Peapod, they really developed the supply and service agreement. Now we can procure all our goods at the same cost as Ahold. For Peapod, which did $93 million last year, we have the purchasing power of a $60 billion company. That's very significant.

Webvan is showcasing a model that was largely perceived as a failure: the central warehouse model. Peapod is showcasing another model, the clicks and bricks model. You aren't competing in the same markets. Perhaps in the distant future you will be competitors with Webvan again. But if Webvan were to go under today, would you see it as a blow to Peapod? Does it reflect on the sector?
No, I don't think so. I think first of all Webvan is in different geographies than we are--except in Chicago. I think our logistical model is very different than Webvan's logistical model. I think there's a little problem that a lot of people perceive just the way you asked the question. But in my mind it's completely different.

I think you misunderstood me. I know that it's a different model and in different geographies. Still, I'm talking more about the perception of failure for both models. So if Webvan were to fail soon, I'm wondering if it would reflect at all upon the entire sector, including Peapod.
I don't think so. If you look at our experience in Boston...two of our competitors, and, went out of business. But we saw strong sales growth. I think if a customer gets hooked on Internet shopping, they will go to the other supplier of that service. In Chicago we're ready to welcome new customers.

Peapod forecasts profitability, at least in one of the East Coast markets. How far is Ahold willing to push back this expectation of profitability if the recession takes a bigger-than-anticipated bite?
I think there is an expectation in the market because I told everyone last year those projections. And I'm still very confident we will make that expectation. And middle of this year we're going to be profitable in Chicago and we're going to be profitable in one East Coast market. I have no doubt that we will get profitable. So I think that's not just expectation from Ahold, but expectation of the stock market. So I have to make sure that we deliver on our projections.

You recently got a fatter credit line and some more funding. I'm just wondering how you convince Ahold that this isn't a case of good money being thrown at a bad idea just to recover an initial investment?
By having a clear strategy. And having clear milestones. Ahold can measure us to see if we're hitting our milestones.

Is that the same compelling reason you would give to institutional investors as well?
Judge us by our results, that's what I would say.

You came up professionally through Ahold and the grocery sector. How much time are you giving yourself to prove that Peapod can make it before you think that things are not going quite right?
We're fully on track, so for me that's a hypothetical question. We're on track with all our plans.

How do you boost your employee morale nowadays in the face of different closures and an unstable outlook with a looming recession? What do you say to your employees?
Mainly the same thing I told you: clearly explaining our strategy, showing the results for where we are, and (communicating) very well with all our employees.

So would you say that you've had the right recipe at this point? Or do you see some more tinkering sometime down the line?
I just have to say that we're fully on track with our plans for profitability.

I understand that you're on track, but can you still fine-tune something? Do you see anything that would make the business healthier then just getting by?
I think every day we are still making innovations in our business through different products. Since I've been here, we have been also experimenting with longer time windows for delivery. There's still the two-hour window, but we are also experimenting with a six-hour window and unattended service.

For instance, in Washington, 50 percent of our sales come from longer windows and unattended deliveries--very efficient for your logistics. So of course as a company, we're always experimenting and we're learning and we are adjusting. But I think overall we are on track with our plans.

The online grocery business is often held up as a prime example of something that may not be working. It was one of the first with a failed business, when shut down initially. Can you put into perspective how important it is for Peapod or Webvan--at least one of you guys--to prove that selling groceries over the Internet can work? How important is it for the sector? For the consumer's mind? For the mind of the investor?
I think the bottom line is that you need to have profitability, right? Otherwise there's no business model. We live in a capitalistic society here in the United States. So if you don't make money in this business, you don't have a long-term existence. And I think that's our notion; that's why we're working in the company, to work towards those goals.

So of course I know there is a viable business here. And I know that you can make money in this business. Now we have to show it.