WebVan impatiently launched in June 1999 after incorporating in 1997, and eventually lost more than $800 million. It proposed to revolutionize the grocery business by delivering groceries to households who ordered their groceries online. It recruited a well-known executive, George Sheehan, and gained financial backing from several big-name venture capitalists. It laid out an extensive plan to grow in major cities across the United States. It settled on a customer-friendly plan that would deliver groceries within thirty minutes of an order. It aspired to operate out of warehouses in less expensive locations, cutting out expensive retail space, so it could lower its costs enough to make it profitable to charge very low prices for groceries.
There were a few problems with this proposal, but the biggest was most apparent to anyone who had studied the business years earlier, when online grocery ordering and delivering had been tried on a small scale and had not yielded dramatic success. The logistics of delivering perishable products imposed large costs on operations. The prior experiences had not been flawed in any obvious way, and the previous generation of entrepreneurs had executed reasonably well. Try as they might, WebVan’s business was going to be more similar to prior attempts than different from them, despite being shinier, newer, and better publicized. WebVan could improve on the past in only incremental ways at most, but delivering the service at high scale in new facilities.
The economics could be stated in simple terms. WebVan incurred a large sunk cost to entering and incurred high fixed costs during operations. To justify the costs of those facilities and operations, WebVan had to generate large revenue over operating expense. Since the delivered groceries were generally priced at competitive levels and did not generate high margins, and delivery costs were high and did not command high prices, large revenue could be achieved only one way, through a high volume of orders. WebVan’s viability, therefore, came down to a simple economic question in every locale: how many households in a geographic area wanted groceries delivered, and could it become very large?
There were good reasons to be skeptical. The experience of one of the earlier entrants, Peapod, was well known and illustrated the constraints. Peapod started a small-scale version of the grocery delivery business in the Chicago area by partnering with existing grocery stores. They had operated this entrepreneurial business since 1989, improving it constantly, and had showed it was viable. Peapod’s experience also illustrated the challenges. No amount of operational cleverness could reduce the delivery costs—gasoline, vehicle maintenance, a driver’s time. It was expensive to send a van from a warehouse to a customer. No amount of clever marketing—online, in magazines, flyers on door posts, and even from the grocery store partner—could convince most users to pay much money for a delivery service, or use it at all.
The problem did not appear to be the software. It went to something for which no technical solution existed, to something innate in human behavior. Stated simply, users changed their shopping habits with reluctance.
That was so of even the savviest online users in the early 1990s. It was quite sensible, therefore, to expect later users to be more reluctant. After all, these were the most inexperienced online users. No amount of website genius could induce a new online user to break with old habits and do their shopping for groceries on a web page. No clever marketing tool could convince many shoppers to trust the selection of bananas to someone else. Many shoppers wanted to examine the day’s daily specials in person. Many wanted a tactile grocery experience, merely as a way to stretch their legs. Many parents with young children wanted an excuse to get out of a claustrophobic house to roam the aisles. All those simple factors prevented many households from making use of the online service.
None of WebVan’s senior management had extensive experience in the grocery business, or in the online grocery business. It is not surprising, therefore, that WebVan’s management convinced itself that it had something that had eluded previous pioneers. They proposed to build brand new warehouses to gain efficiencies from scale and reduce costs as low as they could go. They believed that the newer features of their well-funded web-based grocery would generate high demand.
The financial vulnerability of the proposal was plain to see: it only could be viable if it achieved a scale of use that no prior pioneer in online groceries had ever come close to achieving. Expensive warehouses and fancy operations would be too expensive if not employed at full capacity. The costs of delivery trucks and drivers would be too high unless demand grew to a point that spread those costs over many customers. The entire cost structure for the business would not be—could not be—low enough unless the business generated a large set of customers to use the capacity at or near its maximum.
In normal times that type of vulnerability would have led investors to call for a cautious expansion plan, reigning in the aspirations of the management. Investors might have asked for less cavalier uses of their money, requiring WebVan to, say, first experiment with different mixes of marketing and operational novelties in a friendly location, such as San Francisco, which had a technically sophisticated population spread around a dense urban location. Yet following the prevailing view, WebVan’s management eschewed caution. It avoided the cautious exploratory practices. WebVan’s management opened in several cities without first testing the concept in one city for an extended period of time.
What happened? Soon after starting it became obvious that WebVan did not differ that much from any of the pioneers. The online grocery business could generate some interest, but not nearly enough to gain the advantages of scale. WebVan could not make any of its financial goals.
Excerpted from How the Internet Became Commercial: Innovation, Privatization, and the Birth of a New Network by Shane Greenstein. Copyright 2015 by Princeton University Press. Reprinted by permission.