Operational Strategy: Webvan and Tesco - Case Study Example

[Supervisor Operational Strategy Introduction Groceries and other food retailers operate in one of the more mundane, yet fundamental and pervasive industry segments in the world. Consequently, the grocery industry is a huge, fragmented and enormously competitive environment. The intense competition is often described as leaving supermarkets to operate on razor thin margins that averaged 1.03 percent of sales in 1997-1998 (Weir, 27-45). During the Internet frenzy of 1998-2000, numerous new, pure play Internet grocers promised consumers that they could have grocers at prices equal to or lower than existing bricks-and-mortar grocery stores, while simultaneously enjoying unparalleled convenience without having to leave the house and battle the crowds at the stores themselves. The most prominent of these companies was Webvan, which reached a stock market value of $7.9 billion at the end of its IPO. Webvan, Home Grocer, PeaPod and several other Internet grocers made huge bets that selling groceries online was a growth market and represented a new way of doing business. Unfortunately, as has been illustrated by the widely publicized collapses of these high profile Internet grocers, there was a substantial gap between theory and practical application. In contrast, there are currently several examples of grocery and other food delivery companies that appear to be making effective use of the Internet as a link with customers. In particular, both Tesco in the UK and Albertson's in the USA currently have Internet channels for selling groceries that are profitable (Hall, pp.A9; Koller, 13-14). Whereas many of the failed Internet grocers appeared to be hoping to capture a large portion of the overall grocery market, companies such as Tesco and Albertson's view Internet ordering of groceries more as an additional sales channel. This channel is unlikely to ever represent a majority of grocer sales, but even a small portion of sales can be quite significant due to the huge size of the overall market. We will first focus on the extent to which the marketing strategies enacted within these firms align with the operations strategies utilized. Proper alignment is seen as critical for success within traditional business formats, as well as with the newer electronic commerce format. We will also examine Webvan and Tesco using a methodology for analyzing the benefits and challenges of e-services in virtually any industry (Boyer et al., 177-90). This methodology borrows from the product profiling method developed by Hill and used in operations strategy (Hill, 2004). It allows for comparisons between traditional and e-commerce methods on nine operations-related scales. This will provide a pictorial explanation of why Webvan was unable to succeed while demonstrating why Tesco is more likely to be more successful. Strategic Alignment One stream of research on operations strategy has focused on the strategic process, including how strategies are developed and refined. In retrospect it is possible to explain the failure of a company such as Webvan and the relative success of Tesco through an evaluation of the strategic process. This section reviews basic theory on the strategic process and utilizes this theory to better understand the likelihood of success in the Internet grocery business. Porter (2001, p. 62) criticized many of the pioneers of Internet business for violating basic strategic principles: "Gaining competitive advantage does not require a radically new approach to business; it requires building on the proven principles of effective strategy". We will examine Webvan as an example of a company that in a rush to prove it was a model "new economy" company, violated several fundamental strategic principles, including the need to match operations and marketing strategies. The operations strategy process is most often modeled as a hierarchical one in which functional strategies such as operations, logistics, marketing and finance are driven by the higher level business strategy. A key element of the strategic framework involves coordinating functional level strategies to work in concert to achieve the overall business strategy rather than to locally optimize outcomes for individual functions, business units, plants or stores. One of the primary challenges in implementing effective strategy involves achieving fit or consensus within an organization - both between business and functional strategies, and between various functional strategies. E-Commerce Profiles Another way to compare the performance of Webvan and Tesco within the electronic commerce area is to utilize an e-operations profiling method (Boyer et al., 177-90). This profiling method evolved from the product profiling procedure developed by Hill (2004) for use in operations strategy analysis. The concept of this e-operations profile is to compare e-commerce methods to traditional methods on the basis of nine operational areas and to provide a quick, visual way of capturing operational differences between the two methods. Some useful insights are found by comparing the traditional grocery store with the Internet versions for both Webvan and Tesco. These comparisons will provide visual representation of why the Webvan model was fatally flawed and why we believe there is good potential for the remaining ventures to be successful. See figure 1 for the resulting profile and comparison. Examining the profiles of Webvan and Tesco provides an interesting picture of how each has compared to traditional grocery order/delivery methods. The first dimension refers to the facilities cost. Theory suggests that facilities costs can be reduced in online business because the fancy, consumer-friendly stores become unnecessary. Facilities can be created to maximize operational efficiency (Boyer, 177-90). However, this strategy may require extensive capital expenditures that will, at least in the short run, increase the cost of doing business there. In building a number of high-tech warehouses, it became more difficult to cover those expenses, especially given their low-cost strategy. A $30 million distribution center may offer efficiencies if fully utilized, but when starting from scratch this represents a huge expenditure - particularly when there is uncertainty about utilization levels and demand. Webvan never attracted enough demand to utilize any of their distribution centers above 20-30 percent, much less near capacity. Tesco, on the other hand, has used existing facilities rather than building new. This approach may not be as efficient for huge volumes, but for a limited size market it serves to minimize facility expenditures while sacrificing some degree of order picking efficiency. Ocado is moderating the distribution center model of Webvan in two basic ways. Essentially, the facility has been designed so that it requires a lower up-front cost and can be operated at lower volumes to achieve a lower break-even cost, while in the end the entire facility will cost a little more because of the phased approach. Second, Ocado is following a strategy that emphasizes quality products at a slightly higher price (due to delivery charges) than in-store products, thus providing increased capital to cover at least a portion of the costs of picking and delivering groceries. In summary, Ocado believes that it can turn the choice of picking methods (i.e. DC vs store) from a disadvantage in terms of initial facility start-up costs to an advantage (i.e. the circle for Webvan on the facilities line in Figure 1 would be replaced by an Ocado circle to the right of Tesco). To achieve this advantage, Ocado must grow the volume processed to the point where the DC is roughly comparable to that processed through approximately 20 stores. Self-sourcing refers to the process by which customers perform some of the work normally done by the business. This transfer of work seems to work best for firms that have a relatively high information requirement for customers or when companies must answer the same question or questions for each transaction (Boyer, 177-90). At first glance, it would appear that a grocery store would gain little from having customers order their groceries online because in traditional shopping venues, it is up to the customer to determine the items needed and physically bring those items to the check-out area. In fact, with online shopping, customers have to input more information than would be required in traditional purchases. However, one possible advantage is the ease of linking customer requests to inventory. Ordering on-line would reduce the number of questions pertaining to the physical location of products. Customers may find it easier to search the database than the entire physical store. In addition, given that so many items purchased in grocery stores are regular, repeat purchases, a customer can utilize a standing order format, only customizing it occasionally. This would greatly reduce the self-sourcing burden. The critical point is that by picking groceries for the consumer, the grocer is taking back some of the work that the consumer used to do themselves, thus even if the grocer can perform this work more efficiently than the consumer, this will result in a cost increase. Such a cost increase is acceptable if and only if the consumer is willing to pay for it. Hence, the implicit match between marketing and operations strategy for current online grocers is to charge consumers for this service. This service is attractive to consumers who are very busy and willing to pay to save time. For example, a recent report in The Grocer found that the average time for a consumer to place an order for 33 items on Sainsbury's Web site was 18 minutes (Internet Business News, 2002). This is beneficial to the consumer if this time is less than the time it would take to go to the store, select groceries, stand in the payment line and return home. Job specialization is often another benefit of e-commerce. Firms are able to differentiate and specialize their workforce because of the lack of face-to-face interaction with customers (Boyer et al., 177-90). With this specialization comes greater efficiency. The process becomes much more like an assembly line, with higher volumes of production possible. This specialization is one advantage that Webvan attempted to gain. Webvan estimated that workers at its automated distribution centers could pick 450 items per hour - a rate that was 20 times as efficient as consumers in grocery stores (O'Briant, 26-33). In comparison, because it relies on existing facilities, Tesco utilizes employees in both the traditional, general, task structure and that of the Internet order fulfillment and delivery. The emerging model (used by Tesco, Safeway, Albertson's etc.) is to employ workers to pick items for consumer orders directly off existing store shelves. This approach may not be as efficient as Webvan's in terms of picking time, but it is likely to be more efficient than consumers for three reasons. First, one picker can be assigned to pick multiple orders simultaneously (think of a very large grocery cart with compartments for multiple orders) - thus achieving economies of scale). Finally, stores can develop software based on routing algorithms that direct the pickers thorough the store with relatively little walking. Customers are much more likely to waste time walking up and down store aisles looking for an item they cannot find. A related operational area concerns the scheduling process. For instance, computerized, automatic transactions allow companies to offer round the clock service without the corresponding staff (Boyer, 177-90). Despite the potential advantage, Webvan faced a complication in scheduling due to its 30-minute delivery goal. In contrast, Ocado offers a one-hour window because they believe that their ideal customer is very busy and greatly values the more precise window, however on the operational side a one hour window is still substantially easier to meet reliably than Webvan's 30 minute window. Reducing the delivery time would have likely required greater delivery capacity, hence the potential for greater staff. Even though most businesses track peak sales times, those that seek to gain an advantage with quick delivery must expend more resources to maintain the necessary slack in human capital. Tesco, on the other hand, may be better able to manage its staffing levels by relying on existing business patterns and redeploying employees from traditional or e-commerce activities as needed. As a basis for comparison, Tesco and Sainsbury's both utilize a two-hour delivery window - which makes the scheduling challenges substantially easier. Figure 1 shows the Tesco approach as being better suited to shipping than Webvan's - this is due to the greater proximity to customers, since Tesco picks orders at local stores, there is less distance to travel to the customer, hence less opportunity for the products to spoil or be damaged. Webvan, on the other hand, had a much further distance to travel and also had a much larger separation between the pickers and the customers - the visibility of Tesco pickers in the stores may help improve quality because these employees have daily contact with customers whereas Webvan pickers are completely segregated. Finally, one of the biggest challenges to all home delivery grocers is getting accurate orders. A 99 percent fill rate per product may sound high for a business stocking in excess of 10,000 SKUs, but that is not the way that customers view home delivery service. If each item has a 1 percent chance of being out of stock, then an order for 60 items has only a 55 percent chance of having all of its items available. Typically, the out of stock rate in grocery stores is fairly high - between 3 percent and 8 percent, so the previous estimate is fairly conservative. The difference between home delivery and in-store shopping is that customers intuitively make their own substitutions - a larger/smaller size of the same product or a similar product. However, when the grocery company is delivering to customers' homes, the customer now is more likely to explicitly blame the company for the unavailability of items. Thus, it is very important for home delivery grocers to reduce the number of substitutions (and outright errors) as much as possible, and given that this rate of substitutions/errors will never approach zero, to find ways to get customers to understand and accept the limitations involved. This is one area where Ocado believes it has an advantage, by picking all groceries at a central DC the in-stock rate should be much higher than at individual stores due to the centralized, single location. The difficulty in shipping groceries the "last mile" to consumers has already been discussed. Our estimates place the cost of home delivery in the range of $10-$20 per order. Conclusion Purchasing groceries and related products is one of the more basic consumer actions, a fact that is very unlikely to change drastically over time. The question remains, however, as to how many of these purchases will be conducted using traditional means such as visiting a particular store or stores and how many will be completed online. The issue for grocers, both brick-and-mortar and online, is which process or combination of processes will prove more desirable and will lead to greater market shares and profit levels. From the comparisons of the Webvan and Tesco models and general knowledge of consumer behavior, we offer several predictions regarding the future of online ordering of groceries. First, as Tesco has so aptly demonstrated, one key to success in the online grocery business is the proper alignment between marketing and operations strategies. For example, Tesco, Albertson's, and MyWebGrocer all view online ordering and the resultant pickup or delivery options as value-added services. They market and price these processes accordingly, to those people most in need of time-saving activities. In contrast to the Webvan approach, these firms charge customers for the time they save by avoiding the physical trip to the store and the shopping experience. Webvan was based on the apparently false premise that efficiencies in operations would more than make up for the additional costs incurred developing the necessary ordering and delivery systems. Today's players in the market, however, have learned from the mistakes of Webvan and other failed online grocers. Notably, a primary lesson is that the efficiencies gained do not automatically translate to increased revenues, and especially not to increased profits. It will also be interesting to see if Ocado can make the DC-based picking model work successfully. Along with a more accurate view of the nature of the service being offered by today's online grocers, comes an even more realistic view of the potential markets. As described earlier, Internet sales are still only 1.5 percent of total revenue for companies such as Tesco. Information gathered from Albertson's press releases suggests that the range in increases due to the provision of online ordering capability is likely to be anywhere from a 1 to 10 percent increase in sales at existing stores. It is likely, however, that it can streamline purchases of routine customer needs. It is also likely that younger consumers used to being able to access most information and purchase most products online, will expect their grocery stores to demonstrate similar capabilities. The results of the e-commerce profiling of Webvan and Tesco demonstrated that Tesco's operational characteristics were better chosen than those of Webvan. Yet, Tesco's current online strategies seem to be, at best, a niche-based alteration of traditional grocery ordering/picking and purchasing methods. This would seem to echo the prediction that online ordering is likely to remain an additional option but not a replacement for traditional methods. However, it is possible that improvements in operations will aid in the attraction of new and maintenance of existing online customers. For example, improvements in the self-sourcing process are likely to make online ordering more desirable and less onerous. Better databases and search engines are likely to reduce the time it takes to request a specific order online. In addition, the benefits from better job specialization of the grocery store personnel and more accurate inventory management are likely to further appeal to customers. More importantly, they are likely to convince consumers to utilize a particular store's online service. Will the emergence of online grocery ordering and shipment to the consumer be a flash in the pan or more of a permanent addition We believe that Webvan and other proponents both promised too much and managed their operations poorly. Improved service (i.e. home delivery or picking of groceries to customer order) does not come free. Instead it comes at an increased cost. When properly utilized, the Internet offers an ordering method that can minimize the trade-off between improved service and low cost groceries. The renewed efforts at online sales offered by Tesco, Ocado, Albertson's, MyWebGorcer, Sainsbury etc. suggest that there is a market for these services, but that the marketing and operations strategies must be carefully matched. Finally, the online ordering and home delivery of groceries is most likely to remain a niche (albeit potentially lucrative) market. Works Cited Weir, T. (2000), "53rd Annual Consumer Expenditures Study: sales boom with the economy", Supermarket Business, Vol. 55 No.9, pp.27-45. Hall, J. (2001), "British supermarket giant cooks up plans to go global - Tesco's move to duplicate high growth at home comes with big risks", Wall Street Journal, pp.A9. Koller, M. (2001), "Grocer builds net traffic - Albertson's expands in Seattle, pushes online/storefront strategy", Internetweek, No.872, pp.13-14. Boyer, K.K., Hallowell, R., Roth, A. (2002), "E-services: operating strategy, a case study and a method for analyzing operational benefits", Journal of Operations Management, Vol. 20 No.2, pp.177-90. Hill, T.J. (2004), Manufacturing Strategy: Text and Cases, 1st ed., Irwin, Burr Ridge, IL, Porter, M. (2001), "Strategy and the Internet", Harvard Business Review, Vol. 79 No.3, pp.62-78.. O'Briant, E. (2000), "Webvan revs up", IIE Solutions, pp.26-33. Appendix Figure 1 Read More