Totally bananas

Why did George Shaheen, the big cheese at Andersen Consulting, give it all up for Webvan, a small-potatoes, online, grocery delivery service?

In September when Andersen Consulting announced it was losing its managing partner and chief executive, George Shaheen, to an upstart online grocery company called Webvan, the consternation was universal. Mr Shaheen, 55, had been with the company 32 years and was within a year of qualifying for a lucrative retirement package.

In September when Andersen Consulting announced it was losing its managing partner and chief executive, George Shaheen, to an upstart online grocery company called Webvan, the consternation was universal. Mr Shaheen, 55, had been with the company 32 years and was within a year of qualifying for a lucrative retirement package.

He had steered Andersen Consulting from its inception as a spin-off from Arthur Andersen 10 years before to its present position as the world's largest management and information technology consultancy, presiding over an eightfold increase in revenue.

To be sure, Andersen Consulting was - and is - engaged in a bitter legal dispute with its parent, Arthur Andersen, over its status. But to move more than halfway across the United States to a company that was just starting and one month away from launching its first public offering of shares seemed precipitate, if not downright foolhardy.

Nor did Webvan look an auspicious choice. A three-year old Online grocery start-up based in Foster City in northern California, it had a customer base of less than 20,000 (less than half the number of employees at Andersen Consulting). Its delivery service, which began in June, extended no further than the San Francisco Bay area, and it is projected to make a loss this year of $73m on sales of $11.9m, with losses increasing into the foreseeable future.

Yet George Shaheen leapt at the opportunity presented by Webvan with all the enthusiasm of a Nineties' 'techie' just out of Stanford, practising everything he had preached at Andersen about the potential of e-commerce. His reward? A base salary of $500,000 a year, and a stake of up to 5 per cent in the company that looked set to leave him with a multi-million-dollar profit, on paper at least.

Colleagues and competitors were shocked. "He's going from head of this $9bn company to start-up Webvan," said Tom Rodenhauser of Consulting Information Services of New Hampshire. "It's just something you don't expect from a 30-year Andersen guy."

Mr Shaheen issued a statement saying: "My choice would have been to retire sometime next year. However, this new opportunity required that I move up my decision, and, as a result, the timing was not under my control." That was 21 September.

A couple of weeks later, his enthusiasm for his new venture helped almost scupper its first public share offering on 7 October. It was postponed "by mutual agreement" after the intervention of the US stock market watchdog, the Securities and Exchange Commission.

The SEC was concerned certain comments and financial projections about Webvan had hyped the company's share value and breached the requirement that a company going public should observe a quiet period in the month before the offering.

The company was taken to task for giving out what were deemed unduly positive projections in public presentations. But it was an interview Mr Shaheen gave to Forbes magazine that drew most flak.

"Webvan" he had told the magazine, was "a mirror image of the credo he preached at Andersen ..." and would set the rules for the largest consumer sector in the economy. It was "all about leverage in technology and reinventing the grocery business, just as Andersen had reinvented consulting ..."

When Webvan submitted its revised registration statement to the SEC on 12 October this parallel between his old and new companies was directly rebutted. "Andersen Consulting and Webvan," it said, "are vastly different businesses and you should not make any comparison between the two companies".

Whether the comparison was justified or not, Mr Shaheen's move was vindicated last week when Webvan launched its shares to the public. The delay appeared to have only enhanced the share value.

The night before, Goldman Sachs, the lead underwriter, raised the estimated price range from $11 to $13 per share, a price that would have given the company a capital infusion of $375m.

On the first day of trading, the price rose to $34 and closed at $24.875 dollars, 65 per cent above the offer price, a market value of $8.37bn, about half the value of the US supermarket giant, Safeway. Compared with some first-day increases of Internet shares, this was not a big triumph.

For a relatively small offering of 25 million shares, or 8 per cent in the online grocery sector, it was a success, valuing George Shaheen's 1.25m shares at more than $30m. He has options to buy 15m more at $8.

One reason for the public confidence in Webvan derives from the prominence of its backers and the strength of its management team. Another is the sheer scale and apparent solidity of the company's ambitions - to automate and expand in ways more sophisticated and grander than anyone has tried. The list of board members is impressive.

Founder and chairman is Louis Borders, 51, who is also the founder and president of Borders, one of the biggest US bookstore chains. Mr Borders, a mathematician, worked for years trying to automate the "back end" of the grocery business, calculating how customers' orders could be assembled, stored and delivered most efficiently.

His vision for Webvan was of supermarket shopping without the supermarket. He once said: "I knew I'd have a real financial model if I could eliminate store costs." Other board members include Christos Cotsakos, chief executive of E-trade, the Internet online share-trading company, and Tim Koogle, chief executive of the Internet company, Yahoo!

Still others boast backgrounds with such resonant names as Merrill Lynch, Oracle and Hewlett Packard. Leading investors include Softbank, a subsidiary of Softbank Corporation of Japan, which owns 15 per cent, Sequoia Capital, CBS and the US media group, Knight Ridder. The underlying concept, and the one that convinced such high-powered investors to part with their cash, is the belief that all the costs involved in the food trade - buying, marketing, storage and delivery - can be drastically cut through advanced automation.

Webvan will not have conventional supermarkets. So far, it has one distribution centre, in Oakland, near San Francisco. The floorspace is 350,000sq ft, equivalent to 18 average American supermarkets. The plans are for many more.

The company wants to deliver 300,000 lines, including hand-cut meats, fresh fruit and vegetables and fine wines, breakfast cereal, cosmetics and toilet paper. Fresh fish, including live lobster, and semi-prepared meals, are on their list. Same-day delivery is promised for an agreed 30 minute "window" convenient to the customer. Webvan's closest competitor is probably HomeGrocer, based near Seattle, Washington.

Backed by Jim Bezos, chief executive of the Online bookstore, Amazon.com, HomeGrocer has a board no less illustrious than Webvan's. It includes the former chief executive of Netscape, Jim Barksdale, and the style and living guru, Martha Stewart, whose newly public company, Martha Stewart Living Omnimedia, is an investor. Joint ventures with Ms Stewart's company are also envisaged.

HomeGrocer, which has not yet gone public, has strong backing from several leading venture capital companies, and recently announced $100m of new private investment to fund the next stage of its expansion. It plans two new distribution centres by the end of this year, one in Orange County near Los Angeles, and as many as 30 such centres by the end of next year, taking in Boston and New York.

"There's not a region that we don't plan on opening at least one facility,' said Terry Drayton, president and co-founder of the company. Among his targets is the San Francisco Bay area, which would bring HomeGrocer into direct competition with Webvan.

HomeGrocer would be Webvan's only immediate competitor in northern California. But other Internet grocers are on the move. Peapod, which sold shares to the public two years ago, is in the Chicago area. Pioneer of the online grocery sector from 1990, it had to start from basics, installing computer modems for its customers.

There were no warehouses of its own, and Peapod bought the goods its customers ordered from other supermarkets. Since then, Streamline, based in Massachusetts, has started, and Netgrocer, based in New Jersey, which this year forecasts a threefold increase in last year's $8m in sales.

Until now, these cyber-stores have kept to their start-up markets, where each has a virtual monopoly. But all have plans for rapid expansion, mostly into well-to-do suburban and metropolitan areas where the supermarket is a drive away, where families are young, where women's time is at a premium and homes have computers.

There is still one hitch. Even with their regional monopolies and choice markets, none of these companies has come within striking distance of making a profit, nor is any projected for years.

Shares in Peapod and Streamline have fallen from their post-issue highs, and Netgrocer called off plans for a public share offering last year, citing poor market conditions. This week, Peapod announced it would soon need a fresh infusion of capital to keep going.

An online flower seller, FTD.com, which went public at the end of September has also lost share-value, leading some analysts to question whether the mass sale of perishable goods on-line is really viable.

Webvan acknowledges the complications of cyber-selling fresh food. It also recognises the strength of the competition, but it believes its bigger, better warehouses have cracked both problems. And while it only has one such giant at present, for its San Francisco Bay area market, it plans 26 more, starting with Atlanta, Chicago and Seattle next year.

These larger warehouses - three times bigger than those of HomeGrocer - are supposed to mean lower labour and leasing costs. Bechtel Corp has been commissioned to build all of them for $1bn; the bill has been met in part by the sale of a 6.5 per cent stake to private investors in July.

Webvan's vice-president of marketing, Chris Mannella, says: "The size of our distribution centres will allow us to push through a higher volume of groceries and deliver benefits to a larger number of clients. We certainly think our warehouse systems will overpower the competition."

Many analysts agree, especially if Webvan diversifies into non-food products, as seems likely.

Michael May, digital commerce analyst for Jupiter Communications of New York, says: "Distribution is expensive, but leveraging that distribution across health and beauty products, dry-cleaning and other services which can be picked up and dropped off would help defray those expenses. It's an extremely complicated and competitive market, but it is a good idea to use distribution as a Trojan horse into the home to sell a range of categories beyond groceries."

He believes Webvan will not only have to make big investments in infrastructure upfront - a risky proposition - but will then have to compete head-on with the distribution network of the leading regional player.

Mary Alice Taylor, recently appointed chief executive of HomeGrocer, sees the scale of Webvan's operation as a potential liability. HomeGrocer's smaller and less-automated warehouses, she argues, can be set up and run faster than Webvan's, will be less prone to error and quicker into profit.

But the debate about "how" has tended to obscure the more fundamental question of "whether" online grocery shopping can be profitable. Will a sufficient number of Americans be persuaded to buy their groceries online and will they take to the idea quickly enough to justify the huge investments that Webvan and others are making?

The grocery market in the US is valued at $450bn, and there is a consensus that the Internet grocery sector will grow only slowly. But even if - as Jupiter Communications estimates - only $7.5bn worth of business is done online by 2003, that is still a good-sized market.

Mary Alice Taylor is more optimistic. The former head of Citigroup global operations and technology says: "The only thing people detest more than grocery shopping is cleaning the house."

Media comment supports her view: newspaper columns are full of working women lamenting the lack of online grocery deliveries in their areas.

The time it takes to drive to out of town supermarkets where most Americans shop, the time it takes to traverse the aisles of these huge and confusing emporia, the queues at the check-outs, and the perpetual demands of the children you have in tow: all these factors should spur the development of Online grocery shopping. People just have to get the idea.

George Dahlman, of US Bankcorp Piper Jaffray, says investors hope online groceries will be the next "milkman concept". He adds: "You can't deliver milk and bananas by Federal Express."

But powerful factors militate against an acceleration of online supermarket shopping. However much women, especially, decry the inconvenience of the regular supermarket shop, will they miss the social aspect of their regular trip to the supermarket?

More significantly, perhaps, will shoppers trust company employees to select their fruit, vegetables and meat? Self-service, however time-consuming, is something Americans prize. The online grocers will have to demonstrate that their workers' (or robots') eye for quality and freshness is as sharp as that of their most choosy customers. That will not be easy.

Americans spend more time shopping for groceries than their European counterparts, if only because of the distance they must often travel.

But can they bring themselves to replace their weekly or monthly excursion with a half-hour or so of pointing and clicking on their computers? If so, there will then be a giant market for the taking. If not, there may still be a market, but it will be much smaller, and it is not at all clear what form it would take.

Would it be primarily for distribution, as existing supermarkets develop their own, local, delivery services? Would it comprise primarily niche markets - an extension of current Internet and mail order catalogue shopping for luxury, ethnic and seasonal food?

For George Shaheen, who once worked at his small-town family grocery shop and is now in the driving seat at Webvan, the answer is both."The key to e-commerce," he says, "is all about the last mile to the customer."

It is now up to us, the customers, to decide what we want.