Executive Briefings

Webvan: Rewriting The Rules On 'Last Mile' Delivery

Webvan Corp., with the help of its technology partners, has broken the code on guaranteed, self-scheduled home delivery. Here's how it gets the goods delivered within a promised 30-minute window and where it plans to take that achievement.

Its service may be reminiscent of the nostalgic days when milk and bread were delivered daily to the doorstep, but no business is more thoroughly modern than that of home courier Webvan Corp. The Foster City, Calif.-based company is completely a child of the Internet Age, combining a sophisticated web storefront with a fulfillment and delivery process that pushes the envelope of supply-chain technology. The result is a marketplace first: self-scheduled, personalized home delivery within guaranteed 30-minute windows.

Webvan's core activity is selling and delivering grocery and non-prescription drug products, but these are only the foundation of a much larger vision. "Clearly we will be the best online grocer, but we will extend our product offering beyond grocery to deliver almost any product to your home that you may desire," said Webvan CFO Robert Swann in a recent presentation at a Business Week executive summit.

It is a grandiose concept and Webvan has very grand plans for its realization. The company has been operating for a little more than a year in the San Francisco Bay Area, opened in Atlanta in April, will soon launch in Chicago and Seattle, and plans to be in 26 major U.S. cities by the end of 2002. Its expansion program received a boost in late June when the company announced an agreement to acquire its closest competitor, HomeGrocer.com Inc., in a stock-for-stock transaction. By the end of this year, the combined Webvan and HomeGrocer operation will serve the additional metropolitan areas of Baltimore, Md.; Bergen County, N.J.; Dallas; Los Angeles and Orange County, Calif.; Portland, Ore.; San Diego, Calif.; and Washington, D.C.

(Editor's Note: The majority of this article was researched and written prior to the announced acquisition and does not take into account the HomeGrocer.com business.)

At each of its locations, Webvan is building a massive and highly automated distribution center - at a cost of approximately $35m each - and is leasing a fleet of trucks and vans. Once in place, says Swann, Webvan "will capitalize on that infrastructure" and on its "unique shopping experience" by expanding its product offering and customer base. The company's DCs, he says, are designed to accommodate 50,000 SKUs even though only 20,000 are needed for Webvan's online grocery business. "That leaves 30,000 excess locations to expand outside of grocery," he notes. Already the company has added small electronics, books, toys, cosmetics, office supplies, and some garden products to its offering.

Webvan Economics
Success for Webvan depends on its ability to convince consumers to change their historical way of shopping and supplant trips to the supermarket with a half-hour at the computer.

That means offering competitive prices as well as top quality products and an unparalleled shopping experience, said CFO Robert Swann, at a recent Business Week executive summit.

Webvan's business model was designed to keep costs-and prices- down, he says. A Webvan distribution center holds the equivalent of 18 supermarkets, but it employs only 900 to 1,000 people compared with the 2,200 to 2,700 required by 18 stores. There also is a substantial savings in real estate and overhead. One facility in an industrial zone is much less expensive to operate than 18 stores near residential areas.

And Webvan has inventory advantages, notes Bud Grebey, director of corporate affairs. Since many online customers order more than 24 hours in advance, he says, "we can much more accurately forecast our needs. That is especially important with perishables like dairy products, where stores tend to have a lot of loss from spoilage." Currently the company has an inventory turn rate of 26, "so we are making money on inventory before we have to pay for it," he says.

Webvan predicts that in its third year of operation, each location will generate $300m in revenue with an operating margin of 12 percent. This compares with an operating margin of 7 percent by today's best-in-class grocers, says Swann.

To help ensure it reaches this goal Webvan "measures religiously," says Swann. Among its most crucial metrics is customer acquisition and retention. In the Bay Area, he says, 100,000 customers ordered from Webvan during its first three quarters of operation. The repeat rate, a critical measure of the success of the first shopping experience, is 78 percent. "Our data suggests that if we can get them to come back five times, they will stay with us forever," he says.

In the second quarter of this year the company took in $28.3m and posted a gross operating margin-revenue from sales less the cost of goods sold -of 28 percent. This compared with revenue of $16.3m and a 25 percent margin for the prior quarter. Of course, with a billion-dollar expansion program it will be some time before Webvan moves into the black.

Like all dotcom companies, Webvan's stock was beaten down in the recent Nasdaq pullback. The stock, which when went public last November, has traded as high as $34 and as low as $4.38. In mid-July it was selling around $8 per share. Importantly, however, the company had $410m in cash at the end of the second quarter, a figure that will increase to $650m when it completes its announced acquisition of rival HomeGrocer.com. According to a report in the Financial Times, Webvan still will have to raise $275m in additional funds to complete its expansion plans over the next 12 months. However, that is half the amount that would have been required without the HomeGrocer acquisition.

While acknowledging that the market environment has changed, Swann believes "there still is a lot of money out there. Money will migrate to the best operators and we believe we will prove that we are the best," he says.

Webvan is backed by CBS Inc. and Knight-Ridder Co., as well as some of the leading sources of venture capital, including Benchmark Capital, Sequoia Capital and Softbank Corp. Founder and chairman Louis Borders, co-founder of bookseller Borders Group, owns 25 percent of the company.


The decision to launch operations with grocery was a well considered one, however. With an annual spend of $655bn, it is a huge retail sector - one capable of generating both the volume density and order frequency needed to make Webvan's ambitious business model work.

At "steady state," the company anticipates filling and delivering 8,000 orders a day with an average value of $103 at each of its locations. It says it will break even at half that volume, a milestone it plans to reach in each city's fifth quarter of operation.
While the acquisition of HomeGrocer eliminates a major Webvan competitor, there are others vying for a piece of the online grocery market, including Albertsons, which offers the option of picking up groceries at a store or having them delivered; and ShopLink.com and Streamline.com, which offer unattended deliveries to installed refrigerated boxes. Webvan believes its fulfillment system and 30-minute guaranteed delivery times set it apart, however, and create what Swann describes as "significant barriers to entry from competitive forces."

Achieving that 30-minute milestone was a key part of Webvan's strategy from the start, but it presented a formidable challenge. "Nobody does 30-minute windows in the industry, not even very mature companies like United Parcel Service and FedEx," says Peter Relan, senior vice president for technology at Webvan. "The technology to do 30-minute windows at scale, which for us is thousands of orders a day, simply didn't exist."
Nor did the fulfillment system that Webvan envisioned, which needed to combine highly automated materials-handling equipment with extremely configurable warehouse management software. "Pieces of the solution were out there, but 'each' picking, using a carousel and conveyor combination at a scale of this kind, really wasn't," says Relan. These solutions, moreover, needed to interface seamlessly and be scaleable and replicable across all of Webvan's planned 26 locations.

To meet this challenge, Webvan "ramped up an in-house engineering team," says Relan, but the company also decided to work with software-vendor partners where possible to speed time to market. The in-house team developed the overall architecture, the "glueware" that connects the system and the "global master algorithms" that solve specific problems. Vendor partners provided critical functional and optimization components and professional services to help implement and integrate them. Key supply-chain partners are Optum Inc., White Plains, N.Y., for warehouse management and Descartes Systems, Waterloo, Ont., for routing and scheduling. Harbinger.net, an Atlanta-based application service provider, is used for communications with suppliers.

Complex Problems
The complexity of the problem that Webvan set out to solve was enormous. Nearly all customer orders involve not only "shelf" products that can be stored at ambient temperature but fresh produce and meats which must be hand picked or cut and kept chilled, temperature-sensitive dairy products, and frozen foods. Many also include freshly prepared entrees or other items from the deli.

A mind-boggling number of calculations are required to optimize each order for workflow efficiency and maximum tote capacity, all while ensuring that ambient items are picked in the right succession - heavy items on the bottom of a tote, chips and bread on top. Prepared-to-order items must be started earlier and frozen goods picked later, but all parts of an order have to be synchronized to arrive together at the correct shipping area for loading onto a truck that has to leave on schedule.

In addition, delivery van routes must be optimized dynamically as time slots are requested by customers in a way that guarantees Webvan's ability to meet the promised delivery time. Customers can ask for next-day delivery or schedule a time up to seven days out. In the Bay Area, same-day delivery soon will be offered to some customers as well.

Webvan decided early to base its distribution system on a hub-and-spoke model. "We knew we wanted central fulfillment," says Gary Dahl, vice president of distribution, who was one of Webvan's founding officers. "We wanted to pack the order in the same container it would be delivered in, and when we looked at the best-of-class in package distribution, they all do it the same way, in hub-and-spoke fashion. So what we did was take the same logic of hub-and-spoke and just apply it to a smaller geographic area."

From the distribution center hubs, orders are trucked to strategically located transfer stations where they are moved into vans that serve specific neighborhoods. This system, adds Relan, "also allows us to cover a large geographic area, a 60-mile radius from the DC. If you draw that circle it covers a lot of ground."

The distribution centers are in some ways more like a supermarket than a typical warehouse. There are three temperature zones, a huge wine cellar (in the Bay Area) a large cigar humidor, an industrial kitchen and specialized areas for produce, seafood and meat. Products are put away in eaches, not cases. A Webvan DC, however, holds the equivalent of 18 supermarkets under one roof, occupying 350,000 square feet.

Webvan knew that it would be impractical to have pickers travel such a large facility to fill orders, so it opted for a system for ambient products that brings stock to picker. Working with Diamond Phoenix, which makes carousel systems, and with Optum, Webvan designed a system where totes move on 4.5 miles of conveyors to pickers stationed at the end of 12 huge carousels, each with 7,500 stocking locations.

This design and Webvan's order complexity pushed Optum into some untried areas. "We had to dive into our configurability capabilities and test some areas that really had never been tested before," says Henry Bruce, vice president of global marketing at Optum. "We pushed the software and also pushed our understanding of what it can do."

This project also drove Optum to advance its ability to interface with materials-handling equipment. Given their high volume and velocity requirements, "Webvan really needed the software driving the materials-handling automation and the warehouse management system software to work together seamlessly," says Bruce. "We had a lot of experience in that area, but this project expanded our competency and pushed us to a new level."

In all this, Webvan was deeply involved both as director and collaborator. "Webvan had the resources, both people and smarts, to work with us to get the job done," says Bruce. "They asked us to 'bravely go where no man has gone before' and they were with us every step of the way."

One of the key components of the fulfillment solution is the use of "round robin" algorithms to locate individual SKUs in many bins scattered throughout the carousels, a process known as inventory striping. This prevents any product from being unavailable should a carousel go down, but it also adds efficiency to the pick/putaway process.

"If you have 15 or 20 orders for a cereal, for example, and you have cereal stocked in one particular section, orders will get backed up waiting for this item," explains Sailesh Saxena, director of strategic consulting at Optum. "So the technology, by spreading product across multiple carousels, also spreads the workload. You minimize pick time, the order fill-rate improves and the time to complete an order shrinks."

Here is how fulfillment works. As orders come into the WMS system via the PeopleSoft Gateway software used by Webvan, the system's "brain" begins devising the optimal picking plan. It first divides products into categories: ambient, chilled and prepared-to-order, and frozen. It determines how many totes will be needed to fill the order and builds a load plan for each tote. The time it will take to pick each part of the order, plus the scheduled delivery time and the existing workload, determine when totes are inducted and how they are routed to different carousel stations. Orders are released in batches so that each carousel serves about 16 totes at a time.

Devising a tote load-plan is more complex than it might seem. Not only must the system know the most efficient picking order, it also must take into account the "crushability" factor, picking fragile items last so they will be on top.

It must understand the size and shape of each item as well. "Suppose an order has 20 items and the last item is a watermelon," says Saxena. With a typical load-planning algorithm, based on volume, "there is a good chance the system would direct you to pick watermelon in two different totes," he says. "So here is where our configurability comes in. We can easily extend the logic to go in and assign an attribute that says watermelon cannot be split across multiple totes."

Picking The Order
The totes are color coded - yellow for ambient, green for chilled and blue for frozen - and each tote is barcoded. As work begins on an order and a tote is inducted, the barcode is scanned, enabling the system to tie that tote to the order. Using the optimized load plan, ambient totes move on conveyor belts to one of the carousel stations, or pods. As the picker scans each tote, the carousel swings around to expose products to be loaded, indicating the appropriate product with a light and a digital readout showing quantity. Typically the picker is working on several totes at once so that frequently ordered items can be picked at the same time for separate orders. Once the items are scanned and placed in the tote, the picker hits a button to confirm that the pick is done. Either the next item appears or the tote moves on. A signal lets the picker know when a tote is complete. He then closes the tote and places it on an express carousel that takes it to the shipping area.
Very fast-moving items like chips that are replenished daily by the supplier, and items like 50-pound bags of dog food that are too big for the carousels, are kept in a separate area and are picked from the shelf.

Devising a tote load-plan is more complex than it might seem.

Order information on special-handling items like fresh produce, cut meats and prepared food is sent to a computer-on-wheels located in those areas. Bar-coded chits are printed with the order requirements - two ripe tomatoes, an eight-ounce steak cut one-inch thick, etc. Once the item is prepared and packaged, the portable computer prints a bar-coded label identifying the order and the item, with weight and price indicated. These items are then put on a shelf space assigned to that order within the chilled area of the facility. A worker walking this area with totes on a dolly cart picks and packs these items and sends completed totes to the shipping area.

Frozen items are picked by workers in polar suits. They use Styrofoam-lined totes containing dry-ice packs to ensure the maintenance of proper temperature.

Pickers also put away items. At receiving, cartons are broken down into individual items and each item is scanned. Ambient items are placed in a tray and the system uses its striping algorithm to assign that tray to a carousel location. The trays then move on the conveyor system to the appropriate carousel pod, where a scan of the tray's barcode brings up putaway instructions.

The fulfillment process is timed to make sure that all the totes in an order arrive in the shipping area at approximately the same time. Here totes are placed on dollies designated for particular geographic zones, still divided by temperature. The dollies are rolled onto a truck with ambient, chilled and frozen compartments.

These trucks go to cross-dock stations surrounding the metropolitan area, where they are organized by route and transferred to chilled delivery vans. The transfer stations are equipped with refrigerators and freezers to accommodate the rare instance when a customer is not available to receive his scheduled delivery.

Scheduling and routing is where the Descartes system comes in. In this case, too, Webvan plowed new territory. "Webvan was looking to attack the route optimization or scheduling optimization problem in a different way," says David Waksberg, Descartes vice president. "They wanted to enable the customer to do self-scheduling and wanted to inform each request with optimization intelligence."

Route optimization usually is done in batch, he explains, "where you have a bunch of jobs and a bunch of resources and the optimizer crunches the numbers and comes up with a solution."

Webvan's one-at-a-time model had never been done before, but "we thought we could probably do it that way," says Waksberg. "Our software actually does incremental optimization very well. It is used in a lot of dynamic situations where new jobs come in and you have to figure out what is the best thing to do."

The Descartes optimizer also was available as a component, which allowed Webvan to do the customization needed to make it fit its system. "They had some very talented people who I think were happy to have an optimization component as flexible as ours, and we were happy to have people that were smart enough to do something that was interesting with it," Waksberg says.

"We built a whole software technology around this component to hook it into our web site and other systems," Relan notes.

The scheduling optimizer interfaces directly with the web site. Once an order is placed, the customer is asked to schedule delivery. A window comes up showing 30-minute time slots, from 7 a.m. to 10 p.m., for the next seven days. Slots are marked as available or unavailable. Unavailability does not necessarily mean that the slot is already taken, however. If could mean that the optimization engine has ruled it out based on the time and location of other committed deliveries. For example, if a customer on one end of a route has been promised a delivery between 3:00 and 3:30, a customer on the opposite end probably would not be offered the 3:30 to 4:00 slot. Obviously, customers ordering further in advance have more delivery choices.

The optimizer can be very creative, however. According to Waksberg, it might determine that the customer looking for a 3:30 to 4:00 delivery could be handed off to the driver on an adjoining route, who will be closer to the address. Webvan also has the option of having the system highlight time slots that are best because the van already has an appointment nearby.

Crossing The Threshold
Before a van is dispatched, a final optimization is done and the system prints out directions to each address for the courier. When the courier arrives at a home, he or she takes the totes inside and unpacks them for the customer. (Alternatively, for a $3 deposit the customer can choose to have the totes left.) Each driver, or courier, carriers a wireless hand-held device that prints out a receipt and an itemized list of the order for the customer.
The same device is used to send a message that the delivery is complete. All the vans are equipped with GPS and are monitored by dispatch. If an unexpected delay occurs, customers are called to let them know when the courier should arrive and to reschedule if that is the customer's choice.

The mobile device also gives the courier access to all of the customer's back orders so if there is a complaint about a product previously delivered, the courier can check the records and give a credit on the spot.

The personal contact that comes with having a courier cross the threshold into the home is an important part of the Webvan model and these employees are carefully screened and trained. "Our goal is bring the human side to what is a very impersonal type of commerce," says Bud Grebey, director of corporate relations. "With e-commerce the closest thing you usually get to personal service is a sign that says 'welcome back, Bud Grebey. If you are not Bud Grebey, click here.'"

"The courier is clearly a strategic element of our business and not simply a cost," says Swann. "Couriers serve as our ambassador and as our sales force to educate the consumer about our expanded products."

Webvan@Work
To further expand its customer base Webvan recently launched a new service called Webvan@Work. It offers small to mid-sized businesses another alternative for procuring basic office supplies, cleaning materials, replenishment products such as snacks and beverages, stamps, fresh flowers and first-aid goods. Webvan also plans to offer catering services for employee meals and business meetings.

"One of the benefits of this program for us is that it allows us to optimize our delivery assets," says Bud Grebey, director of corporate affairs at Webvan. "When we are in full operation, delivering from 7 a.m. to 10 p.m., the hours before work and after school are our busiest times. From around 11 a.m. to 1 p.m., there is a lull."
This is a perfect time to deliver Webvan@Work orders, says Grebey. "It balances the efficiency of our delivery and fulfillment."

In a separate initiative aimed at larger companies, Webvan is working with human resources departments to promote its service as a way to benefit time-pressured employees. The idea is to allow employees to access the internet and do their grocery shopping with Webvan during lunch break. "We will go in and offer discount incentive programs for companies to sign up their employees to shop from Webvan. They can order during the day and have the groceries delivered to their home when they are going to be there," says Grebey.

A slightly different approach currently is being tested with students at Stanford University. "Campuses like Stanford have a problem with too many cars on campus and not enough parking spaces," says Grebey. "With Webvan on campus, students don't need a car to shop."

In this model, students order from Webvan and then pick up their orders at pre-established points. "We have Webvan stops on campus and, for example, on Tuesdays between noon and 3:00, we're there with all the orders for people who live in that part of campus. It's sort of like mail call in the Army," says Grebey.


Moreover, he says, consumers will limit the number of people they allow across their threshold. "We believe the consumer will require touch points that are not many, but few," says Swann. Once Webvan has won their trust, "we believe the consumer will want to leverage the Webvan shopping experience."

A final part of the supply chain involves Webvan's inbound operations. The company has forged relationships with several national grocery wholesalers as well as with local suppliers of fresh produce, seafood, meat and flowers.

Purchases are based on a combination of anticipated and actual demand, since many consumers order more than a day in advance. "In our model we have the advantage of having much more demand-based information to apply to our supply chain," says Relan. "When a customer places an order, they are reserving the inventory."

That inventory may not be in the warehouse at the time the order is placed. To ensure that it is there by the time the order is filled requires fast and reliable communications with suppliers. Webvan has handed over this back-office process to Harbinger Corp. of Atlanta.
Webvan sends purchase orders to harbinger.net, which operates as an application service provider. Harbinger takes that information, puts it in the format required by each supplier, and transmits it electronically. The same applies to confirmations or other messages from the suppliers to Webvan.

Typically the format is standard EDI, says Dan Manack, Harbinger's executive vice president for global operations, but some suppliers are XML-enabled.

"The other thing Harbinger brings to the table is that we go out and work with suppliers that need help with their technology," he says. "Webvan only has to worry about its own business applications. It doesn't have to worry about all of the communications technology that is necessary to deal with heterogeneous data formats and putting all that into EDI or XML or other standards. We do all that."

No Bad Cantaloupes
One of the surprises Webvan has encountered in its first year of operation is consumers' reaction to its fresh produce.

"We knew a typical grocery store does around 8 percent of its volume in produce," says Gary Dahl, vice president of distribution. "Selling online, we thought we would do slightly less," based on the assumption that people want to touch and smell their fruits and veggies.

The opposite has occurred. Webvan sells almost twice as much produce as an average supermarket. The reason is clearly one of quality. Webvan chooses its suppliers carefully, but more importantly, it handles produce far less than supermarkets.

"If you compare what we do to a brick-and-mortar store, you see the difference very quickly," says Dahl. "The brick-and-mortar throws it up on a display and has to keep rotating it. Then you have shoppers doing all the stuff they do to produce-squeezing it, molesting it. On the other hand, we have a lot of produce where, until our picker selects it for an order, the last person who touched it was the guy in the packing shed."

Webvan also makes sure that the produce is not subjected to temperature changes or to misting, which tends to leach the flavor. And it employs produce specialists to do the picking.

"We don't send out bad cantaloupes," says Dahl. "These people really know produce."

Still, this is not an area where 100 percent perfection is achievable. "You can get peaches that look fine and turn out to be mealy," notes Bud Grebey, director of corporate relations. "But the next time the courier comes into your home, you can tell him they weren't any good and he will look it up and take that amount off your current bill."

Typically first-time customers are cautious, says Grebey, ordering one tomato and two bananas. "Then when they see the quality, on their next order they bulk up."

"You really have a chance to differentiate yourself through the fresh side," adds Dahl. "The quality of our meat and produce, and a lot of our prepared meals, have really become a calling card."

Webvan may eventually explore ways to give suppliers a more direct view into their inventory, says Relan. "We are working with a couple of strategic suppliers to define what it means for them to have a view into our inventory and how it would work," he says. "I think it is a very open and exciting field."

Webvan is exploring other mutually beneficial ways to work with suppliers as well. In January, the company signed strategic business alliances with four major consumer-products companies: Kellogg, Nestle USA, Pillsbury and Quaker Oats.

These alliances, according to an announcement released at the time, will enable Webvan to better align products with targeted consumers, helping it "acquire and retain new customers and increase its average order size."

In turn, the company said, Webvan's partners "will gain key insights into the entire online channel, while having the opportunity to test and develop virtual merchandising strategies, online marketing programs and new consumer-behavior models."

"The class of trade called the online shopper is still evolving," adds Dahl. "They don't have the same shopping patterns and habits as a person that goes to a traditional brick-and-mortar store, so there are different correlations of items and things that you can cross-market. There is just tremendous opportunity for both the vendors and ourselves in sharing that data."

There is the potential for operational advantages as well. Webvan currently packages and recycles all the cardboard dunnage that results from its unpacking of cartons at receiving. "Packaging is expensive for the vendors, but it is something that we just rip open and recycle so we can put the items in a tray," says Dahl. "There would be a great advantage in taking those trays and moving them back upstream to have the vendors fill them out. Then it would just be a matter of receiving the product and putting it straight into a carousel."

Webvan's mission is simple: to be the full-service vendor of choice for the "last mile" of e-commerce. It may be a distant goal, but the company's early steps certainly have not lacked boldness. "How do we get there?" asks Swann. "It starts with a revolutionary order-fulfillment model that begins and ends with the customer.

Its service may be reminiscent of the nostalgic days when milk and bread were delivered daily to the doorstep, but no business is more thoroughly modern than that of home courier Webvan Corp. The Foster City, Calif.-based company is completely a child of the Internet Age, combining a sophisticated web storefront with a fulfillment and delivery process that pushes the envelope of supply-chain technology. The result is a marketplace first: self-scheduled, personalized home delivery within guaranteed 30-minute windows.

Webvan's core activity is selling and delivering grocery and non-prescription drug products, but these are only the foundation of a much larger vision. "Clearly we will be the best online grocer, but we will extend our product offering beyond grocery to deliver almost any product to your home that you may desire," said Webvan CFO Robert Swann in a recent presentation at a Business Week executive summit.

It is a grandiose concept and Webvan has very grand plans for its realization. The company has been operating for a little more than a year in the San Francisco Bay Area, opened in Atlanta in April, will soon launch in Chicago and Seattle, and plans to be in 26 major U.S. cities by the end of 2002. Its expansion program received a boost in late June when the company announced an agreement to acquire its closest competitor, HomeGrocer.com Inc., in a stock-for-stock transaction. By the end of this year, the combined Webvan and HomeGrocer operation will serve the additional metropolitan areas of Baltimore, Md.; Bergen County, N.J.; Dallas; Los Angeles and Orange County, Calif.; Portland, Ore.; San Diego, Calif.; and Washington, D.C.

(Editor's Note: The majority of this article was researched and written prior to the announced acquisition and does not take into account the HomeGrocer.com business.)

At each of its locations, Webvan is building a massive and highly automated distribution center - at a cost of approximately $35m each - and is leasing a fleet of trucks and vans. Once in place, says Swann, Webvan "will capitalize on that infrastructure" and on its "unique shopping experience" by expanding its product offering and customer base. The company's DCs, he says, are designed to accommodate 50,000 SKUs even though only 20,000 are needed for Webvan's online grocery business. "That leaves 30,000 excess locations to expand outside of grocery," he notes. Already the company has added small electronics, books, toys, cosmetics, office supplies, and some garden products to its offering.

Webvan Economics
Success for Webvan depends on its ability to convince consumers to change their historical way of shopping and supplant trips to the supermarket with a half-hour at the computer.

That means offering competitive prices as well as top quality products and an unparalleled shopping experience, said CFO Robert Swann, at a recent Business Week executive summit.

Webvan's business model was designed to keep costs-and prices- down, he says. A Webvan distribution center holds the equivalent of 18 supermarkets, but it employs only 900 to 1,000 people compared with the 2,200 to 2,700 required by 18 stores. There also is a substantial savings in real estate and overhead. One facility in an industrial zone is much less expensive to operate than 18 stores near residential areas.

And Webvan has inventory advantages, notes Bud Grebey, director of corporate affairs. Since many online customers order more than 24 hours in advance, he says, "we can much more accurately forecast our needs. That is especially important with perishables like dairy products, where stores tend to have a lot of loss from spoilage." Currently the company has an inventory turn rate of 26, "so we are making money on inventory before we have to pay for it," he says.

Webvan predicts that in its third year of operation, each location will generate $300m in revenue with an operating margin of 12 percent. This compares with an operating margin of 7 percent by today's best-in-class grocers, says Swann.

To help ensure it reaches this goal Webvan "measures religiously," says Swann. Among its most crucial metrics is customer acquisition and retention. In the Bay Area, he says, 100,000 customers ordered from Webvan during its first three quarters of operation. The repeat rate, a critical measure of the success of the first shopping experience, is 78 percent. "Our data suggests that if we can get them to come back five times, they will stay with us forever," he says.

In the second quarter of this year the company took in $28.3m and posted a gross operating margin-revenue from sales less the cost of goods sold -of 28 percent. This compared with revenue of $16.3m and a 25 percent margin for the prior quarter. Of course, with a billion-dollar expansion program it will be some time before Webvan moves into the black.

Like all dotcom companies, Webvan's stock was beaten down in the recent Nasdaq pullback. The stock, which when went public last November, has traded as high as $34 and as low as $4.38. In mid-July it was selling around $8 per share. Importantly, however, the company had $410m in cash at the end of the second quarter, a figure that will increase to $650m when it completes its announced acquisition of rival HomeGrocer.com. According to a report in the Financial Times, Webvan still will have to raise $275m in additional funds to complete its expansion plans over the next 12 months. However, that is half the amount that would have been required without the HomeGrocer acquisition.

While acknowledging that the market environment has changed, Swann believes "there still is a lot of money out there. Money will migrate to the best operators and we believe we will prove that we are the best," he says.

Webvan is backed by CBS Inc. and Knight-Ridder Co., as well as some of the leading sources of venture capital, including Benchmark Capital, Sequoia Capital and Softbank Corp. Founder and chairman Louis Borders, co-founder of bookseller Borders Group, owns 25 percent of the company.


The decision to launch operations with grocery was a well considered one, however. With an annual spend of $655bn, it is a huge retail sector - one capable of generating both the volume density and order frequency needed to make Webvan's ambitious business model work.

At "steady state," the company anticipates filling and delivering 8,000 orders a day with an average value of $103 at each of its locations. It says it will break even at half that volume, a milestone it plans to reach in each city's fifth quarter of operation.
While the acquisition of HomeGrocer eliminates a major Webvan competitor, there are others vying for a piece of the online grocery market, including Albertsons, which offers the option of picking up groceries at a store or having them delivered; and ShopLink.com and Streamline.com, which offer unattended deliveries to installed refrigerated boxes. Webvan believes its fulfillment system and 30-minute guaranteed delivery times set it apart, however, and create what Swann describes as "significant barriers to entry from competitive forces."

Achieving that 30-minute milestone was a key part of Webvan's strategy from the start, but it presented a formidable challenge. "Nobody does 30-minute windows in the industry, not even very mature companies like United Parcel Service and FedEx," says Peter Relan, senior vice president for technology at Webvan. "The technology to do 30-minute windows at scale, which for us is thousands of orders a day, simply didn't exist."
Nor did the fulfillment system that Webvan envisioned, which needed to combine highly automated materials-handling equipment with extremely configurable warehouse management software. "Pieces of the solution were out there, but 'each' picking, using a carousel and conveyor combination at a scale of this kind, really wasn't," says Relan. These solutions, moreover, needed to interface seamlessly and be scaleable and replicable across all of Webvan's planned 26 locations.

To meet this challenge, Webvan "ramped up an in-house engineering team," says Relan, but the company also decided to work with software-vendor partners where possible to speed time to market. The in-house team developed the overall architecture, the "glueware" that connects the system and the "global master algorithms" that solve specific problems. Vendor partners provided critical functional and optimization components and professional services to help implement and integrate them. Key supply-chain partners are Optum Inc., White Plains, N.Y., for warehouse management and Descartes Systems, Waterloo, Ont., for routing and scheduling. Harbinger.net, an Atlanta-based application service provider, is used for communications with suppliers.

Complex Problems
The complexity of the problem that Webvan set out to solve was enormous. Nearly all customer orders involve not only "shelf" products that can be stored at ambient temperature but fresh produce and meats which must be hand picked or cut and kept chilled, temperature-sensitive dairy products, and frozen foods. Many also include freshly prepared entrees or other items from the deli.

A mind-boggling number of calculations are required to optimize each order for workflow efficiency and maximum tote capacity, all while ensuring that ambient items are picked in the right succession - heavy items on the bottom of a tote, chips and bread on top. Prepared-to-order items must be started earlier and frozen goods picked later, but all parts of an order have to be synchronized to arrive together at the correct shipping area for loading onto a truck that has to leave on schedule.

In addition, delivery van routes must be optimized dynamically as time slots are requested by customers in a way that guarantees Webvan's ability to meet the promised delivery time. Customers can ask for next-day delivery or schedule a time up to seven days out. In the Bay Area, same-day delivery soon will be offered to some customers as well.

Webvan decided early to base its distribution system on a hub-and-spoke model. "We knew we wanted central fulfillment," says Gary Dahl, vice president of distribution, who was one of Webvan's founding officers. "We wanted to pack the order in the same container it would be delivered in, and when we looked at the best-of-class in package distribution, they all do it the same way, in hub-and-spoke fashion. So what we did was take the same logic of hub-and-spoke and just apply it to a smaller geographic area."

From the distribution center hubs, orders are trucked to strategically located transfer stations where they are moved into vans that serve specific neighborhoods. This system, adds Relan, "also allows us to cover a large geographic area, a 60-mile radius from the DC. If you draw that circle it covers a lot of ground."

The distribution centers are in some ways more like a supermarket than a typical warehouse. There are three temperature zones, a huge wine cellar (in the Bay Area) a large cigar humidor, an industrial kitchen and specialized areas for produce, seafood and meat. Products are put away in eaches, not cases. A Webvan DC, however, holds the equivalent of 18 supermarkets under one roof, occupying 350,000 square feet.

Webvan knew that it would be impractical to have pickers travel such a large facility to fill orders, so it opted for a system for ambient products that brings stock to picker. Working with Diamond Phoenix, which makes carousel systems, and with Optum, Webvan designed a system where totes move on 4.5 miles of conveyors to pickers stationed at the end of 12 huge carousels, each with 7,500 stocking locations.

This design and Webvan's order complexity pushed Optum into some untried areas. "We had to dive into our configurability capabilities and test some areas that really had never been tested before," says Henry Bruce, vice president of global marketing at Optum. "We pushed the software and also pushed our understanding of what it can do."

This project also drove Optum to advance its ability to interface with materials-handling equipment. Given their high volume and velocity requirements, "Webvan really needed the software driving the materials-handling automation and the warehouse management system software to work together seamlessly," says Bruce. "We had a lot of experience in that area, but this project expanded our competency and pushed us to a new level."

In all this, Webvan was deeply involved both as director and collaborator. "Webvan had the resources, both people and smarts, to work with us to get the job done," says Bruce. "They asked us to 'bravely go where no man has gone before' and they were with us every step of the way."

One of the key components of the fulfillment solution is the use of "round robin" algorithms to locate individual SKUs in many bins scattered throughout the carousels, a process known as inventory striping. This prevents any product from being unavailable should a carousel go down, but it also adds efficiency to the pick/putaway process.

"If you have 15 or 20 orders for a cereal, for example, and you have cereal stocked in one particular section, orders will get backed up waiting for this item," explains Sailesh Saxena, director of strategic consulting at Optum. "So the technology, by spreading product across multiple carousels, also spreads the workload. You minimize pick time, the order fill-rate improves and the time to complete an order shrinks."

Here is how fulfillment works. As orders come into the WMS system via the PeopleSoft Gateway software used by Webvan, the system's "brain" begins devising the optimal picking plan. It first divides products into categories: ambient, chilled and prepared-to-order, and frozen. It determines how many totes will be needed to fill the order and builds a load plan for each tote. The time it will take to pick each part of the order, plus the scheduled delivery time and the existing workload, determine when totes are inducted and how they are routed to different carousel stations. Orders are released in batches so that each carousel serves about 16 totes at a time.

Devising a tote load-plan is more complex than it might seem. Not only must the system know the most efficient picking order, it also must take into account the "crushability" factor, picking fragile items last so they will be on top.

It must understand the size and shape of each item as well. "Suppose an order has 20 items and the last item is a watermelon," says Saxena. With a typical load-planning algorithm, based on volume, "there is a good chance the system would direct you to pick watermelon in two different totes," he says. "So here is where our configurability comes in. We can easily extend the logic to go in and assign an attribute that says watermelon cannot be split across multiple totes."

Picking The Order
The totes are color coded - yellow for ambient, green for chilled and blue for frozen - and each tote is barcoded. As work begins on an order and a tote is inducted, the barcode is scanned, enabling the system to tie that tote to the order. Using the optimized load plan, ambient totes move on conveyor belts to one of the carousel stations, or pods. As the picker scans each tote, the carousel swings around to expose products to be loaded, indicating the appropriate product with a light and a digital readout showing quantity. Typically the picker is working on several totes at once so that frequently ordered items can be picked at the same time for separate orders. Once the items are scanned and placed in the tote, the picker hits a button to confirm that the pick is done. Either the next item appears or the tote moves on. A signal lets the picker know when a tote is complete. He then closes the tote and places it on an express carousel that takes it to the shipping area.
Very fast-moving items like chips that are replenished daily by the supplier, and items like 50-pound bags of dog food that are too big for the carousels, are kept in a separate area and are picked from the shelf.

Devising a tote load-plan is more complex than it might seem.

Order information on special-handling items like fresh produce, cut meats and prepared food is sent to a computer-on-wheels located in those areas. Bar-coded chits are printed with the order requirements - two ripe tomatoes, an eight-ounce steak cut one-inch thick, etc. Once the item is prepared and packaged, the portable computer prints a bar-coded label identifying the order and the item, with weight and price indicated. These items are then put on a shelf space assigned to that order within the chilled area of the facility. A worker walking this area with totes on a dolly cart picks and packs these items and sends completed totes to the shipping area.

Frozen items are picked by workers in polar suits. They use Styrofoam-lined totes containing dry-ice packs to ensure the maintenance of proper temperature.

Pickers also put away items. At receiving, cartons are broken down into individual items and each item is scanned. Ambient items are placed in a tray and the system uses its striping algorithm to assign that tray to a carousel location. The trays then move on the conveyor system to the appropriate carousel pod, where a scan of the tray's barcode brings up putaway instructions.

The fulfillment process is timed to make sure that all the totes in an order arrive in the shipping area at approximately the same time. Here totes are placed on dollies designated for particular geographic zones, still divided by temperature. The dollies are rolled onto a truck with ambient, chilled and frozen compartments.

These trucks go to cross-dock stations surrounding the metropolitan area, where they are organized by route and transferred to chilled delivery vans. The transfer stations are equipped with refrigerators and freezers to accommodate the rare instance when a customer is not available to receive his scheduled delivery.

Scheduling and routing is where the Descartes system comes in. In this case, too, Webvan plowed new territory. "Webvan was looking to attack the route optimization or scheduling optimization problem in a different way," says David Waksberg, Descartes vice president. "They wanted to enable the customer to do self-scheduling and wanted to inform each request with optimization intelligence."

Route optimization usually is done in batch, he explains, "where you have a bunch of jobs and a bunch of resources and the optimizer crunches the numbers and comes up with a solution."

Webvan's one-at-a-time model had never been done before, but "we thought we could probably do it that way," says Waksberg. "Our software actually does incremental optimization very well. It is used in a lot of dynamic situations where new jobs come in and you have to figure out what is the best thing to do."

The Descartes optimizer also was available as a component, which allowed Webvan to do the customization needed to make it fit its system. "They had some very talented people who I think were happy to have an optimization component as flexible as ours, and we were happy to have people that were smart enough to do something that was interesting with it," Waksberg says.

"We built a whole software technology around this component to hook it into our web site and other systems," Relan notes.

The scheduling optimizer interfaces directly with the web site. Once an order is placed, the customer is asked to schedule delivery. A window comes up showing 30-minute time slots, from 7 a.m. to 10 p.m., for the next seven days. Slots are marked as available or unavailable. Unavailability does not necessarily mean that the slot is already taken, however. If could mean that the optimization engine has ruled it out based on the time and location of other committed deliveries. For example, if a customer on one end of a route has been promised a delivery between 3:00 and 3:30, a customer on the opposite end probably would not be offered the 3:30 to 4:00 slot. Obviously, customers ordering further in advance have more delivery choices.

The optimizer can be very creative, however. According to Waksberg, it might determine that the customer looking for a 3:30 to 4:00 delivery could be handed off to the driver on an adjoining route, who will be closer to the address. Webvan also has the option of having the system highlight time slots that are best because the van already has an appointment nearby.

Crossing The Threshold
Before a van is dispatched, a final optimization is done and the system prints out directions to each address for the courier. When the courier arrives at a home, he or she takes the totes inside and unpacks them for the customer. (Alternatively, for a $3 deposit the customer can choose to have the totes left.) Each driver, or courier, carriers a wireless hand-held device that prints out a receipt and an itemized list of the order for the customer.
The same device is used to send a message that the delivery is complete. All the vans are equipped with GPS and are monitored by dispatch. If an unexpected delay occurs, customers are called to let them know when the courier should arrive and to reschedule if that is the customer's choice.

The mobile device also gives the courier access to all of the customer's back orders so if there is a complaint about a product previously delivered, the courier can check the records and give a credit on the spot.

The personal contact that comes with having a courier cross the threshold into the home is an important part of the Webvan model and these employees are carefully screened and trained. "Our goal is bring the human side to what is a very impersonal type of commerce," says Bud Grebey, director of corporate relations. "With e-commerce the closest thing you usually get to personal service is a sign that says 'welcome back, Bud Grebey. If you are not Bud Grebey, click here.'"

"The courier is clearly a strategic element of our business and not simply a cost," says Swann. "Couriers serve as our ambassador and as our sales force to educate the consumer about our expanded products."

Webvan@Work
To further expand its customer base Webvan recently launched a new service called Webvan@Work. It offers small to mid-sized businesses another alternative for procuring basic office supplies, cleaning materials, replenishment products such as snacks and beverages, stamps, fresh flowers and first-aid goods. Webvan also plans to offer catering services for employee meals and business meetings.

"One of the benefits of this program for us is that it allows us to optimize our delivery assets," says Bud Grebey, director of corporate affairs at Webvan. "When we are in full operation, delivering from 7 a.m. to 10 p.m., the hours before work and after school are our busiest times. From around 11 a.m. to 1 p.m., there is a lull."
This is a perfect time to deliver Webvan@Work orders, says Grebey. "It balances the efficiency of our delivery and fulfillment."

In a separate initiative aimed at larger companies, Webvan is working with human resources departments to promote its service as a way to benefit time-pressured employees. The idea is to allow employees to access the internet and do their grocery shopping with Webvan during lunch break. "We will go in and offer discount incentive programs for companies to sign up their employees to shop from Webvan. They can order during the day and have the groceries delivered to their home when they are going to be there," says Grebey.

A slightly different approach currently is being tested with students at Stanford University. "Campuses like Stanford have a problem with too many cars on campus and not enough parking spaces," says Grebey. "With Webvan on campus, students don't need a car to shop."

In this model, students order from Webvan and then pick up their orders at pre-established points. "We have Webvan stops on campus and, for example, on Tuesdays between noon and 3:00, we're there with all the orders for people who live in that part of campus. It's sort of like mail call in the Army," says Grebey.


Moreover, he says, consumers will limit the number of people they allow across their threshold. "We believe the consumer will require touch points that are not many, but few," says Swann. Once Webvan has won their trust, "we believe the consumer will want to leverage the Webvan shopping experience."

A final part of the supply chain involves Webvan's inbound operations. The company has forged relationships with several national grocery wholesalers as well as with local suppliers of fresh produce, seafood, meat and flowers.

Purchases are based on a combination of anticipated and actual demand, since many consumers order more than a day in advance. "In our model we have the advantage of having much more demand-based information to apply to our supply chain," says Relan. "When a customer places an order, they are reserving the inventory."

That inventory may not be in the warehouse at the time the order is placed. To ensure that it is there by the time the order is filled requires fast and reliable communications with suppliers. Webvan has handed over this back-office process to Harbinger Corp. of Atlanta.
Webvan sends purchase orders to harbinger.net, which operates as an application service provider. Harbinger takes that information, puts it in the format required by each supplier, and transmits it electronically. The same applies to confirmations or other messages from the suppliers to Webvan.

Typically the format is standard EDI, says Dan Manack, Harbinger's executive vice president for global operations, but some suppliers are XML-enabled.

"The other thing Harbinger brings to the table is that we go out and work with suppliers that need help with their technology," he says. "Webvan only has to worry about its own business applications. It doesn't have to worry about all of the communications technology that is necessary to deal with heterogeneous data formats and putting all that into EDI or XML or other standards. We do all that."

No Bad Cantaloupes
One of the surprises Webvan has encountered in its first year of operation is consumers' reaction to its fresh produce.

"We knew a typical grocery store does around 8 percent of its volume in produce," says Gary Dahl, vice president of distribution. "Selling online, we thought we would do slightly less," based on the assumption that people want to touch and smell their fruits and veggies.

The opposite has occurred. Webvan sells almost twice as much produce as an average supermarket. The reason is clearly one of quality. Webvan chooses its suppliers carefully, but more importantly, it handles produce far less than supermarkets.

"If you compare what we do to a brick-and-mortar store, you see the difference very quickly," says Dahl. "The brick-and-mortar throws it up on a display and has to keep rotating it. Then you have shoppers doing all the stuff they do to produce-squeezing it, molesting it. On the other hand, we have a lot of produce where, until our picker selects it for an order, the last person who touched it was the guy in the packing shed."

Webvan also makes sure that the produce is not subjected to temperature changes or to misting, which tends to leach the flavor. And it employs produce specialists to do the picking.

"We don't send out bad cantaloupes," says Dahl. "These people really know produce."

Still, this is not an area where 100 percent perfection is achievable. "You can get peaches that look fine and turn out to be mealy," notes Bud Grebey, director of corporate relations. "But the next time the courier comes into your home, you can tell him they weren't any good and he will look it up and take that amount off your current bill."

Typically first-time customers are cautious, says Grebey, ordering one tomato and two bananas. "Then when they see the quality, on their next order they bulk up."

"You really have a chance to differentiate yourself through the fresh side," adds Dahl. "The quality of our meat and produce, and a lot of our prepared meals, have really become a calling card."

Webvan may eventually explore ways to give suppliers a more direct view into their inventory, says Relan. "We are working with a couple of strategic suppliers to define what it means for them to have a view into our inventory and how it would work," he says. "I think it is a very open and exciting field."

Webvan is exploring other mutually beneficial ways to work with suppliers as well. In January, the company signed strategic business alliances with four major consumer-products companies: Kellogg, Nestle USA, Pillsbury and Quaker Oats.

These alliances, according to an announcement released at the time, will enable Webvan to better align products with targeted consumers, helping it "acquire and retain new customers and increase its average order size."

In turn, the company said, Webvan's partners "will gain key insights into the entire online channel, while having the opportunity to test and develop virtual merchandising strategies, online marketing programs and new consumer-behavior models."

"The class of trade called the online shopper is still evolving," adds Dahl. "They don't have the same shopping patterns and habits as a person that goes to a traditional brick-and-mortar store, so there are different correlations of items and things that you can cross-market. There is just tremendous opportunity for both the vendors and ourselves in sharing that data."

There is the potential for operational advantages as well. Webvan currently packages and recycles all the cardboard dunnage that results from its unpacking of cartons at receiving. "Packaging is expensive for the vendors, but it is something that we just rip open and recycle so we can put the items in a tray," says Dahl. "There would be a great advantage in taking those trays and moving them back upstream to have the vendors fill them out. Then it would just be a matter of receiving the product and putting it straight into a carousel."

Webvan's mission is simple: to be the full-service vendor of choice for the "last mile" of e-commerce. It may be a distant goal, but the company's early steps certainly have not lacked boldness. "How do we get there?" asks Swann. "It starts with a revolutionary order-fulfillment model that begins and ends with the customer.