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ENTREPRENEUR PROFILES

10.13.98  
Attention NetGrocer Shoppers! This Bargain May be Too Good to Last
Cheap shipping is burning a hole in its balance sheet

Until recently, NetGrocer Inc. seemed like an entrepreneur's dream concept -- a really useful national Web service that charged bargain prices. Small wonder the company was all set to go public before the market's gyrations ruined investors' appetites for IPOs. Now the question is: How long can it afford to offer such a great deal?

It's an issue that other entrepreneurial pioneers in the Web grocery business are likely to watch closely.

NetGrocer sells nonperishable groceries and other consumer goods over the Net, undercutting grocery stores by as much as 20%. It specializes in the sort of heavy stuff city dwellers loathe lugging home by hand. And shipping costs, which tend to be the drawback to shopping via the Net, run only $2.99 for orders of less than $50 and $4.99 for larger purchases. That's cheaper than taxi fare. (I tried it and was delighted. My 50-pound order was a bargain, and it arrived in four days, as promised -- intact except for one dented can.)

Unfortunately, the consumer's savings are coming right out of NetGrocer's pocket. Daniel Nissan, NetGrocer's president, concedes that the company is not only operating at a loss, but it has negative gross margins on goods sold because it subsidizes the cost of shipping. That means that until it can lower its own shipping costs and improve margins, the more groceries the company sells, the more money it loses. According to a prospectus filed with the Securities & Exchange Commission, "The company believes that it will incur substantial operating losses for the foreseeable future and that the rate at which such losses will be incurred will increase significantly from current levels."

NET LOSSES. Operating losses at Internet companies are the norm. That said, FedExing 49-cent soup cans does seem like a recipe for balance-sheet trouble. "This is a high-volume business with razor-thin margins," says Ryan Jacob, manager for the Internet Fund and a long-time tracker of initial public offerings. "When you include shipping costs, it's tough to see where this becomes economically viable."

The company filed for an initial public offering, which it hoped would raise $38 million, on July 31 -- just as the IPO market dried up. It has since delayed the offering indefinitely due to market conditions and is seeking additional capital through a private placement. NetGrocer's 1997 revenues were only $281,000, and its net loss that year totaled $3.58 million. Its accumulated deficit from inception through Mar. 31 is about $7.2 million. As of Mar. 31, NetGrocer, in which Cendant has a minority stake, had $7.12 million in working capital.

One reason shipping costs are so exorbitant is that New-York-based NetGrocer (www.netgrocer.com) ships nationally out of one distribution center in New Jersey. The company plans, once sales volume makes it feasible, to open more distribution centers, reducing shipping distances and costs. Although the negative margins look bad, Nissan says the company would have lost more money if it had already opened local distribution centers around the country.

"A SUPERIOR MODEL." Nissan believes that NetGrocer has a superior economic model to ordinary bricks and mortar grocery stores. Its fixed real estate and labor costs are much lower than those of traditional stores. And despite its lower prices, it is making money on products sold. Part of its plan to boost margins is to sell more expensive goods along with groceries. Along with dry goods, for instance, NetGrocer sells small appliances, music, books, and children's toys. If the company can sell more products, its marginal cost per shipment will decrease, says Nissan. It also plans to make money by providing market research and marketing services to manufacturers. In fact, it announced such a deal with Unilever Foods earlier this year.

This business model assumes the 24-hour-a-day convenience of Net shopping for groceries will lure customers by the droves. Online U.S. grocery sales totaled $85 million in 1997 and are expected to reach $270 million in 1998 and $6.6 billion in 2002, according to Jupiter Communications, an Internet research company. That will total about 17% of online consumer spending, but it's a fraction of the overall $500 billion spent annually on groceries in the U.S. About 40% of household spending on groceries is for dry goods.

To attract customers, NetGrocer boasts an exclusive marketing deal with America Online (AOL), and it has alliances with high-traffic sites including Excite (XCIT) and Yahoo! (YHOO). Even so, NetGrocer faces plenty of competition on the Web. Peapod (PPOD), which operates as a membership service in seven metropolitan areas and sells fresh fruit and meats, is probably the best known. It went public in June, 1997, at $16 a share and now trades at less than $3 a share. In the first half of 1998, it lost a net $8.5 million on revenue of $36.4 million.

NetGrocer also competes with regional online shopping services, including Streamline, Home Grocer, and HomeRuns. But Jupiter says they're less of a threat to NetGrocer because local businesses can't benefit as much from economies of scale. Jupiter also believes that focusing on discount nonperishables is a business model that will work eventually. "Online sales of dry goods will drive the majority of volume sales in this product segment in the future," Jupiter's 1998 Online Shopping Report predicts.

Investors probably shouldn't hold their breath for NetGrocer's IPO. But online shoppers will find that its service will save time and money -- as long as it can afford to offer such good deals.

By Amey Stone in New York
amey_stone@businessweek.com


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