Small Business

Can FreshDirect Bring Home the Bacon?


You'd have to be crazy to start an online grocery business these days. E-commerce doesn't have its former caché. Cyber-grocers WebVan and Kozmo.com, which also handled other home-delivery merchandise, were two of the dot-com era's spectacular flameouts.

So call Joe Fedele crazy. Last July, he launched FreshDirect.com, an online grocery service that caters to demanding New York City foodies. It offers 15,000 products, including cherimoya (a.k.a. custard apples), idiazabal (an aged sheep-milk cheese from the Basque region of the Pyrenees), and 30 different cuts of steak -- all at 10% to 35% below supermarket prices.

Fedele is used to people thinking he's nuts. In 1993, everyone laughed when he launched Fairway Uptown, a gourmet supermarket in a dicey section of Harlem. But low prices on exotic fruits, freshly made bread, and superfresh meat and seafood drew crowds from as far away as Connecticut and New Jersey.

Also, by largely cutting out the middleman, Fedele was able to earn margins of near 20%, more than double the industry average. He thinks FreshDirect's 300,000-square-foot production center will help him provide the best food possible to demanding New York gourmands.

COOL CONCEPT. While grocery stores set the temperature at 70 degrees so people can shop in comfort, FreshDirect's state-of-the-art facility is all about what's best for the food. It has nine separate climate-controlled ripening rooms, each set according to the optimal temperature for different types of fruit. That means 36 degrees to 40 degrees for cantaloupe and honeydew melons, 51 degrees and up for peaches, nectarines, and plums. Meat is cut in rooms cooled to 38 degrees to prevent bacterial contamination. Ice cream is stored at -40 degrees, so customers never find their pints of Ciao Bello have melted and been refrozen.

Seven miles of fiber-optic cable connect every thermometer, scale, and conveyer belt to a high-tech control room: If the temperature in the peach-ripening room drops below the ideal 51 degrees, FreshDirect central command is alerted within 15 minutes. Fedele also has invested millions of dollars in sophisticated software that tracks and manages food deliveries in the same way FedEx monitors the worldwide movement of its packages. At any given moment, he can pinpoint where your order is within 20 feet.

Finally, Fedele has made two smart decisions. First, FreshDirect's minimum order is $40. That, plus the $3.95 delivery charge, ensures the service won't run into the same problems as Kozmo, which lost money on deliveries. Second, Fedele has cut out the middleman entirely. That's important, not only to lower costs, but to offer consumers a wider variety of products. Most shoppers have no idea that supermarkets sell shelf space to the highest bidders, a process known as "slotting." In 2000, seven food producers owned 90% of the shelf space in U.S. supermarkets. Fedele calls it "extortion."

In mid-September, Fedele talked to BusinessWeek Online Technology Reporter Jane Black about marrying high-tech and fresh food and why FreshDirect is anything but another misguided dot-com. Edited excerpts of their conversation follow:

Q: How does FreshDirect differ from other online food startups?

A: First, we cut out all the middlemen. We buy from the farm.... That saves us money, but it also allows us to improve on quality. We actually take the flour and bake the bread [ourselves]. We [cut up] steaks.

Second, technology allows us to [leverage] our collective knowledge. We take the best managers in every category and ask them to pour their knowledge into our system. Their knowledge controls the work of everyone that works for them, so you can ensure quality 99.9% of the time.

Our head baker gives us the best formula for the best sourdough baguette. And [based on his instructions] the computer controls the mix. If [a baker] doesn't put the right amount of the right ingredient in, the computer won't let you proceed. It controls the oven temperature, so there's never a mistake. Every loaf is identical. The quality is all top-notch.

Q: Buying food, though, is a sensual experience. Will consumers ever be happy clicking a mouse instead of touching a crusty loaf of bread or smelling a cantaloupe?

A: People don't need to touch, feel, and smell food. They just think they do.... People don't want to smell a cantaloupe. They want to know if it's ripe. People buy based on attributes or functionality -- ripeness, sweetness, a cheese to go with a certain kind of wine. Our site educates them on how to do that.

Everything is ranked by taste and price. You can say, "I want a sweet and crisp apple," and we'll show you that there are four or five different kinds of apples you can get right now that fit the characteristics you want. Rather than buying a Granny Smith because you think you like a Granny Smith, you buy the best sweet, crisp apple in season.

Or you can say, "I want to make applesauce. What is the best apple for that?" Or you can say, "I want coffee that tastes like this" and our site will tell you what kind of bean makes that kind of coffee.

Q: What did WebVan and, on a much smaller scale, Kozmo do wrong?

A: They tried to change behavioral pattern with convenience. And convenience doesn't change behavioral patterns -- especially for food. You go to the butcher with the best meat. You go to the best bagel shop for the crustiest bagels. You go to one deli for smoked salmon and another for fresh mozzarella. Choice and value changes patterns of behavior.

Look at what Wal-Mart did.... Sam Walton said, "I'm going to go 20 miles outside town and build a store. And I'll offer value merchandise and people will come." And everybody laughed. Who's laughing now? Wal-Mart earned $218 billion last year.

Now think about Costco or Price Club. The founders said, "I'll make the most inconvenient shopping experience for consumers. I'm going to build a cinderblock building with concrete floors and put no one on the floor to service you." Guess who won JD Power's Consumer satisfaction award for the last two years? Costco.

Finally, look at Fairway Uptown. In 1993, I said, "I'm going to make you come up to 132nd for your perishables. What do you think they all said? They laughed. But I gave customers better meat, better fish, and better produce at a better price. And it didn't take long for that store to do more business than anywhere in the city -- and get more publicity than any food store ever got.

Q: Some online grocers have survived. Peapod is now owned by Dutch megagrocer Royal Ahold, and Safeway has an online delivery service called GroceryWorks.

A: The big guys have bought in, but the businesses still make no sense. They are doing what you used to do -- picking items off a grocery-store shelf, aggregating them in a shopping cart, and taking them to your house. To do that and still make money, you have to charge a 35% premium.

Q: What are your projections for the business?

A: We believe we'll get 5% of the New York market... After that, who knows? We have to make it work here first. We won't take one step until we do. One of our saving graces is we're not a public company. Public companies grow for the inherent nature of growth, whether it's logical or not. We're going to do it right. We're going to capture New York. And if we do that right, we'll go to Boston or Washington.

Q: Can this work outside New York City? You're already delivering to suburbs on Long Island.

A: We have two very different delivery models: one for the cities and one for suburbs. Take a New York City lifestyle. You're getting [in taxis], you're getting on subways, you're getting on buses. Home-delivery makes sense because you can't carry bags of food around with you.

In the suburbs, you live in the car. You drive to the train station, go to work, then get back on the train, back in the car, and go home. Or you get in your car and drive to an office park. Those train stations and office parks are aggregation points. So we send a refrigerated truck to the aggregation point that can carry groceries for 500 customers. And when [the customers] are ready to go home, they pull up, get their boxes of groceries, put them in the car, and drive off.

Our refrigerated trailer sits there from 2 in the afternoon to 8 at night. You don't wait for us to come. Our trucks wait for you.


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