Webvan Case Study Analysis Example

In 1989 the blockbuster movie “Field of Dreams” captured two uniquely American ideals: baseball and taking risks to build your dream. The classic line “If you build it, he will come,” emboldened a poor Iowa farmer, played by Kevin Costner, to build a baseball diamond against all odds and at risk of nearly bankrupting his business. Fortunately for him, building his dream paid off and people did indeed come to his baseball field.

But that was a movie. In real life, he would have gone bankrupt.

The Story of Webvan

Roughly 7 years later at the height of the dot-com bubble, an internet startup emerged with a business model idea many investors were certain would transform the $450 Billion grocery industry. The idea was simple: order your groceries online, using that new-fangled thing called the “internet,” and they’ll be delivered to your door later that same day. Sounds awesome, right?

Investors definitely thought it did, so much so that they put up over $800 million in private and public capital to allow the already successful Louis Borders (who started Borders Bookstore in the 1970’s) to build the business and “Get Big Fast”. Their plan: execute the business model idea and they, the grocery buyers, will come in droves.

Ready, Fire, Go Out of Business

Armed with a war chest of cash, Webvan executed their business plan flawlessly. They hired a seasoned CEO from Anderson Consulting (now Accenture) and lined up an all-star board of experienced venture capitalists. With the help of Bechtel, an acclaimed engineering firm, they built state-of-the-art warehouse fulfillment centers complete with robots and miles of conveyor belts designed to route over 10,000 bins of groceries to their proper shipping area.

At it’s peak Webvan serviced 10 major US markets including San Francisco, Dallas, San Diego, LA, Chicago, and Atlanta.

There was just one issue – customers didn’t come.

In the year 2000, a year after its famed IPO, Webvan generated just shy of $200,000 in gross revenues (Slideshare). Fractions of pennies compared to the $800 million received from investors. The next year, 2001, Webvan ran out of cash and went out of business.

“We believe we had a brilliant concept. We were just ahead of our time.” – Bud Grebey, Webvan spokesman at the announcement in 2001 that Webvan has suspended its operations (WSJ).

The Results of Executing Without Validating

All too often we see this issue of a brilliant entrepreneur with an untested dream and determination to make that untested dream into reality. While few flame out as spectacularly as Webvan, the price paid in lost time and money is substantial.

This begs the question, what went wrong?

In hindsight it’s easy to see that the major mistake Webvan made was executing an expensive business model without answering one fundamental question: do people want to buy groceries online?

At the time, the answer to that question was a resounding no.

But since they didn’t seem to ask that question, or if they did then they didn’t get valid feedback, they pressed forth with the plan. In those days before the dot-com crash, the mantra in Silicon Valley was “Get Big Fast.” The thought was that startups should be laser focused on achieving scale in order to achieve profitability. This was an important assumption in Webvan’s business model as well because the costs to deliver goods was prohibitively high and Webvan’s operations would only achieve profitability when delivered at scale. This further pressurized the management team to execute the business model as quickly as possible.

In Startups Validation > Execution

Since the Webvan debacle ended in bankruptcy in 2001, Silicon Valley startups and investors have been refining a new approach to reducing customer adoption risk: validate assumptions before executing a business model. Otherwise known as the “Lean Startup” movement.

The godfather of this movement is the seasoned entrepreneur and UC Berkeley professor Steve Blank. His approach suggests that the most important thing startups must do is “customer development” in parallel to product development. His ideas have been popularized by his pupil Eric Ries who wrote “The Lean Startup.”

One tool that Steve Blank has written about that has proved helpful to both investors and entrepreneurs is called “Investment Readiness Levels,” a series of milestones start-ups must go through in order to prove their business model hypothesis. Below is an image describing these levels.

Using this series of milestones it’s easy to see where Webvan went wrong as they basically skipped IRL 3: Problem/Solution Validation. The other issue this highlights is that instead of creating MVP’s (Minimum Viable Products) and testing their ideas on a small scale they created fully completed products and tested them on an enormous scale.

Had Webvan’s focus been on validating their business model assumptions before scaling, they may have had an opportunity to pivot early on into doing something that customers actually wanted.

Below is a quick business model canvas I created for Webvan that highlights the areas they validated as viable in green, the questionable areas in yellow and the invalidated areas in red.

Notice that the customer segment section is red as well as the value proposition. These form the crux of a new business idea and are the most important components of a business model to experiment on first.

If they could have a do-over and were thinking of starting this business right now, all they would need is a few days time and a few hundred dollars to run a quick experiment to see if people would want this service. For next to nothing they could have setup a bare-bones website that listed several common grocery items like eggs, milk, bread, etc. Then they could have gone to several homes and asked the people there if they wouldn’t mind trying out this new concept of 30 minute grocery delivery. They could show the website and have the customer take some orders. Those orders could have been texted to someone at a grocery store nearby (before building a giant multi-million dollar warehouse) who would buy the items and deliver them to the person’s home. They could then ask the person “Is this how you would want to buy your groceries?”

This simple experiment, ran several times with several different types of people, could have saved $800M in lost investment capital!

Webvan is a classic story of why we needed the principles in the Lean Startup. It’s a refreshing alternative to the “If we build it, they will come” strategy!

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Whether just starting a small business or looking to expand your existing business, you want to make sure you take the right steps to succeed. One way is to look at how other successful companies did it.

But you can often learn just as much looking at business failures. Webvan is generally considered one of the biggest failures ever.

Here we look at some of Webvan’s mistakes.

First, Some Background

Louis Borders started the company.  He and his brother, Tom, founded Borders Books while students at the University of Michigan.  Tom focused on the books. Louis developed a software program that tracked inventory and predicted future sales.  The brothers sold the company to Kmart in 1992. In 1996, Louis started a new firm called Intelligent Systems for Retail. He was convinced an online company using a software system that managed the inventory and delivery of a wide variety of products would be very successful. His vision was similar to the modern-day Amazon.  He set out to find investors.

Some of the first investors he met with were the partners at Benchmark Capital.  Louis impressed them. However, his idea didn’t. The following comment appears in Webvan: A Disaster on The Web,

“The partners, though initially doubtful about the project, were impressed by Borders’ intelligence and determination. They persuaded him to start his site with groceries. He agreed and Benchmark Capital agreed to invest $3.5 million in his venture.”

Louis obtained another $150 million from other investors, including Yahoo, CBS and Knight-Ridder. Later, an initial public offering added $375 million more. The new firm was named Webvan and at the very start had $1.2 billion in capital.

The board members and its executives saw the company as tech startup not as an online supermarket. The felt an online grocery store offered people

  • Greater convenience than traditional grocery stores,
  • A wider variety of products,
  • Better prices (They advertised their products would cost 5% less than other stores.), and
  • Free delivery within a 30 minute window.

Webvan took its first orders in June of 1999, then shut down in June of 2001. Management burned through through over a billion dollars in just two years.

Webvan’s Top Three Mistakes

Mistake #1 – Neither Louis nor his executive staff had any prior experience in the retail grocery business. They didn’t seem to know it has one of the smallest profit margins – between 1 and 2% of sales.

To survive in 2000 and 2001, the company needed an average order size of $103.  In February of 2000 the average order was $80.  By the end of that year it had only increased to $81.

In 2000, the company’s daily expenses averaged $1.8 million. Daily sales only averaged $489,000.

Lesson #1: Know the Industry

Are the profit margins sufficient for your company to achieve success?

  • How many sales can your company realistically expect to make in the first six months and then in the first year?
  • How many customers do you need for those sales?
  • What do you need to charge per sale?

Mistake #2 – Webvan did not understand its customer.  No focus groups or surveys were done to see what the average American wanted when grocery shopping.  If these had been done, the company would have learned:

  • Most people prefer to pick out their own vegetables, fruits and meats.
  • Many grocery shoppers are impulse shoppers. While shopping, they select other items not on their lists.
  • Many use coupons. (Webvan did not accept coupons until late in their existence.)
  • Some buy economy sizes to save money. (Webvan did not carry these larger sizes.)
  • People do other things when out grocery shopping. They pick up prescriptions, dry cleaning and go to other stores,
  • Some stay-at-home moms believe they’d look bad if they shopped online rather than go out to buy groceries. This has since changed, but Webvan was early to the game.

Webvan also required an order be placed 24 hours in advance.  Shoppers also had to specify a 30 minute window when they would be home to accept delivery. While this was geared to accommodate busy working people, many found last minute changes prevented them from being home at the specified time.

Many people tried Webvan once; half of them never returned to buy again.

Lesson #2:  Know Your Customer

  • Do people want your product or service?
  • Are there enough customers who will buy it?
  • How much competition will you have?
  • What will you have to do to get customers to buy?
  • How long will it take to generate a profit?

Mistake #3 – Webvan built its own infrastructure rather than using what was already available.

Webvan opened in San Francisco and got its first order on June 2, 1999. In early July, it signed a contract with Bechtel to build 26 distribution centers across the country within 2 years.  Webvan paid a billion dollars for the distribution centers.

  • Each center was 350,000 square feet and fully automated. (There were over 4 miles of conveyer belts in each.)
  • The design of these centers was never tested in advance.
  • Each distribution center contained a butcher area. These all went unused when the company decided to outsource their meat business.
  • Each distribution center had lazy Susans in refrigerated areas. They did not work properly.
  • Products were crushed on the conveyor belts.
  • Totes with orders fell over.
  • Orders were incomplete.

Each center only operated at 35% of capacity.

Lesson #3: Don’t Reinvent the Wheel

  • Use existing infrastructures whenever possible.
  • Test and refine early versions before building new ones.

Correct your mistakes along the way. You won’t spend money unnecessarily. You’ll also avoid problems.

If you want to find out more about Webvan’s collapse, there are many articles on the web about it. A very good one is Anatomy of a Dot-Com Failure: The Case of Online Grocer Webvan.

Final Thoughts

Back in the Dot Com era, the mantra of entrepreneurs was to Get Big Fast. Venture Capital firms loved this model because they thought being “first mover” was a huge advantage. Today most Venture Capital firms still believe in Get Big Fast, but they temper their excitement by embracing the Minimum Viable Product (MVP) approach — the rapid expansion phase only begins once a company has achieved a minimum level of market acceptance using the minimum viable product. This approach seems to work better, and definitely reduces the likelihood of catastrophic early stage business failures.

At Ground Floor Partners we generally focus on businesses that grow more organically. That doesn’t mean they can’t grow quickly, but it does mean their business model doesn’t depend on landing huge amounts of capital before generating reasonable cash flow.

Webvan falls at the opposite end of the spectrum. They raised massive amounts of capital long before they had a single customer. But the lessons from Webvan’s arrogant and catastrophic failure are universal. Anyone who plans to start a business should pay attention; otherwise they just might end up where Webvan did: broke and out of business.

 

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