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Tesco, PLC: From Mouse to House in Online Grocery Retailing

We have got a two-year lead over our competitors on the Internet and we intend to exploit that. We are the largest grocery internet retailer in the world. Mr. Terry Leahy, CEO, Tesco, PLC. April 2000.

It was a bright sunny morning in May 2000 as Mr. Tim Mason, e-commerce Director for Tesco, was driving through the lush English countryside on his way to work at company headquarters in Cheshunt, Hertfordshire. He was running through alternative scenarios of the competitive battle that was just emerging in online grocery retailing. In April, Mr. Leahy, the CEO, at a meeting of stock analysts had observed that Tesco.com (Tescos online retailing venture) was two years ahead of its rivals in implementing its online strategy. He was convinced that Tesco.com would clearly be the winner. It would be Mr. Masons responsibility to deliver on that promise. Tesco had grown from stride to stride to become the largest brick and mortar grocery chain in the U.K. In 1995 it overtook the venerable Sainsburys, an entrenched leader in the market since the late 1800s. Since then, there had been no looking back for Tesco. For the fiscal year 2000, Tesco reported sales of 18.7 billion and net income of 1 billion, an increase of 11% (Exhibit I). It controlled just over 15% (Sainsburys 12.5%) of the fragmented grocery industry in the country; although, in densely populated areas in the south and southeast, Tesco and Sainsburys together held between 45% and 57% of the market. Much of this meteoric growth resulted from a combination of astute real estate planning, excellent location strategy, creative execution of multiple format stores and above all its ability to keep pace with prevailing customer trends. Pile it high and sell it cheap was the slogan that launched Tesco and the company was leaving no stone unturned to offer its customers the best value for their money. It was against this backdrop that the company decided to enter the world of e-commerce. The e-venture was a carefully planned strategic move for Tesco. It originated in September 1996 when a conventional telesales mail order service was launched. This was followed by a shop-at-home alternative that was built on a CD-ROM-based catalog that consumers could use to generate a shopping list before uploading it to Tescos servers. In little over a year, the company had decided to enter into cyberspace with a direct Internet-based service. Tesco premiered its completely online grocery shopping experience to herald its entry into the world of cyber retailing. After its debut the company had attracted 500,000 online customers, accepting online orders at 100 of its stores. Although the company had not reported specific financials for the eventure, it reportedly lost 11.2 million in fiscal 2000. Despite this setback, the company had announced that it would extend its network of e-enabled stores to another 300 locations, covering 90% of the U.K. population shortly.1 In anticipation of this growth burst, it planned to create 7,000 new jobs.
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Tesco outlines ambitions to expand online, Financial Times, May 26, 2000.

Copyright 2001 Thunderbird, The American Graduate School of International Management. All rights reserved. This case was prepared by Professor Kannan Ramaswamy, with research assistance by Mr. Gennady Dikalov, MIM 2000, for the purpose of classroom discussion only, and not to indicate either effective or ineffective management.

It even started its own Internet Service Provider (ISP) arm as a prelude to bringing more customers online. The path to profitability was not going to be easy, however. As the traffic light turned green, Mr. Masons thoughts focused on Tescos online competitive advantage. There were many questions that needed to be addressed. Although Tesco had shown tremendous technological savvy in launching its Web site on a shoestring budget with a group of Dell servers and standard, off-the-shelf software packages, it might soon be time for a reality check when scalability of its systems comes in question. Just as soon as the site went online, some customers began complaining about the inordinate delays in accessing Web pages at certain times of the day. If that perception stuck, it could adversely affect the company. While Tesco was using its regular stores as the backbone for its online efforts, competitors such as Sainsburys were building dedicated warehouses and picking centers to streamline their operations. For them, it was no longer a hybrid bricks-and-clicks offering but a structure that had separate facilities for online operations. With an increasing number of online customers, Tescos hybrid model could become inefficient. Should the company switch horses now and jump into the creation of dedicated facilities or forge new ground by continuing to fine-tune its current approach? Perhaps the decisions in the technological and fulfillment arenas were not mutually exclusive like they appeared to be. Scalability in each dimension could soon become critical. As if local competition were not enough, established e-tailers from the U.S. were making deep incursions in the U.K. market. Amazon.com had recently been rated as Britains top retail site generating 31.2 million in sales in the first quarter of 2000. Mr. Mason knew that plans called for stepping up Tescos presence in non-food areas eventually rising to 45%-50% of all online sales. This meant that it would have to take on Amazon.com in what was widely perceived to be areas of Amazons strength. Would Amazon turn its attention to the lucrative grocery business once it had a string of warehouses in place in the U.K. market? As he pulled into the parking lot, Mr. Mason realized that critical times lay ahead. He was only hoping that Mr. Leahy was right about the two-year advantage.

Tesco: The Company

In 1919 Sir Jack Cohen founded Tesco as a small organization that sold groceries to Londons East End markets. It wasnt until 1929 that Tesco opened its first store in Burnt Oak, Edgware. Until then, all of its activities were primarily focused on selling to the retail trade. The company grew over the years and in 1947 was listed on the Stock Exchange as Tesco Stores (Holdings) attracting a share price of 75p (pence). As of early 2000 the company operated 225 superstores, 220 supermarkets, 48 neighborhood stores, 42 Metro stores, and 21 Express stores in the U.K. It also had operations in Ireland, the Czech Republic, Poland, Hungary, Slovakia, and Thailand. While Tescos strategy had taken various forms over the years, it had maintained an unflagging focus on delivering the best value possible to its customers. Taking a leaf from the successful grocery supermarkets that evolved in the United States in the 1930s, Mr. Cohen instituted a set of core principles that had served the company well. Tesco introduced a variety of innovative practices that have increased efficiency and reduced operating cost over the years. In January 2000, A.C. Nielsen, a market research company, rated Tesco as the lowest-cost supermarket for food in all of Europe. Tescos experience with the regulatory labyrinth in the retail sector in the U.K. gave it some important experience benefits. For example, the regulatory hurdles that made it difficult to establish large stores drove its multiple format growth strategy. In the U.K., town councils and municipalities had a very strong position of power and in many cases held the final say on where stores were built, how long they would stay open, and how big they would be. Blanketing the entire country with superstores was therefore a pipe dream. Instead, Tesco used novel formats that were tailored to fit area-specific regulation. After 1998 it considerably slowed down building new stores in the U.K., betting on the growth of its online endeavors to help sustain growth. The company firmly believed in expanding its offerings of goods and services as it strove to become an end-to-end solution provider for all the customers needs offering both food and non-food items at its stores
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Tescos Move into Online Shopping

Tesco was the first in the U.K. to set up a transactional Web site where customers could log in to a central system to purchase groceries online. Since then, it had moved into other non-food lines and added a considerably wider delivery region. In many ways, Tesco was a company that was waiting for the Internet to evolve into the digital marketplace that it later became. It had always prided itself on an excellent information technology (IT) support network and had leveraged its IT skills to enhance efficiencies in its traditional brick and mortar stores for quite some time. This emphasis had given the company a leg up in terms of the experience curve, having provided it the opportunity to get its internal house in order while meeting the challenges of conducting business digitally. Although Europe by the turn of the century was lagging behind the U.S. in all areas of electronic retailing, it did have a significant lead in one categoryonline groceries. Since Tesco had roughly 70% of the online grocery market, it could legitimately claim responsibility for that lead. It was indeed the worlds largest online grocery business.

Tescos IT Prowess
Information Week ranked Tesco as the best among British supermarkets in terms of its IT operations and third among all of European supermarket chains.2 It spent between 130 million and 150 million every year to stay abreast with advances in IT. It operated a tri-level architecture anchored by mainframes and assisted by middle system servers and PC client front-ends. Its private digital network connected all its stores in real time. The company had integrated its IT skills into multiple areas spanning both front office operations as well as the backroom operations. At the customer end, the companys IT infrastructure provided the backbone for customer service and support operations. It was used to administer a remarkably successful loyalty card scheme. Similar to a frequent flier program, the scheme awarded points to enrolled customers for purchases made. The awards could then be exchanged for products. The Clubcard program reached over 10 million customers by early 2000. Managing such a large customer base required significant IT expertise. For example, the company received 100,000 telephone calls, 5,000 letters, and 1,500 e-mails from its customers in a typical week!3 At the front-end, IT played a key role in the acquisition of scanner data, integration of the data with the inventory control system, customer accounts, and generating orders for supplies as needed. When a customers purchases were scanned at the point of sale, the transaction recorded the price on the bill, relayed the information to inventory control making changes to inventory levels in real time, and triggered an ordering process with a distribution request based on current inventory levels sent directly to forklift operators on the floor of Tescos warehouses. Analysis of purchase data through data mining techniques helped forecast trends much more effectively, plan inventory levels more precisely, and provided a well-orchestrated system of running store operations. While these systems proved to be really innovative, keeping up with technological changes had not been easy. For example, many critics suggested that the equipment the company used was quite outdated and did not offer the capacity to scale upwards. Despite its storied reputation as a technology big-spender, Tesco appeared to be behind the times perhaps because of past decisions. For example, the company used a mixture of homegrown software packages and off-the shelf packages that raised questions about its ability to blend them together into a seamless whole.

Distribution Acumen
Tescos distribution network was an integral part of its success story. It operated 13 strategically located warehouses or distribution centers throughout the country. Contractors operated an additional six such centers on behalf of Tesco. A typical warehouse covered an area of 300,000 square feet and handled
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Information Week, 19-20/12/1997. www.tesco.com, 2000

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some 50 million units a year. Each center scheduled roughly 2,500 deliveries to its stores daily and was normally responsible for serving a 50-to-80-store population. The deliveries occurred in waves depending on the nature of goods delivered. For example, fresh produce was delivered right before the stores opened while dry goods were delivered at less busy times during the course of the day.4 The distribution system was integrated with a supplier extranet that Tesco had built in partnership with GE Information Services. Called the Tesco Information Exchange (TIE), this system was first introduced for a small set of large suppliers such as Procter & Gamble (P&G) and Nestle but had since been expanded to cover a wider range of smaller suppliers as well. It encompassed 400 suppliers and over 2,500 users. Intended as a complement to the EDI (Electronic Data Interchange) system already in use, TIE was linked to a number of Tescos key systems to give suppliers access to relevant and up-to-date information such as Electronic Point of Sale (EPOS) data to track sales and inventory. TIE promised numerous benefits for participating suppliers as well. It had the potential to generate significant savings in planning joint promotions, more efficient inventory planning, and more sophisticated analysis of inventory flow data. For example, Jonathan Kemp, the Customer Business Development Manager for P&G, observed, During the trial we spotted that the demand for one of our lines had reached 8,000 units after two days, compared with an original forecast of 10,000 units for the whole week! As a result, we were able to respond and increase depot stock at short notice. This resulted in a joint business gain of around 50,000and more importantly, we avoided disappointing some 15,000 shoppers.5 Tesco also joined the Worldwide Retail Exchange (WRE), a business-to-business exchange promoted by 11 retailers. It included Albertsons (U.S.), Auchan (France), Casino (France), CVS (U.S.), Kingfisher (U.K.), K-Mart (U.S.), Marks & Spencer (U.K.), Royal Ahold (The Netherlands), Safeway Inc. (U.S.), Target (U.S.) and Tesco (U.K.). The exchange was designed to facilitate trading between suppliers, retailers, partners, and distributors. Participating companies anticipated that the interaction on the WRE would be more efficient due to standardized item information. It also included an auction facility and other features designed to dovetail with the ERP (Enterprise Resource Planning) systems of participating retailers aimed at reducing supply chain costs.

Moving into Digital Commerce

Armed with information infrastructure assets and distribution capabilities Tesco launched its online grocery shopping service in 1996. It offered customers two different ways of using its shop-at-home service. First, a customer could obtain a CD-ROM catalog containing information relating to 3,000 of the 20,000 products that Tesco normally carried. The customer could update the CD-ROM catalog after establishing a connection to Tescos servers. Once the update was received, the customers could log off and prepare an order offline before connecting again to transmit their orders to Tesco. This cumbersome method was necessitated by the high connect time costs that were prevalent in the U.K. The second method allowed the customers to browse Tescos product selection, check prices and availability, place an order online, and also designate a delivery slot. All of this could be accomplished via the Internet through the Tesco Direct site (www.tescodirect.com). Tesco owned its own ISP network (www.tesco.net) and offered free Internet service to all its customers. The company had developed two Web sites6 that customers could access easily. The corporate website (www.tesco.com) provided relevant information regarding online shopping, specials and promotions as well as corporate information. It had a comparison-shopping engine that was quite powerful in that it offered real-time comparisons of prices on select items including fresh produce. Tesco used onthe-ground market intelligence to provide comparisons with key competitors such as Sainsburys, Asda, and Iceland. The corporate Web site was linked to the dedicated shopping site as well. Tesco Direct, where most online shoppers entered, consisted of a set of simple, easily navigable pages that offered
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www.tesco.com, 2000 www.tesco.com, 2000 6 The two sites were merged for more efficient control and management.
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pertinent information such as nutrition, use instructions, and recipes to the time-conscious shopper. Over four years, the offerings at this site increased significantly. By mid-2000 the company offered much more than fresh produce and groceries. Customers could shop for music, books, videos, kitchen equipment, office supplies, computers, and a host of other products. Unlike grocery sales, which were restricted to a specific geographic region due to distribution constraints, non-food products such as kitchen equipment and bed linen were available for sales throughout the country. The company had an arrangement with ParcelForce (a trucking company similar to RPS, the FedEx company in the U.S.) for order fulfillment. Given the wider reach that was possible for selling dry goods, Tesco aimed to generate 40% to 50% of sales revenues from non-grocery products. In keeping with that target, the company was contemplating the addition of clothes to its offerings. Despite the breadth of its non-food offerings, the Financial Times reported that in fiscal year 2000 most of Tescos online sales of 125 million were from groceries.7

The Way it Worked

When an order was received at Tesco Direct, it was routed to a computer located in the store that was nearest to the physical location of the customer. The incoming order was assigned to a delivery van at the local store and then forwarded to a picking trolley manned by store personnel. This trolley, a modified version of a shopping cart, was equipped with a price scanner and a shelf identifier screen. The layout of the store was pre-coded into the system, and hence the person doing the shopping was directed to the aisles where the product was to be picked. Since the entire process was controlled electronically, there was little room for human error. For example, once the product was picked, it had to be scanned to ensure a match with the order and for capturing pricing information before it went into the trolley. Once the picking was completed, the trolley was sent to the delivery van directly. While all of this seemed to be well orchestrated, there were very important issues that arose during execution. (See Exhibit II for a schematic showing the ordering and fulfillment process.) The personal shopper who was responsible for picking the order had to compete with regular, in-store shoppers since the order was to be fulfilled within a store environment and not a warehouse. Hence, one often saw store personnel jostling shoppers as they raced to fill orders for delivery within the two-hour window that Tesco promised. This system of using local stores to deliver online orders imposed some strain in terms of scheduling, especially since all the stores in the geographic region required a fleet of vans ready to deliver. These vans had to be equipped with refrigeration units to ensure that chilled and frozen products were delivered fresh. Tesco maintained that its customers could not get any fresher food even if they went to the store themselves. Customers paid a delivery fee of 5 per order (approximately $8) for groceries and 2.95 for an order of non-food products such as linens, office products, tableware, or kitchen equipment. The delivery fee hardly made up for the dedicated vans and in-store picking personnel. (See Exhibit III for fulfillment cost estimates.) Further, since most of the ideal target audience for the service, time-conscious shoppers, were seldom available at home during the day to receive deliveries, a large bulk of the orders had to be fulfilled in the evening hours. This meant that the store was a lot more crowded with regular shoppers, creating delays. Since the transportation infrastructure around densely populated areas was not adequate, it also meant that Tesco drivers were fighting rush-hour traffic, all of which contributed to missed and delayed deliveries. Despite the high operating costs associated with this online model, Tesco argued that it did make money on Internet sales because the average shopper bought much more online than at the store. It was estimated that an average online shopper bought products worth 5 while in-store shoppers averaged only 25.8 Online shoppers seemed to be more willing to mix food and non-food purchases, unlike their in-store counterparts. All this added up to higher sales per customer in the form of books, CDs, videos, and housewares. However, most of Tescos online customers seemed to use Tesco Direct more for food items, specifically fresh food, than other products. In fact, they tended to buy more fresh food than
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Tesco outlines ambitions to expand online, Financial Times, May 26, 2000. Tearaway Tesco, Economist, Feb. 5, 2000.
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they would normally do when they visited the store. The company reported that 50% of the online sales were incremental (25% new customers plus 25% higher sales from current customers), while the other 50% was cannibalization of current customer purchases moving online from offline.9 The sales growth picture was desirable indeed. If customer reach became the key determinant of success as many of the analysts believed it would, Tesco would be well on its way to achieving superior performance. Appealing as it was from a capital expenditure viewpoint, the model seemed to be under constant strain. What it had saved in terms of equipment and software seemed likely to hurt in areas of customer service because it had negatively impacted access times (time it took a customer to log into the system and place an order), and customers had started to complain. Tesco had recently announced that it would employ an additional 7,000 people to man its stores. However, it remained to be seen whether the additional manpower would make up for a technological infrastructure that had not been scaled upward to meet demand. It was certain that the competitive conditions that prevailed would be quite unforgiving of any lapses. Tesco had recently announced that it was seriously evaluating entry into the North American market. Canadas Financial Post reported that Mr. Terry Leahy, CEO of Tesco, told analysts that the company is researching the opportunity to take our model internationally.10 He believed that Tesco had significant experience advantages including technology that would make it an attractive partner across the Atlantic. It was rumored that the company was also eyeing markets in continental Europe and Asia where it already had a brick and mortar presence. On other fronts, Tesco unveiled plans to build Internet cafes in its stores to offer customers free and easy access as a means of spurring the growth of digital preparedness. It entered into partnerships with companies such as Autonomy to offer customers online assistance with their shopping, with Charcolonline to build a digital mortgage supermarket, and German cataloger Otto Versand to offer baby accessories and home furnishings through Tesco Direct. Its ISP arm had developed into a full-fledged portal of some note and the company began to notice some important synergies between its ISP backbone and e-commerce front-end offerings.

The Competitive Landscape

Jupiter Communications, a respected Internet consulting firm, reported that online grocery shopping alone would grow to 2.5 billion by 2004 in the U.K., accounting for 19% of all online purchases. However, another market research company, Verdict Research, U.K., expected that most of the online grocery sales growth would materialize from cannibalization of brick and mortar stores and only a paltry 4% was expected to come from new sales online. This created an even greater sense of urgency among the leading companies to introduce new online models or risk obsolescence fairly soon. In terms of digital preparedness, the picture was quite bleak but encouraging at the same time. The Economist Intelligence Unit (EIU) reported that only 30% of the U.K. population was online compared to nearly 50% in the U.S. While this could be interpreted as a sign of untapped potential, it also signaled the steep climb that lay ahead for online retailing. Despite the disparity between the U.S. and most of Europe, all accounts pointed to a leveling of online populations and even an acceleration of European online retailing sales in the near future. According to a report from the European Information Technology Observatory, although Europe accounted for only 1/8 of all worldwide online sales in 1998, it was expected to generate 2/3 of the total by 2002. It is this promise of growth that had retailers lining up to stake their ground. Tesco faced a variety of rivals both in its traditional food lines as well as its non-food lines. Competition in the grocery business came from the major chains, namely Sainsburys, Asda, a company owned by Wal-Mart, and Safeway.

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ABN Amro Food and Drug Retailers Sector Research, May 23, 2000. Britains Tesco eyes North America, Financial Post, May 10, 2000.
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Sainsburys was the storied granddaddy among U.K.s grocery chains, known for its attention to detail and quality of produce. It connoted more of an upscale shopping experience than either Tesco or Asda. The company had recently acquired Shaws, a chain of grocery stores in Massachusetts, U.S. It had also been dabbling in online sales for some time. It started with an experimental contract to provide employees of Hewlett Packards Bracknell plant the option of buying their groceries online. They could place orders during the day and the goods would be delivered to their offices in time for their drive home. At a national level, the company had been offering a restricted product line limited to flowers, wine, and chocolates since February 1995. It had started a new service called Sainsburys to you, an Internet-enabled shopping site (www.sainsburys.com), much like Tesco Direct but largely focused on groceries and a few non-food items. This site was a partnership with Line One, an ISP that was to be packaged to offer free access to all Sainsburys customers. The delivery area that the company initially supported was quite small in comparison to Tesco and that, according to Sainsburys, was by design. The company believed that Tescos model of clicks and mortar would not be successful in the long term as demand exploded. Intent on eliminating the inefficiencies that were endemic to the pick-in-the-store system, Sainsburys had been building warehouses dedicated to supporting online shopping. According to Jennifer Baker-Hurst, Sainsburys Head of Strategic Development, Online customers, weve found, are less tolerant, and fulfillment of orders has to be perfect. Thats difficult in-store because of the high out-of-stock situations. Service levels will always be compromised. She added, Pickers in stores pick 100 items per hour. In a warehouse it can be 300 items per hour, which can be increased to 600 to 700 per hour with greater automation.11 Sainsburys plan called for combining in-store picking with dedicated warehouses to significantly improve efficiency and shorten delivery times. It foresaw a model under which it would use its warehouses for slow-moving items or in sparsely populated areas, combined with in-store picking of chilled, frozen, and fresh foods in densely populated areas. The company hoped to enroll 30 million customers in the U.K. by 2003. It was open to debate whether Sainsburys model was more easily scalable than Tescos. Asda, the Wal-Mart company, had been offering a service it called asda@home for 5,000 lines of products managed from two picking centers in Croydon and Watford. It was building two more warehouses in the London area in mid-2000 to increase the scope of its online retailing offerings. It was estimated that the Watford warehouse, for example, cost 4 million. Asda represented one end of the fulfillment continuum, having chosen to rely exclusively on warehouses, unlike Tesco that was using its stores, or Sainsburys that was using in-store picking and warehouses. It was quite possible that it had chosen the warehouse route simply because its store network was quite sparse and did not correspond to high growth online market regions. The lack of legacy infrastructure allowed Asda to come up with a different model. Safeway, the fourth largest grocery chain in the U.K., was betting on a completely different approach. It offered neither online ordering nor home delivery. Instead, it was using a fax/phone-based customer collection service. Customers could either fax their orders or call in their orders ahead of time and drive to the nearest store to pick up their purchases. Iceland, a fairly small operator but nevertheless one with a national presence, recently became the first grocery chain to offer 2,750 lines over the Internet with free delivery throughout U.K. subject to a minimum order of 40. The company reportedly made 100,000 home deliveries a week across Internet, in-store, and phone/fax ordering. Iceland also used an in-store picking approach similar to Tesco. Waitrose, another grocery chain of national repute, offered delivery of groceries with a twist. It would deliver only to offices but not homes! It ran a fairly successful Waitrose at Work scheme for the purpose.12 It remained to be seen which of these models would ultimately emerge as the most promising one for online grocery retailing. Betting on the right model could have enormous consequences. Exhibit V provides estimates of potential costs associated with alternative delivery formats. While the cost elements might drive some of the format decisions that lay ahead, there were other important intangibles
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Quoted in To build or not to build, Super Market News, May 8, 2000. Diverging routes to the online buyers heart, Financial Times, March 15, 2000.
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to consider as well. Issues such as differentiability, brand building, reach, and convenience might prove to be equally important.

Across the Pond

The U.S. consumers had not really taken to online grocery shopping in quite the same way as those in Europe, especially the U.K. According to Forrester Research, only 2.8% of U.S. consumers used the Internet to shop for groceries. The poor rate of converts was blamed on a variety of factors including the inability of companies to offer a fail-proof delivery system, the sprawl into suburbia that required complex math to figure out delivery routes, and the general lack of a fulfillment infrastructure. However, some of the larger players were betting that things would change soon.13 eMarketer (www.emarketer.com) predicted that the number of households buying groceries online would increase to 6.9 million by 2002, a growth of over 3,000%. In early 2000 Webvan, Peapod, Netgrocer, and Streamline were the key contenders for what was believed to be a market ripe for picking. Louis Borders, the entrepreneur who established the Borders book chain, founded Webvan. Mr. George Shaheen, who headed Andersen Consulting before joining Webvan, ran the company. Webvan delivered in the cities of San Francisco, Atlanta, Sacramento, and was in the pre-launch testing mode in Chicago. It prided itself on its customer service and had been rated among the best online grocers by Gomez.com (www.gomez.com), an independent e-ratings company. Its offerings spanned a wide spectrum that included food items and non-food items such as office supplies, music, videos, books, and housewares. The company generated a substantial amount of cash after its initial public offering, much of which was earmarked for building warehouses in the 24 markets that it sought to enter. Mr. Shaheen believed that a network of state-of-the-art warehouses would go a long way toward solving critical fulfillment problems that could plague an online grocers reputation. However, by early 2001 the company ran out of capital and had to declare bankruptcy. The most visible online grocer in the U.S. had been in operation only for a few years but could not weather the challenges of planning warehousing and logistics, not to mention the enormous amount of capital investment that it required. Peapod (www.peapod.com) was the oldest online grocery retailer in the U.S., having started operations in 1989 in Skokie, Illinois. Royal Ahold of the Netherlands acquired a significant interest in Peapod, thus opening up the possibility of leveraging Aholds U.S. holdings in the form of the Stop and Shop chain of stores that were widely popular especially in the Northeastern U.S. Peapod also used centralized warehouses to deliver produce and food items to well-defined geographic markets. It also had local agreements with smaller chains to function as picking centers. It had opened its non-perishables service to the 48 contiguous states in the U.S. at a flat fee of $7.95 per order. According to the company, it was the largest online drugstore and the largest online pet store in the country. Netgrocer (www.netgrocer.com), a fairly early entrant to the online grocery business, shipped a wide range of groceries other than perishables such as milk and fruit throughout the 48 contiguous states from a warehouse in New Jersey. It teamed up with Federal Express to offer a shipping service that ensured fulfillment of orders within 1-4 days. It cost approximately 10% of the value of an order for shipping. Streamline (www.streamline.com) was probably the closest to offering its customers a very attractive package of goods and services targeted at addressing day-to-day needs such as dry cleaning, clothing repair, film processing, and prescription drug pickup in addition to fresh produce and groceries. Customers paid a monthly membership fee of $30 in addition to the value of their orders. Streamline either installed a full-size refrigerator in the garage or delivered orders in a temperature-controlled box. It also installed a keyless entry system to the garage so that orders could be delivered even if the customers were not home, an important convenience to working customers. The service was available in the metro areas of Massachusetts, Illinois, Maryland/Washington, D.C., and New Jersey among others. Analysts be13

Online grocery shopping still faces hurdles, New York Times, July 3, 2000.
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lieved that this model held significant promise because it offered customers a one-stop clearinghouse approach for all their needs. Despite the convenience that Streamline promised, it was forced to shut its doors in November 2000 because it was unable to raise financing. Despite the promise of convenience and the fertile landscape of a highly connected target audience in the U.S., many of the companies were facing serious financial troubles. The U.S. was littered with failed online grocery companies. Some analysts believed that the general downturn in the fortunes of Internet companies would sound the death knell for many more online grocery retailers. The obstacles of warehousing and logistics were too overwhelming. Perhaps Tesco would be ideally suited to buck the trend if it chose to set up operations in the United States. While many of the U.S.-based online grocers were pure plays (not being tethered to a brick and mortar operation), Tesco would possibly enter with a clicks and mortar approach built around store-based fulfillment. This approach was only now being attempted in isolated U.S. markets and that, too, only as a substitute for telephone-based ordering processes. Some analysts believed that population density was a key performance driver in fulfillment. While the average population density per square kilometer in the U.K. was 245, in the U.S. it was a paltry 27.2 people. This would suggest that physical distribution economies might be much more difficult to harness in the U.S. Would Tesco have to rethink its distribution mechanism if it were to cross the Atlantic?

The Future Looms

As Mr. Tim Mason settled down to take stock of the days priorities, the telephone rang incessantly. Mr. Leahy was on the line with significant news. He had just confirmed plans with the Board that Tesco Direct would be spun off as an autonomous entity consolidating all the e-commerce and Web-based activities of the company. The Board felt quite strongly that Mr. Mason should be given the opportunity to head up the new division as its Chairman since he had done well in nurturing Tesco Direct. Mr. Leahy was hopeful that Mr. Mason would accept the offer in time for the next meeting of the Board early next week. He also extended an invitation to Mr. Mason to attend that meeting where the members of the Board would be eager to hear of his plans for Tesco.com. Mr. Mason needed some time to collect his thoughts about the offer and told Mr. Leahy that he would reflect on the proposition over the weekend. As soon as he finished his conversation with Mr. Leahy, a flood of questions rushed into his mind. Should he choose to accept the offer to head up Tesco.com, hed have to chart a course that would deliver superior performance on several fronts. The Board would definitely want to see a plan to increase the sales of non-food items. The company had recently targeted 40% to 50% for such sales. If Tesco wanted to increase its non-food business (e.g., books, videos, music, computers, electronics), it would have to prepare for a frontal assault on Amazon since the U.S. e-tailer had already evolved into similar product areas with a famous brand name as well. It was building a warehouse network in the U.K. Closer to home, the Bertelsmann venture, Bertelsmann Online (www.bol.com), launched from Germany, had been gathering a sizable following all across Europe and parts of Asia as well. It had launched localized Web sites in multiple markets, establishing a portal of sorts within the realm of B2C commerce. BOL had been quite active in the U.K. Retail consultants, Management Horizons Europe and Nelson Sofres, reported findings from a survey of a large sample of U.K. online shoppers that showed more than 30% of those surveyed reported that their last purchase was from Amazon, 3.7% from Bertelsmann, and only 3% from Tesco.14 These were long odds. Mr. Mason had a lot to think about in terms of future strategy. Should he revisit the fulfillment process and move to warehouses to increase efficiency? Should he recommend moving into the North American online grocery market and bet on leveraging the experience benefits gained in the U.K.? Given the current popularity of Tesco in grocery retailing, would it make sense to launch a pan-Euro14

A British E-Grocer takes on Amazon, Fortune, June 12, 2000.

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pean offering to encompass regions where Tesco had a bricks and mortar base (e.g., Ireland, Slovakia, Czech Republic, Poland, Hungary), or would it help to first shore up the U.K. market by expanding within the country? Of course, the larger question was really whether Tesco should continue its foray into non-food products or at least emphasize it much more. After all, Mr. Mason had seen recent sales figures showing that his online customers shopped at Tesco mostly for fresh food.

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Exhibit I

Tescos Five-Year Financial and Operating Statistics 1996 1997 1998 1999 2000

Year ended February Financial Statistics in million Sales U.K. Rest of Europe Asia Total Sales net of value added tax Operating Profit U.K. Rest of Europe Asia Total Operating Profits Operating Margin U.K. Rest of Europe Asia Total Group Return ratios Return on shareholder funds Return on capital employed Net assets per share Productivity ratios Turnover per employee Profit per employee Wages per employee Weekly sales per sq. ft Full time employee equivalents

11560 534 12094 713 11 724 6.2% 2.1% 6.0% 20.4% 16.9% 56p 143335 8841 13948 18.31 80650

13118 769 13887 760 14 774 5.8% 1.8% 5.5% 20.1% 17.1% 60p 146326 8478 14222 19.74 89649 14.2% 568 26300 123 88 116

14791 1481 16452 875 37 912 5.8% 2.5% 5.6% 21.3% 18.7% 59p 149799 8755 15079 20.48 99941 14.8% 618 26600 180 113 172

15835 1167 17158 919 48 -2 965 5.8% 4.1% -1.3% 5.6% 21.3% 17.2% 65p 151138 8771 15271 21.05 104772 15.4% 639 26654 202 157 177

16958 1374 464 18796 993 51 -1 1043 5.9% 3.7% 0.02% 5.5% 20.9% 16.1% 70p 156427 9160 15600 21.43 108409 15.5% 659 27720 197 156 169

Market Position Market share in food and drink shops 13.4% Number of stores 545 Average store size 000 sq. ft 25600 Share Price Performance High Low Year End 113 82 90

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Exhibit II

The Order Fulfillment Process at Tesco

Exhibit II The Order Fulfillment Process at Tesco
ORDER

ORDER

Tesco neighborhood store Customer generates order based on CDROM catalog or directly online
ORDER

www.tescodirect.com Tesco employee picks order in the neighborhood store

A special Tesco van delivers order during a customer determined two-hour window

Exhibit III

Estimated Fulfillment Costs for In-Store Picking 2.00 1.70 0.80 1.60 6.10 Remarks 15 mins. @ 8 per hour including benefits 7 deliveries an hour @ 12 per hour Depreciation of picking and delivery equipment

Type of fulfillment cost Picking Delivery Van operating costs Other costs Total fulfillment cost

Source: Based on estimates by ABN Amro Food and Drug Retailers sector research report, May 23, 2000.

Exhibit IV Potential Profits Gained on In-Store Sales and Internet Sales Sales revenue per customer Net margin @ 6% Delivery charge Fulfillment costs EBIT Store sales 25.00 1.50 1.50 Internet sales 85.00 5.10 5.00 6.10 4.00

Source: Based on estimates by ABN Amro Food and Drug Retailers sector research report, May 23, 2000.

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Exhibit V

Projected Costs as a % of Sales Revenues in Alternative Grocery Models Pure play Bricks & Clicks in-store picking In-house delivery Outsourced 23.00% 23.00% 5.00% 5.00% 1.50% 1.50% 2.50% 2.50% 0.40% 0.14% 1.70% 1.70% 5.40% 6.50% 16.50% 17.34% 6.50% 5.66% 79m 28m Bricks & Mortar 23.00% 9.50% 2.00% 1.50% 1.40% 7.00% 0.00% 21.40% 1.60% 280m

Bricks & Clicks warehouse picking In-house delivery Outsourced Gross Margin 23.00% 23.00% 23.00% Labor cost 3.33% 3.33% 3.33% Administrative costs 1.50% 1.50% 1.50% Advertising 10.00% 2.50% 2.50% Depreciation 0.75% 1.01% 0.75% Other expenses 1.00% 1.00% 1.00% Delivery cost 10.80% 5.40% 6.50% Total operating costs 27.35% 14.74% 16.55% Net Margin -4.35% 8.26% 6.45% Capital Expenditure $ 201m 201m 150m

Cost Element

1. Assumes sales of $1 billion in all models 2. Assumes that the customer will share delivery costs in all models except pure plays Source: Based on projections by Lehman Brothers in Tesco: From local to global and clicks growth, June 12, 2000.

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