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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, MIM2000, for the purpose of classroom discussion only, and not to indicate either effective or ineffective management.

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, wasdriving 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 justemerging in online grocery retailing. In April, Mr. Leahy, the CEO, at a meeting of stock analysts hadobserved that Tesco.com (Tesco’s online retailing venture) was two years ahead of its rivals in imple-menting its online strategy. He was convinced that Tesco.com would clearly be the winner. It would beMr. Mason’s responsibility to deliver on that promise.

Tesco had grown from stride to stride to become the largest brick and mortar grocery chain in theU.K. In 1995 it overtook the venerable Sainsbury’s, an entrenched leader in the market since the late1800s. Since then, there had been no looking back for Tesco. For the fiscal year 2000, Tesco reportedsales of £18.7 billion and net income of £1 billion, an increase of 11% (Exhibit I). It controlled just over15% (Sainsbury’s 12.5%) of the fragmented grocery industry in the country; although, in densely popu-lated areas in the south and southeast, Tesco and Sainsbury’s together held between 45% and 57% of themarket. 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 keeppace with prevailing customer trends. “Pile it high and sell it cheap” was the slogan that launched Tescoand the company was leaving no stone unturned to offer its customers the best value for their money. Itwas 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 1996when a conventional telesales mail order service was launched. This was followed by a shop-at-homealternative that was built on a CD-ROM-based catalog that consumers could use to generate a shoppinglist before uploading it to Tesco’s servers.

In little over a year, the company had decided to enter into cyberspace with a direct Internet-basedservice. Tesco premiered its completely online grocery shopping experience to herald its entry into theworld of cyber retailing. After its debut the company had attracted 500,000 online customers, acceptingonline orders at 100 of its stores. Although the company had not reported specific financials for the e-venture, it reportedly lost £11.2 million in fiscal 2000. Despite this setback, the company had an-nounced that it would extend its network of e-enabled stores to another 300 locations, covering 90% ofthe U.K. population shortly.1 In anticipation of this growth burst, it planned to create 7,000 new jobs.

1 “Tesco outlines ambitions to expand online,” Financial Times, May 26, 2000.

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It even started its own Internet Service Provider (ISP) arm as a prelude to bringing more customersonline. The path to profitability was not going to be easy, however.

As the traffic light turned green, Mr. Mason’s thoughts focused on Tesco’s online competitiveadvantage. There were many questions that needed to be addressed. Although Tesco had shown tremen-dous technological savvy in launching its Web site on a shoestring budget with a group of Dell serversand standard, off-the-shelf software packages, it might soon be time for a reality check when scalabilityof its systems comes in question. Just as soon as the site went online, some customers began complain-ing about the inordinate delays in accessing Web pages at certain times of the day. If that perceptionstuck, it could adversely affect the company. While Tesco was using its regular stores as the backbone forits online efforts, competitors such as Sainsbury’s were building dedicated warehouses and picking cen-ters to streamline their operations. For them, it was no longer a hybrid bricks-and-clicks offering but astructure that had separate facilities for online operations. With an increasing number of online custom-ers, Tesco’s hybrid model could become inefficient. Should the company switch horses now and jumpinto the creation of dedicated facilities or forge new ground by continuing to fine-tune its currentapproach? Perhaps the decisions in the technological and fulfillment arenas were not mutually exclusivelike 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 deepincursions in the U.K. market. Amazon.com had recently been rated as Britain’s top retail site generat-ing £31.2 million in sales in the first quarter of 2000. Mr. Mason knew that plans called for stepping upTesco’s presence in non-food areas eventually rising to 45%-50% of all online sales. This meant that itwould have to take on Amazon.com in what was widely perceived to be areas of Amazon’s strength.Would Amazon turn its attention to the lucrative grocery business once it had a string of warehouses inplace in the U.K. market? As he pulled into the parking lot, Mr. Mason realized that critical times layahead. 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 London’s East Endmarkets. It wasn’t until 1929 that Tesco opened its first store in Burnt Oak, Edgware. Until then, all ofits activities were primarily focused on selling to the retail trade. The company grew over the years andin 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 neighborhoodstores, 42 Metro stores, and 21 Express stores in the U.K. It also had operations in Ireland, the CzechRepublic, Poland, Hungary, Slovakia, and Thailand.

While Tesco’s strategy had taken various forms over the years, it had maintained an unflaggingfocus on delivering the best value possible to its customers. Taking a leaf from the successful grocerysupermarkets that evolved in the United States in the 1930s, Mr. Cohen instituted a set of core prin-ciples that had served the company well. Tesco introduced a variety of innovative practices that haveincreased efficiency and reduced operating cost over the years. In January 2000, A.C. Nielsen, a marketresearch company, rated Tesco as the lowest-cost supermarket for food in all of Europe.

Tesco’s experience with the regulatory labyrinth in the retail sector in the U.K. gave it some impor-tant experience benefits. For example, the regulatory hurdles that made it difficult to establish largestores drove its multiple format growth strategy. In the U.K., town councils and municipalities had avery strong position of power and in many cases held the final say on where stores were built, how longthey would stay open, and how big they would be. Blanketing the entire country with superstores wastherefore a pipe dream. Instead, Tesco used novel formats that were tailored to fit area-specific regula-tion. After 1998 it considerably slowed down building new stores in the U.K., betting on the growth ofits online endeavors to help sustain growth. The company firmly believed in expanding its offerings ofgoods and services as it strove to become an end-to-end solution provider for all the customer’s needsoffering both food and non-food items at its stores

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Tesco’s 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 acentral system to purchase groceries online. Since then, it had moved into other non-food lines andadded a considerably wider delivery region. In many ways, Tesco was a company that was waiting for theInternet to evolve into the digital marketplace that it later became. It had always prided itself on anexcellent information technology (IT) support network and had leveraged its IT skills to enhance effi-ciencies in its traditional brick and mortar stores for quite some time. This emphasis had given thecompany a leg up in terms of the experience curve, having provided it the opportunity to get its internalhouse in order while meeting the challenges of conducting business digitally. Although Europe by theturn of the century was lagging behind the U.S. in all areas of electronic retailing, it did have a signifi-cant lead in one category—online groceries. Since Tesco had roughly 70% of the online grocery market,it could legitimately claim responsibility for that lead. It was indeed the world’s largest online grocerybusiness.

Tesco’s IT Prowess

Information Week ranked Tesco as the best among British supermarkets in terms of its IT operations andthird among all of European supermarket chains.2 It spent between £130 million and £150 millionevery year to stay abreast with advances in IT. It operated a tri-level architecture anchored by main-frames and assisted by middle system servers and PC client front-ends. Its private digital network con-nected all its stores in real time. The company had integrated its IT skills into multiple areas spanningboth front office operations as well as the backroom operations. At the customer end, the company’s ITinfrastructure provided the backbone for customer service and support operations. It was used to ad-minister a remarkably successful loyalty card scheme. Similar to a frequent flier program, the schemeawarded points to enrolled customers for purchases made. The awards could then be exchanged forproducts. The Clubcard program reached over 10 million customers by early 2000. Managing such alarge customer base required significant IT expertise. For example, the company received 100,000 tele-phone 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 datawith the inventory control system, customer accounts, and generating orders for supplies as needed.When a customer’s purchases were scanned at the point of sale, the transaction recorded the price on thebill, relayed the information to inventory control making changes to inventory levels in real time, andtriggered an ordering process with a distribution request based on current inventory levels sent directlyto forklift operators on the floor of Tesco’s warehouses. Analysis of purchase data through data miningtechniques helped forecast trends much more effectively, plan inventory levels more precisely, and pro-vided a well-orchestrated system of running store operations.

While these systems proved to be really innovative, keeping up with technological changes had notbeen easy. For example, many critics suggested that the equipment the company used was quite out-dated 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 raisedquestions about its ability to blend them together into a seamless whole.

Distribution Acumen

Tesco’s distribution network was an integral part of its success story. It operated 13 strategically locatedwarehouses or distribution centers throughout the country. Contractors operated an additional six suchcenters on behalf of Tesco. A typical warehouse covered an area of 300,000 square feet and handled

2 Information Week, 19-20/12/1997.3 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 wasnormally responsible for serving a 50-to-80-store population. The deliveries occurred in waves depend-ing on the nature of goods delivered. For example, fresh produce was delivered right before the storesopened 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 partnershipwith GE Information Services. Called the Tesco Information Exchange (TIE), this system was firstintroduced for a small set of large suppliers such as Procter & Gamble (P&G) and Nestle but had sincebeen expanded to cover a wider range of smaller suppliers as well. It encompassed 400 suppliers and over2,500 users. Intended as a complement to the EDI (Electronic Data Interchange) system already in use,TIE was linked to a number of Tesco’s key systems to give suppliers access to relevant and up-to-dateinformation such as Electronic Point of Sale (EPOS) data to track sales and inventory. TIE promisednumerous benefits for participating suppliers as well. It had the potential to generate significant savingsin planning joint promotions, more efficient inventory planning, and more sophisticated analysis ofinventory flow data. For example, Jonathan Kemp, the Customer Business Development Manager forP&G, observed, “During the trial we spotted that the demand for one of our lines had reached 8,000units 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 ofaround £50,000—and more importantly, we avoided disappointing some 15,000 shoppers.”5

Tesco also joined the Worldwide Retail Exchange (WRE), a business-to-business exchange pro-moted by 11 retailers. It included Albertson’s (U.S.), Auchan (France), Casino (France), CVS (U.S.),Kingfisher (U.K.), K-Mart (U.S.), Marks & Spencer (U.K.), Royal Ahold (The Netherlands), SafewayInc. (U.S.), Target (U.S.) and Tesco (U.K.). The exchange was designed to facilitate trading betweensuppliers, retailers, partners, and distributors. Participating companies anticipated that the interactionon the WRE would be more efficient due to standardized item information. It also included an auctionfacility and other features designed to dovetail with the ERP (Enterprise Resource Planning) systems ofparticipating retailers aimed at reducing supply chain costs.

Moving into Digital Commerce

Armed with information infrastructure assets and distribution capabilities Tesco launched its onlinegrocery shopping service in 1996. It offered customers two different ways of using its shop-at-homeservice. First, a customer could obtain a CD-ROM catalog containing information relating to 3,000 ofthe 20,000 products that Tesco normally carried. The customer could update the CD-ROM catalogafter establishing a connection to Tesco’s servers. Once the update was received, the customers could logoff and prepare an order offline before connecting again to transmit their orders to Tesco. This cumber-some method was necessitated by the high connect time costs that were prevalent in the U.K. Thesecond method allowed the customers to browse Tesco’s product selection, check prices and availability,place an order online, and also designate a delivery slot. All of this could be accomplished via theInternet 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 corporatewebsite (www.tesco.com) provided relevant information regarding online shopping, specials and pro-motions as well as corporate information. It had a comparison-shopping engine that was quite powerfulin that it offered real-time comparisons of prices on select items including fresh produce. Tesco used on-the-ground market intelligence to provide comparisons with key competitors such as Sainsbury’s, 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

4 www.tesco.com, 20005 www.tesco.com, 20006 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 offeredmuch more than fresh produce and groceries. Customers could shop for music, books, videos, kitchenequipment, office supplies, computers, and a host of other products. Unlike grocery sales, which wererestricted to a specific geographic region due to distribution constraints, non-food products such askitchen equipment and bed linen were available for sales throughout the country. The company had anarrangement with ParcelForce (a trucking company similar to RPS, the FedEx company in the U.S.) fororder fulfillment. Given the wider reach that was possible for selling dry goods, Tesco aimed to generate40% to 50% of sales revenues from non-grocery products. In keeping with that target, the company wascontemplating the addition of clothes to its offerings. Despite the breadth of its non-food offerings, theFinancial Times reported that in fiscal year 2000 most of Tesco’s online sales of £125 million were fromgroceries.7

The Way it Worked

When an order was received at Tesco Direct, it was routed to a computer located in the store that wasnearest to the physical location of the customer. The incoming order was assigned to a delivery van atthe local store and then forwarded to a picking trolley manned by store personnel. This trolley, a modi-fied version of a shopping cart, was equipped with a price scanner and a shelf identifier screen. Thelayout of the store was pre-coded into the system, and hence the person doing the shopping was directedto 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 scannedto 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 thisseemed to be well orchestrated, there were very important issues that arose during execution. (See Ex-hibit 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 thetwo-hour window that Tesco promised. This system of using local stores to deliver online orders im-posed some strain in terms of scheduling, especially since all the stores in the geographic region requireda fleet of vans ready to deliver. These vans had to be equipped with refrigeration units to ensure thatchilled and frozen products were delivered fresh. Tesco maintained that its customers could not get anyfresher 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, officeproducts, tableware, or kitchen equipment. The delivery fee hardly made up for the dedicated vans andin-store picking personnel. (See Exhibit III for fulfillment cost estimates.) Further, since most of theideal target audience for the service, time-conscious shoppers, were seldom available at home during theday to receive deliveries, a large bulk of the orders had to be fulfilled in the evening hours. This meantthat the store was a lot more crowded with regular shoppers, creating delays. Since the transportationinfrastructure around densely populated areas was not adequate, it also meant that Tesco drivers werefighting 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 makemoney on Internet sales because the average shopper bought much more online than at the store. It wasestimated that an average online shopper bought products worth £5 while in-store shoppers averagedonly £25.8 Online shoppers seemed to be more willing to mix food and non-food purchases, unliketheir in-store counterparts. All this added up to higher sales per customer in the form of books, CDs,videos, and housewares. However, most of Tesco’s online customers seemed to use Tesco Direct more forfood items, specifically fresh food, than other products. In fact, they tended to buy more fresh food than

7 “Tesco outlines ambitions to expand online,” Financial Times, May 26, 2000.8 “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 saleswere incremental (25% new customers plus 25% higher sales from current customers), while the other50% was cannibalization of current customer purchases moving online from offline.9 The sales growthpicture was desirable indeed. If customer reach became the key determinant of success as many of theanalysts 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 constantstrain. What it had saved in terms of equipment and software seemed likely to hurt in areas of customerservice because it had negatively impacted access times (time it took a customer to log into the systemand place an order), and customers had started to complain. Tesco had recently announced that it wouldemploy an additional 7,000 people to man its stores. However, it remained to be seen whether theadditional manpower would make up for a technological infrastructure that had not been scaled upwardto meet demand. It was certain that the competitive conditions that prevailed would be quite unforgiv-ing of any lapses.

Tesco had recently announced that it was seriously evaluating entry into the North Americanmarket. Canada’s Financial Post reported that Mr. Terry Leahy, CEO of Tesco, told analysts that thecompany “is researching the opportunity to take our model internationally.”10 He believed that Tescohad significant experience advantages including technology that would make it an attractive partneracross the Atlantic. It was rumored that the company was also eyeing markets in continental Europe andAsia where it already had a brick and mortar presence. On other fronts, Tesco unveiled plans to buildInternet cafes in its stores to offer customers free and easy access as a means of spurring the growth ofdigital preparedness. It entered into partnerships with companies such as Autonomy to offer customersonline assistance with their shopping, with Charcolonline to build a digital mortgage supermarket, andGerman 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 noticesome 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 shoppingalone 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 onlinegrocery sales growth would materialize from cannibalization of brick and mortar stores and only a paltry4% was expected to come from new sales online. This created an even greater sense of urgency amongthe 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. TheEconomist Intelligence Unit (EIU) reported that only 30% of the U.K. population was online com-pared to nearly 50% in the U.S. While this could be interpreted as a sign of untapped potential, it alsosignaled the steep climb that lay ahead for online retailing. Despite the disparity between the U.S. andmost of Europe, all accounts pointed to a leveling of online populations and even an acceleration ofEuropean online retailing sales in the near future. According to a report from the European InformationTechnology 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 liningup to stake their ground.

Tesco faced a variety of rivals both in its traditional food lines as well as its non-food lines. Com-petition in the grocery business came from the major chains, namely Sainsbury’s, Asda, a companyowned by Wal-Mart, and Safeway.

9 ABN Amro Food and Drug Retailers Sector Research, May 23, 2000.10 “Britain’s Tesco eyes North America,” Financial Post, May 10, 2000.

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Sainsbury’s was the storied granddaddy among U.K.’s grocery chains, known for its attention todetail and quality of produce. It connoted more of an upscale shopping experience than either Tesco orAsda. The company had recently acquired Shaw’s, a chain of grocery stores in Massachusetts, U.S. It hadalso been dabbling in online sales for some time. It started with an experimental contract to provideemployees of Hewlett Packard’s Bracknell plant the option of buying their groceries online. They couldplace orders during the day and the goods would be delivered to their offices in time for their drivehome. 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 “Sainsbury’s to you,” anInternet-enabled shopping site (www.sainsburys.com), much like Tesco Direct but largely focused ongroceries and a few non-food items. This site was a partnership with Line One, an ISP that was to bepackaged to offer free access to all Sainsbury’s customers. The delivery area that the company initiallysupported was quite small in comparison to Tesco and that, according to Sainsbury’s, was by design. Thecompany believed that Tesco’s model of clicks and mortar would not be successful in the long term asdemand exploded. Intent on eliminating the inefficiencies that were endemic to the pick-in-the-storesystem, Sainsbury’s had been building warehouses dedicated to supporting online shopping. Accordingto Jennifer Baker-Hurst, Sainsbury’s Head of Strategic Development, “Online customers, we’ve found,are less tolerant, and fulfillment of orders has to be perfect. That’s difficult in-store because of the highout-of-stock situations. Service levels will always be compromised.” She added, “Pickers in stores pick100 items per hour. In a warehouse it can be 300 items per hour, which can be increased to 600 to 700per hour with greater automation.”11 Sainsbury’s plan called for combining in-store picking with dedi-cated warehouses to significantly improve efficiency and shorten delivery times. It foresaw a modelunder which it would use its warehouses for slow-moving items or in sparsely populated areas, com-bined with in-store picking of chilled, frozen, and fresh foods in densely populated areas. The companyhoped to enroll 30 million customers in the U.K. by 2003. It was open to debate whether Sainsbury’smodel was more easily scalable than Tesco’s.

Asda, the Wal-Mart company, had been offering a service it called asda@home for 5,000 lines ofproducts managed from two picking centers in Croydon and Watford. It was building two more ware-houses in the London area in mid-2000 to increase the scope of its online retailing offerings. It wasestimated that the Watford warehouse, for example, cost £4 million. Asda represented one end of thefulfillment continuum, having chosen to rely exclusively on warehouses, unlike Tesco that was using itsstores, or Sainsbury’s that was using in-store picking and warehouses. It was quite possible that it hadchosen the warehouse route simply because its store network was quite sparse and did not correspond tohigh growth online market regions. The lack of legacy infrastructure allowed Asda to come up with adifferent model.

Safeway, the fourth largest grocery chain in the U.K., was betting on a completely different ap-proach. It offered neither online ordering nor home delivery. Instead, it was using a fax/phone-basedcustomer collection service. Customers could either fax their orders or call in their orders ahead of timeand drive to the nearest store to pick up their purchases. Iceland, a fairly small operator but neverthelessone with a national presence, recently became the first grocery chain to offer 2,750 lines over the Internetwith free delivery throughout U.K. subject to a minimum order of £40. The company reportedly made100,000 home deliveries a week across Internet, in-store, and phone/fax ordering. Iceland also used anin-store picking approach similar to Tesco. Waitrose, another grocery chain of national repute, offereddelivery 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 onefor online grocery retailing. Betting on the right model could have enormous consequences. Exhibit Vprovides estimates of potential costs associated with alternative delivery formats. While the cost ele-ments might drive some of the format decisions that lay ahead, there were other important intangibles

11 Quoted in “To build or not to build,” Super Market News, May 8, 2000.12 “Diverging routes to the online buyer’s heart,” Financial Times, March 15, 2000.

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to consider as well. Issues such as differentiability, brand building, reach, and convenience might proveto 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 inEurope, especially the U.K. According to Forrester Research, only 2.8% of U.S. consumers used theInternet to shop for groceries. The poor rate of converts was blamed on a variety of factors including theinability of companies to offer a fail-proof delivery system, the sprawl into suburbia that required com-plex 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 by2002, a growth of over 3,000%. In early 2000 Webvan, Peapod, Netgrocer, and Streamline were the keycontenders 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. Webvandelivered in the cities of San Francisco, Atlanta, Sacramento, and was in the pre-launch testing mode inChicago. It prided itself on its customer service and had been rated among the best online grocers byGomez.com (www.gomez.com), an independent e-ratings company. Its offerings spanned a wide spec-trum that included food items and non-food items such as office supplies, music, videos, books, andhousewares. The company generated a substantial amount of cash after its initial public offering, muchof which was earmarked for building warehouses in the 24 markets that it sought to enter. Mr. Shaheenbelieved that a network of state-of-the-art warehouses would go a long way toward solving criticalfulfillment problems that could plague an online grocer’s reputation. However, by early 2001 the com-pany ran out of capital and had to declare bankruptcy. The most visible online grocer in the U.S. hadbeen in operation only for a few years but could not weather the challenges of planning warehousingand 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 op-erations in 1989 in Skokie, Illinois. Royal Ahold of the Netherlands acquired a significant interest inPeapod, thus opening up the possibility of leveraging Ahold’s U.S. holdings in the form of the Stop andShop chain of stores that were widely popular especially in the Northeastern U.S. Peapod also usedcentralized warehouses to deliver produce and food items to well-defined geographic markets. It alsohad local agreements with smaller chains to function as picking centers. It had opened its non-perish-ables service to the 48 contiguous states in the U.S. at a flat fee of $7.95 per order. According to thecompany, 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 awide range of groceries other than perishables such as milk and fruit throughout the 48 contiguousstates from a warehouse in New Jersey. It teamed up with Federal Express to offer a shipping service thatensured fulfillment of orders within 1-4 days. It cost approximately 10% of the value of an order forshipping.

Streamline (www.streamline.com) was probably the closest to offering its customers a very attrac-tive package of goods and services targeted at addressing day-to-day needs such as dry cleaning, clothingrepair, film processing, and prescription drug pickup in addition to fresh produce and groceries. Cus-tomers paid a monthly membership fee of $30 in addition to the value of their orders. Streamline eitherinstalled a full-size refrigerator in the garage or delivered orders in a temperature-controlled box. It alsoinstalled a keyless entry system to the garage so that orders could be delivered even if the customers werenot home, an important convenience to working customers. The service was available in the metro areasof Massachusetts, Illinois, Maryland/Washington, D.C., and New Jersey among others. Analysts be-

13 “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 clearinghouseapproach for all their needs. Despite the convenience that Streamline promised, it was forced to shut itsdoors in November 2000 because it was unable to raise financing.

Despite the promise of convenience and the fertile landscape of a highly connected target audi-ence in the U.S., many of the companies were facing serious financial troubles. The U.S. was litteredwith failed online grocery companies. Some analysts believed that the general downturn in the fortunesof Internet companies would sound the death knell for many more online grocery retailers. The ob-stacles 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 theUnited States. While many of the U.S.-based online grocers were “pure plays” (not being tethered to abrick and mortar operation), Tesco would possibly enter with a clicks and mortar approach built aroundstore-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 populationdensity was a key performance driver in fulfillment. While the average population density per squarekilometer in the U.K. was 245, in the U.S. it was a paltry 27.2 people. This would suggest that physicaldistribution economies might be much more difficult to harness in the U.S. Would Tesco have torethink its distribution mechanism if it were to cross the Atlantic?

The Future Looms

As Mr. Tim Mason settled down to take stock of the day’s priorities, the telephone rang incessantly. Mr.Leahy was on the line with significant news. He had just confirmed plans with the Board that TescoDirect would be spun off as an autonomous entity consolidating all the e-commerce and Web-basedactivities of the company. The Board felt quite strongly that Mr. Mason should be given the opportunityto 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 Boardearly next week. He also extended an invitation to Mr. Mason to attend that meeting where the mem-bers of the Board would be eager to hear of his plans for Tesco.com. Mr. Mason needed some time tocollect his thoughts about the offer and told Mr. Leahy that he would reflect on the proposition over theweekend. As soon as he finished his conversation with Mr. Leahy, a flood of questions rushed into hismind.

Should he choose to accept the offer to head up Tesco.com, he’d have to chart a course that woulddeliver superior performance on several fronts. The Board would definitely want to see a plan to increasethe sales of non-food items. The company had recently targeted 40% to 50% for such sales. If Tescowanted to increase its non-food business (e.g., books, videos, music, computers, electronics), it wouldhave to prepare for a frontal assault on Amazon since the U.S. e-tailer had already evolved into similarproduct 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 Ger-many, had been gathering a sizable following all across Europe and parts of Asia as well. It had launchedlocalized Web sites in multiple markets, establishing a portal of sorts within the realm of B2C com-merce. BOL had been quite active in the U.K. Retail consultants, Management Horizons Europe andNelson Sofres, reported findings from a survey of a large sample of U.K. online shoppers that showedmore than 30% of those surveyed reported that their last purchase was from Amazon, 3.7% fromBertelsmann, 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 fulfillmentprocess and move to warehouses to increase efficiency? Should he recommend moving into the NorthAmerican 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-Euro-

14 “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 expandingwithin the country? Of course, the larger question was really whether Tesco should continue its forayinto non-food products or at least emphasize it much more. After all, Mr. Mason had seen recent salesfigures showing that his online customers shopped at Tesco mostly for fresh food.

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Exhibit I Tesco’s Five-Year Financial and Operating Statistics

Year ended February 1996 1997 1998 1999 2000Financial Statistics in £ million

SalesU.K. 11560 13118 14791 15835 16958Rest of Europe 534 769 1481 1167 1374Asia 464Total Sales net of value added tax 12094 13887 16452 17158 18796

Operating ProfitU.K. 713 760 875 919 993Rest of Europe 11 14 37 48 51Asia -2 -1Total Operating Profits 724 774 912 965 1043

Operating MarginU.K. 6.2% 5.8% 5.8% 5.8% 5.9%Rest of Europe 2.1% 1.8% 2.5% 4.1% 3.7%Asia -1.3% 0.02%Total Group 6.0% 5.5% 5.6% 5.6% 5.5%

Return ratiosReturn on shareholder funds 20.4% 20.1% 21.3% 21.3% 20.9%Return on capital employed 16.9% 17.1% 18.7% 17.2% 16.1%Net assets per share 56p 60p 59p 65p 70p

Productivity ratios £Turnover per employee 143335 146326 149799 151138 156427Profit per employee 8841 8478 8755 8771 9160Wages per employee 13948 14222 15079 15271 15600Weekly sales per sq. ft 18.31 19.74 20.48 21.05 21.43Full time employee equivalents 80650 89649 99941 104772 108409

Market PositionMarket share in food and drink shops 13.4% 14.2% 14.8% 15.4% 15.5%Number of stores 545 568 618 639 659Average store size ’000 sq. ft 25600 26300 26600 26654 27720

Share Price PerformanceHigh 113 123 180 202 197Low 82 88 113 157 156Year End 90 116 172 177 169

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Exhibit III Estimated Fulfillment Costs for In-Store Picking

Type of fulfillment cost £ RemarksPicking 2.00 15 mins. @ £8 per hour including benefitsDelivery 1.70 7 deliveries an hour @ £12 per hourVan operating costs 0.80Other costs 1.60 Depreciation of picking and delivery equipmentTotal fulfillment cost 6.10

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

Store sales £ Internet sales £Sales revenue per customer 25.00 85.00Net margin @ 6% 1.50 5.10Delivery charge 5.00Fulfillment costs 6.10EBIT 1.50 4.00

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

Exhibit II The Order Fulfillment Process at Tesco

ORDER

ORDER

ORDER

Exhibit IIThe Order Fulfillment Process at Tesco

www.tescodirect.com

Tesconeighborhood store

Customer generatesorder based on CD-

ROM catalog ordirectly online

Tesco employeepicks order in the

neighborhood store

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

ORDER

ORDER

ORDER

Exhibit IIThe Order Fulfillment Process at Tesco

www.tescodirect.com

Tesconeighborhood store

Customer generatesorder based on CD-

ROM catalog ordirectly online

Tesco employeepicks order in the

neighborhood store

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

A07-01-0011 13

Exhibit V Projected Costs as a % of Sales Revenues in Alternative Grocery Models

Cost Element Pure play Bricks & Clicks Bricks & Clicks Bricks &warehouse picking in-store picking Mortar

In-house delivery Outsourced In-house delivery OutsourcedGross Margin 23.00% 23.00% 23.00% 23.00% 23.00% 23.00%Labor cost 3.33% 3.33% 3.33% 5.00% 5.00% 9.50%Administrative costs 1.50% 1.50% 1.50% 1.50% 1.50% 2.00%Advertising 10.00% 2.50% 2.50% 2.50% 2.50% 1.50%Depreciation 0.75% 1.01% 0.75% 0.40% 0.14% 1.40%Other expenses 1.00% 1.00% 1.00% 1.70% 1.70% 7.00%Delivery cost 10.80% 5.40% 6.50% 5.40% 6.50% 0.00%Total operating costs 27.35% 14.74% 16.55% 16.50% 17.34% 21.40%Net Margin -4.35% 8.26% 6.45% 6.50% 5.66% 1.60%Capital Expenditure $ 201m 201m 150m 79m 28m 280m

1. Assumes sales of $1 billion in all models2. 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.