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  8.13. Webvan and the Financial Model (4 min.)

Webvan was an online retailer that gambled heavily on their financial model. Although the Webvan team had no experience in the grocery industry, they assumed they could revolutionize the industry by replacing typical grocery stores with highly efficient distribution centers from which they could ship customers groceries they ordered online. But a closer look at the numbers raises some important questions.

To begin, the grocery business is a low-margin business with return on sales of 1% to 3%. This means that a successful grocer needs high volume to be profitable. Webvan assumed that by taking out retail stores and replacing them with delivery from distribution centers, they could cut costs. But Webvan based their financial model on being able to utilize their massive distribution centers at full capacity within three quarters after opening. As it turned out, no Webvan distribution center reached full capacity - ever. Another critical assumption revolved around the cost of servicing customers. As it turned out, Webvan spent on average $210 to acquire customers. Then, although they had anticipated customers would make an average order of $103 on a regular basis, actual orders were both less frequent and lower in dollar value ($81 on average) than anticipated. But the real killer came in forgetting that customers of regular grocery store customers carry their own groceries home. The average cost to deliver an order using Webvan’s complex delivery network was $27.

The numbers just didn’t work in a business with 1% to 3% margins when it cost $210 to acquire a customer and then $27 to deliver an $81 order. Not surprisingly, Webvan racked up losses of over a billion dollars and eventually folded. Rather than testing their initial assumptions as cheaply as possible, Webvan spent a billion dollars to find out they were wrong.