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Under terms of the agreement, GroceryWorks will become Safeway's exclusive partner for selling groceries online, and in return Safeway gets a 50% stake in GroceryWork's common stock. The agreement seals a preliminary accord reached in April.
It isn't the first deal between old world and new world grocers. In April, Dutch grocery giant Royal Ahold (NYSE: AHO) rescued online grocer Peapod (Nasdaq: PPOD) with a $73 million investment, enough to get 51% of Peapod's common stock.
What does all this mean? Some regard the recent deals as a concession from grocery stores that the online supermarket business is a viable game. After all, WebVan's (Nasdaq: WBVN) sales grew 79% sequentially in the first quarter to $16.3 million, and active customer accounts grew to 87,000 from 47,000 over the same period. Market research firm Jupiter Communications has estimated the online grocery market will generate $7.5 billion in three years.
Perhaps, but I doubt the stand-alone online grocers will generate most of those sales. Who will? More than likely, Safeway, Kroger (NYSE: KR), and other traditional grocers. The big grocery stores that moved online at a snail's pace are starting to look patient, not slow. Safeway views the online grocery business as a niche market, not a revolution in the making, and it's found a cheap way to participate in those incremental revenues.
A Safeway spokeswoman summed it up in an interview this morning. Through the investment, GroceryWorks gets Safeway's buying power, name recognition, publicity in print and radio ads, a nearly nationwide distribution system, and much lower customer acquisition costs.
In return, Safeway gets a ready-made Internet business that's been tested, at least in Houston, Dallas, and Fort Worth. My bet is that it will be a lot easier for Safeway to generate small profits from the online grocery business than for stand-alone companies faced with the prospect of building an uncertain, high-volume business to scale from scratch, especially once they have to compete against companies with the kind of buying power Safeway enjoys.
Keep in mind that online grocers aren't exactly virtual businesses. Webvan, for example, estimates it would cost nearly $1 billion to build another 26 distribution centers nationwide. Its state-of-the-art centers cost about $30 million and cover more than 300,000 sq. ft. Currently, the company's San Francisco-based center operates at about 35% capacity and isn't expected to reach designed capacity for years.
GroceryWorks plans to build out distribution centers in the 110,000 sq. ft. range, each for about $7 million, a spokeswoman said.
Webvan is selling a convenience, a service by many accounts it performs well, but to make money for shareholders it will have to beat its cost of capital. That will be tough to do against low-cost providers like Safeway.
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