I. Introduction

          E-commerce is thought to better facilitate consumer decision making than traditional markets. The increased amount of product information available to consumers could lead to better alignment between consumer preferences and products selected. Moreover, the greater ease with which consumers can compare products across retailers is thought to mitigate some consumer switching costs. To the extent that these effects are realized, Internet retailing could lead to greater market efficiency and, thus, consumer and total welfare (Brynjolfsson and Smith, 1999). In contrast, for most products, E-commerce suffers from high distribution costs. Online shoppers bear a pecuniary cost for delivery of the product. In traditional markets, consumers bear a non-pecuniary cost from transporting the product to the consumer’s home. Online shopping becomes less attractive for products that suffer from market based delivery service, e.g. perishables, or for people with lower values of their own time.

          For some products, namely groceries, product selection and delivery are jointly produced in a grocery store visit. While online shopping may facilitate product selection, consumers may not benefit from a large reduction in actual visits to supermarkets. Consumers who purchase for immediate consumption or who will purchase some items at the traditional retailer may not experience any reduction in total delivery costs. To mitigate these costs, online grocery shoppers are likely to make larger, regularly scheduled purchases and, in doing so, make human capital investments specific to a particular Internet retailer. If these human capital investments are large, consumers will still face substantial switching costs online. In this case, Internet grocery markets may not be much more efficient that traditional grocery markets.

          This general proposition is investigated through a series of tests between prices charged by and traditional retailers. Price data for two dozen items sold at thirty-two retailers in eight medium sized Illinois and Indiana cities and comparable items sold over the Internet were collected. Retailers in each town were sampled every four weeks. The resulting dataset is particularly suited for testing the effects of consumer search and distribution costs on pricing patterns. This paper specifically investigates whether improvements in market efficiency observed in other Internet based retailing (e.g., books, music, financial services) are likely to be observed for grocery retailing. The data allow comparisons between price levels, price dispersion, and changes in prices.

II. Online Grocery Industry Background

          Having only begun in the last four to five years, online retailing is new and online grocery retailing is even newer. Products amenable to early adoption by online retailers included books, music, and financial service and travel arrangements. Consumer acceptance of online shopping for a broader array of products has grown more gradually. Online sales of food items have grown even more slowly than sales of most product categories (Lose, Bellman, and Johnson, 1999, Ward, 2000a). Often, consumers consider online shopping to be an extension of catalog shopping (Ward, 2000b). Indeed, there is evidence that higher-end gift food items, such as gourmet foods, chocolates and fruit baskets that are more amenable to catalog sales, have a larger share of total food sold online than they do total food sold from traditional retailers.

          Online purchasing of groceries offers some advantages and disadvantages over traditional, brick and mortar (B&M) purchasing. Being computer mediated, all the advantages of computers can be exploited. These include creating and maintaining lists of frequently purchased items for future purchases, email notification of specials, collection of revealed consumer preference information, and presentation of new items that are complementary to past purchases. Besides the advantages of computer mediation, online shopping can save time for some consumers. Essentially, an online shopper is hiring someone else to pick items from the shelves and deliver them to the shopper’s home, tasks that are typically performed by the shopper. At a minimum, online grocery retailing may to fill a niche in catering to individuals with high opportunity cost of time.

          Two strategies for selling groceries seem to have emerged. First, B&M supermarket chains are retailing online, as with Schnuck’s, or are affiliating with online retailers, as with Jewel/Peapod. A traditional retailer becomes a hybrid retailer by making its in-store items available in its existing geographic markets for order fulfillment and provides delivery of the selected items. Second, new entrants, like NetGrocer, have opened web based grocery stores with a limited selection of products available nationwide that are delivered via an overnight delivery service like FedEx. These strategies have different implications for consumer and producer behavior, and thus for the efficiency of the markets they serve.

          Hybrid stores have some advantages over Internet only stores. First, there are few incremental costs of acquiring inventory. No new physical facilities need be built. Second, brand name reputation can be easily extended into the new marketing channel rather than being developed from scratch. Third, the shopping experience can be tailored to be more similar to what grocery shoppers are used to. Human capital developed by customers for say, store brands comparisons and store layouts, can be leveraged into the online channel. Fourth, since they serve local markets, they are better able to offer a full line of products, including perishable items. However, in order to insure against spoilage and other problems associated with delivery, they often must vertically integrate into delivery services.

III. The Internet and Efficiency

          Market efficiency refers to both productive efficiency, how cheaply can the product be produced and allocative efficiency, the extent to which the product is assigned to users who value it most. These concepts are usually identified with the economic welfare measures of producer surplus and consumer surplus. Lowering costs while holding prices constant tends to increase producer surplus. Similarly, lowering price tends to increase consumer surplus. In general, some portion of a firm’s cost reductions is usually passed on in the form of lower prices leading to both increased consumer surplus and possibly increased producer surplus. Therefore, price reductions are often indicators of increased market efficiency. (Note, however, that price reductions could correspond to quality reductions. If so, the decreased willingness to pay could dominate the price reduction, implying a decrease in market efficiency.

          Productive efficiencies arise from reductions in fixed costs and not affect marginal costs. In this case, to a first approximation, they do not affect prices. Therefore, fixed cost reductions increase producer surplus but, because price is unchanged, they do not affect consumer surplus. However, fixed cost reductions can lead to increased consumer surplus indirectly, by making entry of marginal firms viable. Increased consumer substitution toward these new entrants can lower, which lowers price. Alternatively, entrants may fill an otherwise unserved niche in product space that better aligns consumer preferences with product attributes for some consumers. Either effect would represent increased allocative efficiency.

          Recent research suggests that increased product information may not always translate into increased consumer price sensitivity online (Lynch, J. and Ariely, 1998, Degeratu, Rangaswamy, and Wu, 1999, and Shankar, Rangaswamy, and Pusatari, 1999). However, because these markets are so new, it is likely that the customer base for these online markets includes a disproportionate number of consumers who value convenience over price. If so, these results may not hold up as a more broad consumer base develops.

          Consumer switching costs could be lower online than with B&M stores. This too, would tend to make competition more vigorous, reduce, and drive prices closer to marginal costs. However, once again, switching costs for groceries are not likely to fall as much as they would for other products commonly marketed online. This is again due to the market basket nature typical of grocery shopping. Human capital specific to an online retailer is developed that lowers future transactions costs associated with finding and choosing preferred items. Since much of this human capital is abandoned when a customer switches retailers, consumers are reluctant to switch.
The reasons for this consumer resistance, I believe, are the following:

1. Grocery shopping is a habitual act. While the average consumer shops for groceries 2.2 times per week (Kahn and McAlister 96), few consumers shop so often for cars, books, or airline tickets. Thus, grocery shopping is more habitual, and it will take more effort to change consumer buying patterns. Moreover, consumers often visit several stores in a week, presumably looking for specific items or hoping to take advantage of specific promotions.

2. Grocery shopping is a community act. Most grocery consumers shop with a friend, be it a spouse, child, or friend (Kahn and McAlister 123). Online grocers must overcome the "serious social obstacle" that "the community function of buying groceries at local supermarkets--where folks can interact with friends neighbors, and relatives--is sometimes more important than the inconvenience associated with filling up a shopping cart".

3. There is no significant time savings associated with online shopping. Excluding driving time, the average consumer spends 45 minutes in his visit to the supermarket (Khan and McAlister 122), while the Peapod (an online supermarket) buyer spends 37 minutes (Khan and McAlister 93).

4. Delivery is cumbersome and expensive, but also slow. In the age of instant gratification, Internet delivery will have to offer significant value to make up for slow delivery relative to traditional shopping. (Delivery time could be considered time in checkout and driving home, still quicker than even the speediest UPS man.)

IV. Recommendations

          On the other hand, online grocers can leverage the following advantages to achieve profitability.

1. By stocking 75% less stock keeping units (SKUs) than B&M stores, online grocers can achieve significant cost savings. While the average B&M supermarket stocks 40,333 items (Food Manufacturer's Institute), Homegrocer.com stocks 11,000 items (E-Commerce Times), and Peapod stocks 20,000 items (Khan & McAlister 93). Lower numbers of SKUs improves inventory control and reduces sales lost to out-of-stocks, currently 3.1% of all sales (Khan and McAlister 180). Some 8.2% of SKUs in B&M stores are out-of-stock at any one time (Kahn and McAlister 180), so reducing SKUs by 75% should significantly improve inventory tracking ability and reduce lost sales associated with out-of-stocks.

Consumers, it may be argued, want variety and resent lack of choice among items. However, studies show that consumers may actually react positively to reduced variety when designed properly. By eliminating unpopular sizes, varieties, and items, and placing more of the popular sizes and items in their place (although such popular items were already stocked), consumers actually perceive more variety (Khan and McAlister 185). Today's consumers are more time-starved than ever (spending 20-25% less time in supermarkets than before), yet they are bombarded with 20-25% more SKUs to chose from. Thus, conclude Khan and McAlister, "brands and brand [size variety] can be reduced without affecting sales or consumer perceptions of variety" (66). Additionally, online grocers, by stocking less items, can reduce inventory and warehouse costs and increase margins.

2. Online grocers can provide better organized information. Consumers value information, but only when in a useable form. Consider the information overload caused in the cereal aisle. There are 150 cereals in the average supermarket, each of which has 100 pieces of information on its box, or 15,000 pieces of information total (Kahn and McAlister 161). In such a disorganized form, the information is difficult to absorb and process. By ranking items according to criteria relevant to consumers, such as value, nutritional content, and taste, online grocery stores can help consumers make better informed decisions.

          While the Internet grocery business will surely grow with the Internet, I believe that it will still be only a minor part of total grocery expenditures into the foreseeable future. I further predict that the "booms" in other industries online will precede any boom in online grocery shopping, for the reasons discussed above.

IV. Strategy

          For the past fifty plus years, grocery shopping has always been popular event for a common household: the father, mother, son(s) and/or daughter(s) would go to the local supermarket to buy treats of their choice. However changes in the economy some families have difficulties in finding excess time to go grocery shopping in a daily or weekly basis, both spouses may be working. With this innovating approach can save time and effort to shop at supermarkets.

          Company’s main approach should set apart from the general e-commerce business strategy; that is, to deliver the goods from start to finish. The company should provide a unique website that helps encourage repeat purchases and differentiate it from other competitors. On the website, customers can shop for products in several ways – they can search for a specific product by brand name or category, sort by sale items, price etc. The user friendly website is a leading factor in building brand loyalty, creating credibility of the company, and attracting and its customer.

          Teamwork is the key in attaining results for a company, such as the importance of finding partners to reduce costs and sharing risk. Other online retail stores went bankrupt because they expanded too quickly. The funds provided by investors were consumes faster than the company could provide a return. Although other similar e-business plans might have been excellent, the shortfalls of funds led to their demise. As a result the company should take a conservative approach to expanding.

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