PEAPOD

1. How attractive is Peapods operation from an external investment perspective?

Under which conditions is Peapod a desirable investment?
Our Analysis indicates Peapod is not a desirable investment.
From a VCAP framework point of view, firstly, Peapod lacked capabilities in fulfillment of the
orders as evidenced by growing costs and frequently changing distribution center models. Secondly,
though Peapod started gathering and developing assets it could not match them with the processes to
create value and improve their bottomline. Comparing it to Webvan, we saw that Webvan
understood that the core to a successful grocery delivery operation lay in an efficient distribution
center and invested heavily in building a world class warehouse. (We recognize that it failed due to
other factors such as demand). From the EVA standpoint, we compare a customers next best
alternative to online grocery shopping, which is shopping in stores. From that, we see that there is
minimal economic value add in that margins in delivery remain similarly low as the grocery stores
and the additional economic benefits came from the delivery system, but it was minimal.
Looking simply at Peapods financials, we can see that there is a steady increase in net sales over
time, but net losses have increase dramatically in Q4-2000 and Q1-2001. When digging deeper, we
see that there is positive top line growth. Orders per market and orders per customer are increasing
steadily over time, signifying strong and growing demand for Peapods service. We do see a
considerable drop in average order size, from $132 at its peak in Q1-1999 to ~$121 in 2001.
However, average order size has been consistent for the previous year and the drop may be attributed
to a calculated change in business strategy.

On the cost side, we can clearly see that Peapods gross margins are increasing over time, from
20.1% in 1999 to 32% in 2001. This increase in margins is a healthy sign as we can see that Peapod
is leveraging partnerships and economies of scale over time.

Operations Strategy
OPNS 454
Friday, January 16 2015

Chhavi Adtani
Nihar Shah

Michael Chen
Waleed Bawaked

Although we see positive trends in revenue and COGS despite closing some markets, fulfillment
costs have increase substantially in the same two-year period, from $36 per order in 1999 to over $60
per order in 2001. These costs are now nearly 50% of the order size and are simply unsustainable. In
order for Peapod to have profitable operations, these costs need to be under $30, and even though
Peapod has closed down unprofitable markets, there does not seem to be any evidence that these
costs will decrease by more than 50% over time.
Because of the high fulfillment costs, Peapod is not an attractive investment. Peapod would have
to decrease its fulfillment costs by at least 50% per order to prove the viability of the business model
and merit an investment.

2. What are the key performance drivers of Peapods cost to serve a customer?
In order to achieve profitability, Peapod needs to focus on reducing its cost to serve a
customer. In order to measure this cost, we will divide the cost into two buckets: fulfillment costs and
delivery costs. Given Peapods business model, we can determine Peapods fulfillment and outbound
costs per order and determine if changes to the business model or increased demand could streamline
costs.
In the figure below, we assumed that each of the nine fulfillment centers have $150,000 per
month of fixed costs and 92 employees at $12 per hour fully loaded. This results in $9.2M in total
fulfillment costs. At current demand levels, this results in fulfillment costs per order of $42.92. Since
the gross profit per order is less than $40, these fulfillment costs alone make Peapod unprofitable. In
order to achieve profitability, this costs needs to be significantly reduced per order, either by
increasing demand or closing unprofitable fulfillment centers.
From a delivery perspective, we assumed that each truck will run two shifts and each shift
will deliver 19 orders. Under these assumptions, each order will cost Peapod $8.74 in fixed truck
costs and labor. With less than a $40 gross margin per order, efficiencies in delivery through more
optimal routing can be a significant benefit to the company.

Operations Strategy
OPNS 454
Friday, January 16 2015

Chhavi Adtani
Nihar Shah

Michael Chen
Waleed Bawaked

In order to determine the viability of the company, we looked at how changes in demand and
fulfillment costs would affect net profit. In this sensitivity analysis, we assume all other costs would
stay the same (gross margin and other fixed overhead). As demand (number of orders) increases, net
loss would increase since the margin net of fulfillment costs are negative in its current state.
However, if we can decrease fulfillment costs to $20 and nearly triple demand, Peapod can achieve
profitability.
Under its current operations, it is unlikely that Peopod can be a viable business. For that reason, any
investments in the business should be suspended unless Peapod makes considerable changes in its
business model.

To further analyze Peapod efficiency we calculated the ROIC, as demonstrated in Exhibit 1, of the 1st
of 2001 that was -40%, as it can be seen from below chart. Therefore, by incorporating above
mentioned sensitivity analysis, we identified the following levers that could help combined improve
the company ROIC:
Lever

Required % increase to increase ROIC by 1%

Number of Customers Basae

Order per customer
Dollars per order
Number of employees per FC

2.26%
2.26%
0.47%
2.3%

Operations Strategy
OPNS 454
Friday, January 16 2015

Chhavi Adtani
Nihar Shah

Michael Chen
Waleed Bawaked

Exhibit 1 The ROIC Tree

NOPAT(l
oss)

Operations Strategy
OPNS 454
Friday, January 16 2015

Chhavi Adtani
Nihar Shah

Michael Chen
Waleed Bawaked