FreshDirect: A Successful Online Grocer (!) Aims to Fend Off Amazon and Walmart With Customer Service

Last Updated May 10, 2010 12:50 PM EDT

FreshDirect, a New York City online grocer that delivers in several northeastern states, is seeking $100 million to expand into new markets -- and competitors like Kroger (KR) and Safeway (SWY) are looking at its business model as a potential defense against the expansion of Walmart (WMT).

As the service has grown, it's become apparent that FreshDirect is succeeding where others have failed because it has avoided the dual specters of excessive capital spending and too-rapid expansion. (Though the first iteration of the service was launched in Manhattan 2002, it still hasn't expanded to the entirety of New York City, even as it has begun testing select markets in New Jersey and Connecticut.)

It has also saved money and headaches by staking bets on small boutique brands. At the end of April, the company began carrying homemade drink mixers by a small New York bar called Employees Only. The mixers, which include basics like grenadine and lime cordial, weren't picked up because they're big sellers; in fact, FreshDirect is the first grocery outlet to carry them at all. Taking a page from the playbook of Whole Foods (WFMI), which has all but launched small brands like Van Leeuwen artisan ice cream by giving them a shot at a big market, FreshDirect has positioned itself to satisfy its customers' local-vore tastes while, at the same time, cutting down on its reliance on big food service companies who could bully it. (Amazon (AMZN) has used a similar tactic in the e-commerce space by cultivating its network of small business partners.)

FreshDirect has also been making a study of its order data to create something of a "recommendation engine" ala Netflix (NFLX). The company's office delivery arm, FreshDirect at the Office, publishes a list of the top-twenty best selling items from its office customers, which has allowed offices to get a better idea of what to order for their employees.

In fact, customer data is one of the company's primary focuses. At a forum held on May 5, the principal analyst at Forrester Research singled out FreshDirect as one of three companies that has leveraged consumer data particularly well. Richard Braddock, FreshDirect's CEO, wrote a guest column on DestinationCRM this past December putting forth the company's strategy, which he says relies heavily on frequent customer surveys to keep users enfranchised. As he says:

For example, our data analysis process helped us realize that customers were concerned that they were unable to personally inspect produce and seafood products purchased on our site. To resolve this issue, FreshDirect repurposed our production process and hired produce and seafood experts to rate these products daily. More than 60 percent of our customers tell us they now use this rating system when they buy from us.
It hasn't been without its growing pains. Waste continues to be a problem; although the company has made marked improvements in efficiency, it still sometimes devotes an entire delivery box to, say, a single bottle of salad dressing. But as Epicurious has observed, its online ordering system has slickly trained its customers to keep working shopping lists, compelling them to make ordering routine. Once the routine has become rote, the customer is hooked.

It's worth mentioning that the company has cut its teeth in one of the most brutal grocery markets in the country. Outside players like Costco (COST), Whole Foods and Trader Joe's have stolen a lot of customers from older New York City chains like D'Agostino, even as pharmacies like Rite-Aid (RAD) and CVS (CVS) venture into the grocery business too. Add the financial crisis to the mix, and you have a rather uninviting market.

But if FreshDirect continues to succeed, it will seem doubly incredible thanks to the legacy of Webvan, one of the most spectacular failures of the dot-com boom. Amazon, which owns the remnants of Webvan, is still involved in the grocery delivery business; in 2007 it began piloting a service called AmazonFresh in the Seattle area, but has been slow to expand. Publix Super Markets also tried and failed at delivery in 2003.

Walmart is hoping to defeat FreshDirect and its competitors with smaller stores in urban areas that will combine pharmacy and grocery goods. It will open about 400 of these stores per annum in the coming years, some of them with a Hispanic theme to appeal to those buyers, and others in Los Angeles, New York and Chicago markets that have heretofore put up opposition to big Walmart stores. Its first Chicago grocery store is set to open before the end of this year. Such aggressive expansion might preempt FreshDirect's forays into new markets -- but the allure of virtually-selected, home-delivered groceries remains a strong one.