Online Grocers Check Out of Cities, Into Wealthy Neighborhoods

The answer is five: New York, Los Angeles, Chicago, Houston and San Diego (*correction).

The fifth and sixth most populous cities, Philadelphia and Phoenix, appear to be out of luck. Additionally, even online grocery service in the five cities that are served is typically limited to narrow areas, such as Northern San Diego or select segments of greater Los Angeles.

These holes in the fabric of online grocery delivery are partially the result of acquisitions and closures that have eliminated names like Webvan, HomeGrocer.com and HomeRuns.com from the industry.

If you live in an area where online grocery service has been canceled -- or where it never arrived in the first place -- you might need to be more patient than ever. In the new age of online delivery, Net grocery providers have become extremely cautious not only about what cities they will venture into, but even which neighborhoods within a given city they will try.

The New Model

At first glance, the mishmash of cities currently being served by the online grocery market might appear to be the random result of the general chaos that has struck the industry. Take a closer look, however, and a certain pattern emerges.

Why can shoppers in Fairfield County, Connecticut order their milk and bread online, while folks in Dallas have to grocery shop the "old school" way? Why do people in Boston, Washington, D.C. and Seattle get the online grocery privilege, while consumers in larger cities, such as San Antonio, Detroit and Phoenix, have to drive to the supermarket?

"It's not a matter of major city versus non-major city," Gartner (NYSE: IT) analyst Kevin Murphy told the E-Commerce Times. "The model that's proven to work is where an existing grocery chain with a strong presence in the market develops its own online ordering system and uses its own stores as the warehouse."

Going Upscale

At the same time, even having a strong brick chain such as Safeway (NYSE: SWY) (NYSE: SWY) or Albertson's (NYSE: ABS) (NYSE: ABS) in your area might not be enough to help you click your way through the aisles.

"We tend to still be thinking of online groceries in a mass market approach, but you can't look at it that way," Murphy said. "The demand is much spottier than that. It will be tested and rolled out store by store, by chains that have the best collection of stores in upscale neighborhoods."

In other words, there is a very good reason why folks in Fairfield County can get online groceries while other major metropolitan areas cannot. According to Murphy, Fairfield is one of the highest income counties in the country.

In the Lab

Murphy said that the future business model for online grocers will look very much like the Fairfield County model that Royal Ahold (NYSE: AHO) -- now in the process of buying all outstanding shares of Peapod (Nasdaq: PPOD) -- has in the works.

Ahold has linked Peapod with Stop-N-Shop, Ahold's local Fairfield chain. The plan then calls for Stop-N-Shop to assign a few online delivery trucks to one of its most upscale area stores.

If the online deliveries get enough business in the area, Stop-N-Shop can build a warehouse there, add more trucks, and expand. If not, Royal Ahold can move on to try a new area. The approach provides a low-cost way of experimentation.

Taking Aim

Although it appears that online grocers are simply catering to the rich, at its core, the neighborhood-by-neighborhood approach illustrates fundamental marketing techniques, according to Murphy.

"It's a lot more targeted approach if you can do it store by store, rather than building an entire warehouse up front," Murphy said.

In this case, the targets are those neighborhoods where consumers are particularly starved for time and price sensitivity is not an issue, according to Murphy.

UK grocer Tesco (Nasdaq: TESOF) was the company that "cracked the code," Murphy said, by discovering that if it rolled out small, by sending just two trucks to the right store, its online operation could be profitable.

The scaled-back business model might be great news for the Internet grocery industry, but it is bad news for all but a select group of potential online grocery shoppers.

*Editor's Correction Note: In the original version of this article, we reported that the city of Houston was no longer serviced by any online grocery companies. In fact, GroceryDrop.com makes deliveries of groceries in Houston.