FreshDirect, LLC

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FreshDirect, LLC

23–30 Borden Avenue
Long Island City, New York 11101
U.S.A.
Telephone: (718) 928-1000
Fax: (718) 433-0648
Web site: http://www.freshdirect.com

Private Company
Founded: 1999
Sales: $200 million (2005 est.)
NAIC: 311991 Perishable Prepared Food Manufacturing

FreshDirect, LLC, is a privately owned Long Island City, New York-based online grocer serving a large portion of metropolitan New York City, as well as select communities in Long Island, New York's Westchester County, and New Jersey. Unlike previous Internet grocery ventures, WebVan and Kozmo.com, that failed in spectacular fashion, FreshDirect does not emphasize convenience, nor does it attempt to emulate a supermarket. It does not, for that matter, even view itself as an Internet grocer. Rather, FreshDirect focuses on the quality of the food and concentrates on higher margin items: fresh produce, fresh meat and seafood, baked goods, and prepared dishes. A typical supermarket might carry 25,000 different packaged goods and about 2,200 perishable products, and sales are split 50-50 between package goods and perishables. FreshDirect, on the other hand, offers 5,000 perishable products and 3,000 packaged goods, and three-quarters of its revenues come from perishables. FreshDirect covers the staples—laundry detergents, paper products, and popular drinks—but it does not offer all the top brands or all the sizes. Nevertheless, FreshDirect has built up a loyal base of customers. The company is able to cut out the middleman, buying directly from farmers and other producers, and uses its size and brand exclusivity to negotiate price breaks with manufacturers. As a result, FreshDirect is able to compete with supermarkets on the price of basic goods. Moreover, FreshDirect holds another advantage over supermarkets because its 300,000-square-foot distribution facility in Long Island City does not have to worry about shoppers. The facility is split into a number of sections where the optimum temperature for the storage and picking of different foods is maintained. In this way, FreshDirect is able to offer higher quality perishables and enjoy a much lower spoilage rate than a supermarket.

COMPANY FOUNDED: 1999

FreshDirect was cofounded in 1999 by investment banker Jason Ackerman and supermarket veteran Joseph Fedele. Although his father owned a factory in New Jersey and he was in line to take over, Ackerman chose to follow the lead of his uncle, Peter Ackerman, a chief lieutenant of Michael Milken, Wall Street's junk-bond king. Jason Ackerman earned a degree from Boston University and then went to work at his uncle's firm, Drexel Burnham Lambert, serving as a financial analyst for a year before joining Donaldson Lufkin & Jenrette (DLJ) in 1990. During his eight-year tenure at DLJ he was involved with the supermarket and specialty retail industries. He put that experience to use in 1999 when he approached Fedele about establishing a chain of fresh-food stores.

Fedele, some 15 years older, got his start in the food business in the early 1970s working as a food trader. He was very familiar with both the fresh-food concept and the New York market. In 1994 he and three partners converted an old meat-packing plant in Harlem into a large fresh-food market called By Choice. To keep the meats fresh, the store kept the temperature around 36 degrees. By Choice closed that same year but was reborn the next year when the owners of Fairway Market, a well-established Upper Westside Manhattan grocery store, stepped in as an investor. Renamed Fairway, the Harlem store became a popular supermarket, drawing customers from Manhattan as well as Westchester. The store added a produce area that was kept warmer than 36 degrees, the Fairway approach to temperature control that foreshadowed the design of FreshDirect's Long Island distribution center.

Serving as the president of both By Choice and Fairway, the gruff Fedele was forced out and sold his interest in Fairway in 1999. He was then approached by Ackerman to start a new venture, but they soon abandoned the idea of traditional fresh-food stores because they concluded that after opening five stores they would be unable to manage quality. Instead, they began developing a new model that relied on the combination of online ordering and central distribution. They were not alone in pursuing the idea of linking the power of the Internet to grocery shopping, of course, but their focus was on fresh food—not the delivery technology. In essence they sought to shorten the supply chain to produce a fresher product at a lower price. Their inspiration came from Dell Computer Corporation, which had achieved spectacular success by shortening the supply chain in the production of personal computers, cutting out the middleman to directly purchase components that could be assembled together under the Dell brand. Ackerman and Fedele established FreshDirect and secured $100 million in funding, most of which came from Peter Ackerman, who was running a private investment firm at the time.

In late 1999 FreshDirect began constructing its central distribution facility in Long Island City, but ironing out the wrinkles in the business model proved difficult and time consuming. During the three years it took to launch the business, the dot-com bubble burst and WebVan, Kozmo.com, and a host of other Internet grocers had flamed out. FreshDirect was seen as just another Internet boondoggle destined for failure. Nonetheless Ackerman and Fedele husbanded their cash and slowly worked out their concept. To avoid making costly, and perhaps fatal, design mistakes, FreshDirect developed a virtual business model to test the effectiveness of its system to receive, batch, and process orders.

BETA TEST: 2002

By 2002 FreshDirect was ready to begin operations. First it conducted a beta test on Roosevelt Island on the East River, chosen because it was located close to the company's distribution center and underserved by grocery stores. FreshDirect implemented a marketing plan developed with the MacKenzie Agency. To prepare the ground on Roosevelt Island, local organizations such as senior centers, churches, and book clubs were contacted. Actors dressed as vegetables, fruits, fish, and meat handed out flyers. In large apartment buildings FreshDirect offered free breakfasts in the morning and free snacks at night. Promotional materials included ads in local newspapers and posters on bus shelters and phone kiosks. The company also made an attractive offer to encourage people to try the service: a $50 discount on the first order. As a result of this effort about 55 percent of all households on Roosevelt Island gave FreshDirect a try, and 80 percent ordered at least twice more.

In September 2002 FreshDirect was ready to roll out its service neighborhood by neighborhood, starting with Battery Park City in Lower Manhattan, an upscale community that had a limited number of grocery stores and was also easily reached by FreshDirect trucks using the Franklin D. Roosevelt Drive that skirted the East River in Manhattan. At first deliveries did not begin until 4:30 p.m., conducted in two-hour windows chosen by the customer, who were primarily professionals not able to accept deliveries during the day. Earlier hours were available on weekends, and later, as the service expanded, the number of delivery hours increased.

COMPANY PERSPECTIVES

We have all the irresistibly fresh food you could want, plus popular grocery brands for up to 25% less than supermarket prices and we bring it right to your door.

After Battery City Park, FreshDirect began serving other parts of the New York City borough of Queens that were close to Long Island City, followed by the Murray Hill section of Manhattan, Midtown, and then spread north through the Upper Eastside. As it expanded into the Upper West Side of Manhattan, FreshDirect came into conflict with Fedele's former venture, Fairway, as well as some other upscale grocers, Gristede's and Balducci's. Fairway was not happy about Fedele playing up his connection to its success and at both of its locations began posting signs and handing out flyers to make sure people knew that Fairway had no connections to FreshDirect. Fedele responded by dispatching his giant human fruits and vegetables to hand out flyers in front of Fairway to promote FreshDirect. For its part, Gristede's was upset over posters that maintained FreshDirect's prices were 35 percent lower than Gristede's and Balducci's. Gristede's sued FreshDirect, which promptly removed the offending ads.

The city's upscale grocers, although fierce competitors, all agreed on one thing: FreshDirect's model would not work, the company was losing money on every transaction, and that it would be out of business within two years. Still, FreshDirect had no trouble attracting more venture capital. In fact, the company was looking for $20 million but was able to garner $31 million from private equity funds in September 2003. Funds sponsored by AIG Global Investment Corp. invested $15 million of that amount, and the balance was divided among CIBC Capital Partners, Canyon Capital Partners, and Mercantile Capital Partners. With the additional cash, FreshDirect was able to add new product lines, such as organic produce, and continue its expansion into new neighborhoods. FreshDirect entered Brooklyn in October 2003, spreading from the trendy Dumbo (Down Under the Manhattan Bridge Overpass) neighborhood near the Brooklyn Bridge and nearby Brooklyn Heights to the densely populated Park Slope neighborhood bordering Brooklyn's Prospect Park. By the end of the year FreshDirect sales reached the $125 million mark as the business worked toward profitability.

With success came problems, however. Residents of some neighborhoods served by FreshDirect were not happy with the constant presence of FreshDirect trucks, many of which were parked for hours at a time, as deliverymen used it as a central distribution point from which to wheel purchases to customers. In some cases the trucks were stationed at a location so that customers could pick up their own orders at their convenience. Yet the company probably received far more complaints from people who were upset that their neighborhood was not yet served by FreshDirect, even though surrounding streets were covered. To make sure that a neighborhood had enough demand to support the cost of delivery, FreshDirect kept count of advance registrations and e-mails requesting service, and only when a critical mass was reached did it begin serving a new neighborhood.

NEW CEO: 2004

FreshDirect underwent a shuffling of the executive ranks in late 2003 and into 2004. In October 2003 the company hired as chief operating officer Dean Furbish, a former vice-president of NASDAQ Transaction Services. Then, early in 2004, Fedele was ousted as chief executive, prompting him to file a lawsuit claiming that the FreshDirect board of directors had engineered a power grab. Ackerman took over as CEO, but he was replaced by Furbish in September 2004. In addition, a new president, Steve Michaelson, previously a top executive at both Wegmans Food Markets and Weis Markets, was brought in. Ackerman remained as chief financial officer and served as the chairman of the board. He held the latter post until June 2005, when board member Richard Braddock, the former CEO of Priceline.com and a Citicorp veteran, succeeded him. Braddock also invested several million dollars in the company.

KEY DATES

1999:: Company founded.
2002:: Delivery service begins.
2003:: Additional funding secured.
2004:: New management team is installed.

FreshDirect achieved cachet among upscale New York consumers, becoming the subject of cocktail party conversation. In the summer of 2004 the company moved beyond its previous guerrilla marketing approach, doubling its marketing budget to more than $2 million and hiring a new advertising agency—Gotham, Inc.—to develop a marketing campaign that included print, radio, and outdoor elements. Instead of driving brand awareness like previous efforts, the new campaign sought to position FreshDirect as a lifestyle brand to help its spread throughout the New York metropolitan area. In addition to filling out neighborhoods in Brooklyn and Queens, FreshDirect began to work its way across Long Island to the east and the affluent Westchester County communities to the north. To the west FreshDirect trucks began to deliver to the Riverdale section of the Bronx and into New Jersey to Hoboken and Jersey City. Therefore, while it was invading new markets, FreshDirect defended its position. In 2005 the company was once again out in force handing out flyers, this time in the Union Square area, making a preemptive strike against Whole Foods Markets, a natural food chain that was about to open a new store. The flyers maintained FreshDirect was "Better Than Whole Foods," and a price comparison on a number of items made the case that FreshDirect was less expensive as well.

From the outset FreshDirect was interested in applying its business model to other major cities, but the new management team shied away from taking such a step, fearful of expanding too quickly and falling by the wayside like WebVan and Kozmo.com. Instead, the company continued to focus on its Long Island City facility, which was capable of supporting some $900 million in annual sales. FreshDirect also looked to take advantage of its processing capabilities by growing its corporate catering segment, a huge business in Manhattan, dotted with scores of towering office buildings. In addition, the company looked to add a national mail-order service. The cautious approach had worked well for FreshDirect, and there was every reason to believe that the company would continue to grow and avoid the pitfalls of previous attempts to marry the Internet with grocery shopping.

Ed Dinger