Tech giants serving up real competition for FreshDirect

For years, FreshDirect has thrived in New York City, with a relative monopoly on the online food-delivery business.

The straightforward concept behind FreshDirect—founded in 1999 but which didn't make its first delivery until 2002—was coupling the power of the Internet with the sourcing of local farmers, creating a faster warehouse-to-home supply chain.

"The traditional supermarket model has so many steps in between the farmer making a particular product and that product getting into a customer's hands," said FreshDirect co-founder and CEO Jason Ackerman, adding, "Each step includes more people, more time and more delivery and distribution costs."

But in tech, delivering early on an idea may not continually to pay off, especially as competition heats up.

A worker handles finished grocery boxes ready for delivery at the FreshDirect online grocery service warehouse in New York.
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A worker handles finished grocery boxes ready for delivery at the FreshDirect online grocery service warehouse in New York.

In a smartphone era where every purchase can be made by consumers using nothing more than their thumb and an Internet connection, Silicon Valley is betting big that the grocery industry is the next sector ripe for disruption. The online food-delivery market is not just trendy but also becoming very crowded as a result—and backed by deep-pocketed technology companies and billions in venture capital investments.

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The bricks-and-mortar supermarket chain old guard isn't sitting still.

Wal-Mart Stores—which generates half of its business from food—has been testing the online grocery concept, in markets such as San Jose, California; Bentonville, Arkansas; Phoenix; Denver, Colorado; and Huntsville, Alabama. The Peapod service, owned by supermarket holding company Ahold USA (Stop & Shop, Giant Food Stores)—and which has an even longer history than FreshDirect—is delivering to all five New York City boroughs and opening a new warehouse last summer to double its service capacity. It also delivers across many Eastern and Midwest states.

Tech giants from Amazon to Google are vying for a piece of the online food-delivery business. Food-delivery start-ups, including Instacart and Blue Apron, have been valued in the billions.

And in maybe the biggest shift, "We're starting to see this on-demand economy where players you might not even consider in the space can be in the space. They've become carriers, and food gets more complicated," said Robert Peck, a tech-sector analyst for SunTrust Robinson Humphrey, who has focused on Internet companies for more than a decade.

The prime example of how far the online grocery trend is extending is on-demand car start-up Uber, the most richly valued start-up in the U.S., which announced in April that it was introducing a food service in New York and Chicago, pledging to deliver meals to customers in 10 minutes or less.

"We're starting to see this on-demand economy where players you might not even consider in the space can be in the space." -Robert Peck, tech analyst at SunTrust Robinson Humphrey

AmazonFresh and Instacart have same-day delivery (a feature FreshDirect does not offer at this point).

Google announced in May that it's partnering with six food-delivery services in the U.S.: Seamless, Grubhub, Eat24, Delivery.com, BeyondMenu and MyPizza.com. Now you can use the Google Search page to order takeout or delivery from your favorite restaurants. And Google said in a statement that it's planning more food-delivery services.

(The chart below of Google search activity suggests that the competitive threat has accelerated.)

Peck said the differentiating factors in the online food-delivery war will be food selection and fees and not current market share.

"Whoever has the best choices and can deliver the fastest will have the competitive edge. That's why you see AmazonFresh," Peck said. To survive, FreshDirect will have to have selection, delivery speed and the ability to match prices with Amazon—not only keep prices low but reduce them even further if it wants to stay in the game, Peck said.

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FreshDirect's 47-year-old CEO Jason Ackerman isn't worried. Over fresh-baked croissants, chips, guacamole and cheeses from local farmers, he said in an interview in his office that there's more than enough room for more competition.

"Food is the largest single retail category that exists," Ackerman said. He estimates that online sales make up less than 4 percent of all food sales today, and he predicts that will rise from 4 percent to 15 percent over the next decade.

Today it has about 3,000 employees, a third of which drive trucks and deliver food to doorsteps every day in five states in the Northeast: New York, New Jersey, Connecticut, Delaware and Philadelphia. The company declined to provide revenue and sales projections, citing its status as a privately held company.

The birth of online food delivery

FreshDirect's very first delivery took place on Roosevelt Island on July 11, 2002—not so conveniently located in the middle of the East River between Manhattan and Queens. To make that first delivery happen, it took three years, about 125 people, tens of thousands of dollars and a 3,000-square-foot manufacturing warehouse with the latest technology.

After all of that, they finally opened their doors and got (drum roll): "Twelve customers," he said, laughing. "That was a scary time."

His first hires were 35 food experts that he found largely through Craigslist searches, which included a chef from American restaurant One If By Land, Two If By Sea and a bread maker from Ecce Panis. He asked people who supplied the best steak in New York City and was led to a man who had blood on his shirt and was carrying two steak knives. That guy is still with Ackerman today.

Then he hired around 50 technology experts to "map the food chain in the country."

Even as it faces stiff Silicon Valley competition, FreshDirect is no technology dinosaur. A big part of its success has come from its use of data analytics, and that will increase in response to the online delivery services from tech giants. FreshDirect conducts research on customers' online ordering habits to influence the type of foods available and how those foods are presented online.

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For example, customer analytics already can tell the company that customers who order FreshDirect's hand-rolled croissants are the most likely to be repeat customers. In addition to baking 5,000 croissants daily, the company has funneled energy into improving its smartphone and iPad apps for more efficient online shopping.

Based on analyzing customers' ordering habits, FreshDirect has also expanded its selection of pre-made and prepped-to-cook meals—the focus of the start-up Blue Apron—that take minutes to prepare. Frozen options and deals based partly on what's seasonal are also being informed by customer ordering habits.

"Food is the largest single retail category that exists." -Jason Ackerman, FreshDirect CEO

FreshDirect is responding to the anticipated growth in online food sales by opening a new 500,000-square-foot facility in the Bronx, scheduled to open at the end of 2016, which will house its corporate headquarters, food manufacturing and distribution facilities. The company is also expanding certain product lines to include more organic options and specific lists for people with food restrictions, such as gluten-free, low sodium and vegetarian food lists. (You can think of these food lists as the social media equivalent of hashtags.)

The difference between a book and a baguette

In response to customer data and services like AmazonFresh, Ackerman said a major FreshDirect strategy will be to expand its network of relationships with food growers and producers around the world. There has also been an increase in feedback from customers wanting to know where food is coming from, so FreshDirect has incorporated profiles about local farmers on its website.

"Selling a book is not the same as selling hand-sliced prosciutto or a hand-rolled croissant," Ackerman said. "We will compete by our commitment to farm-to-table and fresh products. That's our position."

Ackerman said that the company's first week in business in 2002, one of its then 12 customers ordered 12 cans of marinated artichoke hearts. The company didn't have a reserve of a dozen cans of marinated artichoke hearts, so it delivered six cans.

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"She called customer service, saying she needed a dozen cans right now because she was throwing a party the next day, and then the complaint was escalated to me," Ackerman recalled. "I need all the artichoke hearts right now! I will tell everyone FreshDirect stinks!" Ackerman remembers the woman threatening him. He couldn't afford the bad publicity, so he drove to a store, bought all the cans of marinated artichoke hearts and drove them to the woman's house.

"I realized that if I promise something, I better deliver," he said.

It's a mantra that still holds but, given the competition, may need a fresh take.

By Paula Vasan, special to CNBC.com