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Chewy.com’s Make-or-Break Logistics Dilemma


BRIAN KENNY: The Barkley Hotel and Spa in Ohio is one of the most exclusive and luxurious hotels of its kind with reservations booked up to a year in advance. Their lucky guests enjoy specially designed furniture, individual heated pools, private massage salons and tuck-in belly rubs all for the bargain price of $95 a night, which includes an in-room doggy cam. That’s right. The Barkley is a dog spa and its very existence is evidence that pet owners spare no expense when it comes to their furry friends. To wit, here are some fun facts from the 2021 Spoiled Pet Survey: 83% of pet owners throw birthday parties for their pet each year. 62% have a dedicated social media account for Fido. 65% give their pets CBD gummies to counter anxiety and if forced, 63% would choose their pet over their significant other. With 70% of Americans identifying as pet owners up from 66% in 2020, the players in the hundred billion pet care industry are having trouble keeping pace. Today, on Cold Call we’ve invited Professor Jeffrey Rayport to discuss his case entitled, “chewy.com.” I’m your host Brian Kenny, and you’re listening to Cold Call on the HBR Presents Network. Jeffrey Rayport is an expert in online media and e-commerce with a focus on new business opportunities enabled by emerging digital technologies. You are a three-peat guest on Cold Call, I think. I went back and looked at the archives. I think we’ve had you on three times prior to this, so welcome back.

JEFFREY RAYPORT: Amazing. It’s nice of you to put up with me.

BRIAN KENNY: The last time we had you on, you mentioned this case to me at the end and I’ll fess up, I’m a dog owner. I am a card carrying member of Chewy.com. In fact, on the way over to the studio this morning, I got an alert from FedEx that my dog’s package from Chewy had arrived this morning, so an ongoing never ending series of orders and deliveries from Chewy.com at my house. Are you a customer of Chewy? Are you a pet owner?

JEFFREY RAYPORT: We are not pet owners currently.

BRIAN KENNY: This case takes place in 2013, so we’re looking in the rear view mirror a little bit at some challenges that they faced as they hit their stride, so…

JEFFREY RAYPORT: Yes.

BRIAN KENNY: Why don’t we just get started. I’m going to ask you to tell us what the central theme of the case is and what your cold call is to start the case in class.

JEFFREY RAYPORT: Well, the case presents a very interesting conundrum faced by the founder of the company. Many people will know him because he’s considered the grandfather of meme stocks these days, but none other than Ryan Cohen, who was one of the co-founders of Chewy. In late 2013, Ryan is running the company, CEO. It’s a two, two and a half year old venture. He is seeing astronomic top-line growth and his distribution partner, it’s called a third party logistics provider, or a three PL, is not owned or controlled by Chewy. It’s a non-contractual handshake based relationship and he has a problem. The problem is that the three PL, the singular three PL in Mechanicsburg, Pennsylvania, cannot keep up with Chewy’s pace of growth.

BRIAN KENNY: Yeah.

JEFFREY RAYPORT: The question Ryan faces, which many, many entrepreneurs who deal certainly with physical goods face, is at what point do you in-source big aspects of operations like logistics and fulfillment and when does it make sense to outsource them, maybe even in perpetuity depending on the dynamics of the business.

BRIAN KENNY: Uh-huh. How would you start the class? What’s your cold call?

JEFFREY RAYPORT: Well, it’s an interesting one because it’s a bit complex. I start by throwing in every single person in the classroom into the deep end. The deep end being not just the question of what do you do in a general sense, but quite specifically what do you do? Ryan, with his board of directors with whom he’s going to meet of course, it’s an HBS case so there’s always a board meeting around the corner.

BRIAN KENNY: Yeah.

JEFFREY RAYPORT: He’s got to sit down with his board of directors who are telling him that if his three PL can’t keep pace with growth, he’s got to slow growth down and improve relations with the three PL basically treat it as a partnership and help them come along because right now they’re in a sense, falling down on the job.

BRIAN KENNY: Mm-hmm.

JEFFREY RAYPORT: Ryan has four choices, one of which is what the board wants him to do, which is slow down and ameliorate that situation. Then he’s got three choices related to maintaining the pace of growth, one of which is to go to another part of the country, say the West Coast and establish a second three PL relationship. The second is to start, if you will the journey down the learning curve to figure out how to run your own fulfillment logistics in house, meaning to go build a fulfillment center on the west coast or in some other part of the country, or the big bet which is jump in with both feet, sever relations with existing three PL and essentially do a flash cut and in source all of fulfillment essentially now.

BRIAN KENNY: Yeah.

JEFFREY RAYPORT: I say that this is complex because it’s not just that there’s door numbers one, two, three and four, but every one of these has a mountain of negative arguments against it.

BRIAN KENNY: Mm-hmm. We’re going to talk a little bit more about each of those as we get further on to the conversation because it’s not… They’re all very complex and there’s good and bad to each of them. I’m curious as to why you decided to write this case. You’re not a current pet owner, but what intrigued you about the Chewy situation enough to write a case about it?

JEFFREY RAYPORT: Well, it’s a funny story. I was moderating or helping moderate a tech conference down in New York. Actually, I can say it was a very cool tech conference, it took place in Brooklyn, not in Manhattan and we had at the end of the day a panel which relates to something that’s on a lot of people’s minds. The question of, in the age of Amazon are there opportunities for others in this thing called online commerce?

BRIAN KENNY: Mm-hmm.

JEFFREY RAYPORT: We had a predictable set of extraordinary individuals, the founders of Warby Parker, one of the founders of Wayfair. We had Ryan who was founder of Chewy and one other. I was asking the  inevitable question, which is after hearing from them about their business models and why they thought they were defensible, I said, “Tell me what you’re really doing to differentiate yourself from Amazon.”

JEFFREY RAYPORT: Ryan, who was sitting to my left, put his hand up in a polite and slightly sheepish fashion and he said, “Oh, I can give you one.” I said, “Okay, share it, please.”

BRIAN KENNY: Yeah.

JEFFREY RAYPORT: He said, “Last year we wrote five million handwritten notes to our customers.”

BRIAN KENNY: Mm-hmm.

JEFFREY RAYPORT: Now, that got my attention, it got the attention of everyone else in the room as well as the other panelists.

BRIAN KENNY: Yeah.

JEFFREY RAYPORT: After that, I called him up or we had a little chit-chat and said, “That is extraordinary. I’ve got to understand how it is that you’ve taken this idea of high-touch service and scaled it on a technology platform in a way that is created, again competitiveness, sensibility for Chewy.”

BRIAN KENNY: For those who are listening who may not be familiar with Chewy, I think they get the sense now that this is an online pet supply store. I’m going to ask a question in a slightly different way, which is, what business would Chewy say they’re in?

JEFFREY RAYPORT: Well, it’s a fascinating question because one version of it, this is not what Chewy would say, but just among us here in the HBS community.

BRIAN KENNY: Yeah.

JEFFREY RAYPORT: I mean, have we ever seen a more commoditized category of essentially grocery like goods? How do we know that? Well, the single largest channel in the country for pet food and supplies is the grocery channel. Amazon is clearly a huge player and so the question is, how do you make money selling commodity goods online? You don’t, unless there’s an angle of differentiation. Hence, Chewy would say that they are in the business of taking that wonderful, very personal, often even emotionally compelling experience that pet owners have with their local pet store. I mean, there’re 18,000 pet stores in the country, 59% of them are Indie stores as opposed to individual outlets of large chains.

BRIAN KENNY: Mm-hmm.

JEFFREY RAYPORT: In those stores, the owners get to know the pet owners and they recommend goods and they hand sell things. Chewy’s idea is what if you took that and you could scale it in a way that felt so personal and so compelling, even though they’re running a platform that serves tens of millions of US consumers.

BRIAN KENNY: Yeah, I teased a little bit in the opening about how much we spoil our pets. I’m guilty, I think of spoiling my pet, but not necessarily to the extent that the case describes. Let’s talk a little bit about human-grade dog food. The thought of that is a little scary to me.

JEFFREY RAYPORT: It is. I always find it funny that when I read the description of the ingredients of that private label that Chewy has created called “Tylee’s” brand.

BRIAN KENNY: Yeah.

JEFFREY RAYPORT: Tylee being the name of Ryan Cohen’s teacup poodle. I mean, if you can get past the beef heart, which is one of the early ingredients, it sounds absolutely delicious. It’s organic, it’s grass fed.

BRIAN KENNY: Right.

JEFFREY RAYPORT: It’s absolutely human grade.

BRIAN KENNY: Yeah.

JEFFREY RAYPORT: No question.

BRIAN KENNY: I would imagine that if you look back 10, 15 years, people weren’t buying those kinds of products for their pets, so we’ve seen a change in the way that we think about our relationships with our pets and a willingness to spend a lot more money and a way to humanize them, I guess and to really have them be part of the family in a different way. What does the market look like and how much are we spending on these kind of things for our pets?

JEFFREY RAYPORT: It’s a huge market, as you mentioned, it’s over a hundred billion dollars today. At the time of the case, we wrote this case quite recently, but went back in time as you said, to 2013 to frame an existential or moment of truth for the company. Back then it was a $53 billion market. The average pet-owning household spent about $522 a year. Interestingly, to your point Brian, that was a big change from where we’d been 10 or 12 years earlier. One of the big questions that we get into is what’s the difference between Chewy’s prospects and those of Pets.com which was the poster child for.com excess in the first Internet boom. One of the big changes that took place over those 10 or 12 years was what folks in the industry referred to as the humanization of the pet. It’s what you talked about of the furry friend becoming a member of the family. I grew up in Ohio, didn’t know about the Barkley Hotel. Now, that I know about it, $95 a night, it sounds a great deal. Maybe I’ll try staying there. I mean, what a remarkable place. Over that period of time, the needle really did move. What I mean by that is that folks who study this market from the standpoint of consumer psychology define consumers in three categories. They are the humanizers of pets and it sounds like you are proudly one of them.

BRIAN KENNY: Absolutely.

JEFFREY RAYPORT: Then there are the folks who sit in Iowa, go to 4-H fairs every summer and think of their pets as livestock and obviously those are the non-humanizers.

BRIAN KENNY: Yeah.

JEFFREY RAYPORT: And then you have this wonderful category about 5% of the extreme humanizers. These are the folks who not only buy the food and buy the medicated food and buy human grade, but in their effort to humanize the pet when it comes time for Halloween, the pet needs a Halloween costume.

BRIAN KENNY: Oh yeah.

JEFFREY RAYPORT: By the way, Christmas sounds good, let’s get a costume for that too. With more consumers humanizing their pets, a second thing happened, which is referred to as the premiumization of the product.

BRIAN KENNY: Mm-hmm.

JEFFREY RAYPORT: That leads you to human grade, and I did want to share with you one of my favorite statistics from the case.

BRIAN KENNY: Sure.

JEFFREY RAYPORT: I will read from this, Brian, if you’ll forgive me?

BRIAN KENNY: Please.

JEFFREY RAYPORT: I love the fact that you can go on Chewy and buy Nestle Purina Beneful real beef dry dog food. 15 pounds, $11.39. Price per pound, my little calculation, this is high level statistics and analysis coming to you from Harvard, not MIT.

BRIAN KENNY: Right.

JEFFREY RAYPORT: 73 cents a pound. You can also buy K9 Natural’s beef feast raw grain-free freeze-dried dog food in an eight-pound package for $195.99. According to my math, call it arithmetic, that’s about 24 and a half dollars a pound. Now, I don’t know about you, but I can’t find a lot of meat I can buy at Whole Foods for 25 bucks a pound, so-

BRIAN KENNY: A rib eye steak, I think is about the same.

JEFFREY RAYPORT: You can’t spend money like that on human food, so the point is we have done something very significant to change over these 10 years, both the customer and the product. Hence, the economic profile of the business, meaning that with higher prices, there are more gross margin points, there’s more margin to play with and all of a sudden maybe you can build a business worth something.

BRIAN KENNY: Mm-hmm. We haven’t really talked about the big box competitors that Chewy deals with. These are places where you can walk in and all the products are right in front of you. What does the competitive landscape look like when you bring those guys into the mix?

JEFFREY RAYPORT: Well, they essentially split the market with the grocery channel in Amazon. As I said, there are many, many of these Indie stores but alas, the impact of the big boxes in online commerce has meant that the independence who represent 60% of stores for round numbers, represent only 4% of revenues in the industry, so the industry is owned by the giants. Chewy was in effect going up against `not just Amazon and the grocers, but as you say, these very well-established chains that each had between 1100 and 1200 stores in the US at the time and billions of dollars of top line revenues.

BRIAN KENNY: Yeah. Now, pet supplies or pet food was not the first idea that these partners had when they started off with a business. They were going to do jewelry, which is obviously quite different. How did they start there and end up with pet supplies?

JEFFREY RAYPORT: There’s that famous story about Jeff Bezos driving across the country with his then wife, Mackenzie Bezos going through analytically two dozen categories of e-commerce and landing on books as the right thing to sell if you are an e-commerce pioneer. In a sense, Ryan and his two co-founders, [Michael] Blake Day and Alan Attal did something similar. They asked the question, which is maybe an obvious one for anyone who’s been in the online business for a while, which is what is easy to ship, high-end value hence rich in gross margin points for which the logistics are obviously more manageable than they would be if you were Wayfair shipping sofas?

BRIAN KENNY: Got it.

JEFFREY RAYPORT: They came at this initial selection of the jewelry business very analytically until they realized two things. One is that the existing players who weren’t big enough to clobber them, but on the other hand were holbig enough to demonstrate that there was only so much scalability in that business and that the economics were not so attractive for the simple reason that there was very little in the way of repeat purchasing.

BRIAN KENNYw: Mm-hmm.

JEFFREY RAYPORT: They then made the famous pivot.

BRIAN KENNY: Let’s talk a little bit about the early days of Chewy.com and the situation that they faced financially. This was not a well-financed operation initially. Can you talk a little bit about the way that they were able to bootstrap this together and get started, at least on the path that they’re on now?

JEFFREY RAYPORT: They were running the business essentially on what’s referred to as a purchasing card. It’s a credit card for which you don’t revolve credit. You’ve got to settle it every week. It’s granted only to businesses. They had an $800,000 credit line that they were maxing out every single week, so this business was in effect, running on fumes. Just before the time of the case, they’d managed to raise $15 million from, in fact a Boston-based VC firm called Volition. Volition was a believer. A few private investors came in, but Chewy was burning half a million dollars a month had, had seven million dollars of cash on hand, so they had 14 months worth of runway. This is back to where we started. This is an awful position for any scaling startup to be in to have limited runway, limited access to additional cash to have essentially a business where you’re taking title of the inventory and trying to sell it as fast as you can either before or after you take the order. Very challenged to make a business like this work.

BRIAN KENNY: At the time of the case, they were actually pretty well established at this point, so they faced these four decisions that you described. Can you talk a little bit about the challenges that they were facing with the three PL that they were working with at the time?

JEFFREY RAYPORT: This was a three PL that knew something about e-commerce, but knew nothing about shipping big and bulky. The result of that was that packages were wet, they were packed in a sense in a haphazard fashion, and they were falling off or jamming the conveyor belts inside the three PL. In defense of this three pl, which is otherwise a superb business and the chewy folks would say that. This was just a mismatch. Nobody had ever figured out how to ship these kinds of products before through an e-commerce channel successfully.

BRIAN KENNY: Yeah.

JEFFREY RAYPORT: Clearly Pets.com hadn’t and went bankrupt famously 12 or 13 years before, so they really had an issue here, which is it was not a deal made in the spirit of partnership, meaning both sides had a 30 day out, they could renegotiate rates, which were a fee per package shipped anytime either party wanted, which of course was an advantage to Chewy thinking they would drive a harder bargain as their volumes increased, but it also meant that the three PL could walk away the minute it got too painful and by the way, was not particularly interested in gambling on acquiring hundreds of thousands of additional square feet of distribution center space for a bunch of guys who are running this thing on a shoestring.

BRIAN KENNY: Yeah. Just to think about the kinds of products that I’ve bought from Chewy.com, it’s not a straightforward proposition being the fulfillment center for this kind of a business because you’ve got everything from small items, cushy toys or whatever to enormous 50 pound bags of dog food.

JEFFREY RAYPORT: Yes.

BRIAN KENNY: It’s pretty complicated.

JEFFREY RAYPORT: Very complicated. I mean only 10 or 20,000 SKUs, so just to compare that to an Amazon that reportedly has four to 500 million SKUs on a site, if you include Amazon Marketplace or Wayfair with 10 to 12 million SKUs the last time I checked. On one hand, not a lot of products to keep track of by comparison, but on the other hand, as you say huge variability around value, around size, around fragility. On top of that, you’ve got two categories that these other platforms don’t face, one of which is called perishable because a lot of this food is fresh or needs to be refrigerated and will actually obsolesce on the shelf, and the other is veterinarian prescriptions, so medicated product around which there’s more security and more time sensitivity in addition to all your other headaches.

BRIAN KENNY: Right. Can you talk a little bit more about Pets.com? You mentioned it a couple of times, it’s brought up in the case. I’m wondering, that was a cautionary tale for these founders. What did they learn from that and what did they do differently maybe than Pets.com did?

JEFFREY RAYPORT: Well, what’s funny about it is what they didn’t learn. The first conversation I had with Ryan, I asked at least for somebody at my age the obvious question, which is we all know about the Pets.com wipeout. I mean, just to refresh listeners, this is a company that went public early in 2000 inauspicious time. What we know now with 2020 hindsight about when the NASDAQ began its meltdown in April of that year, its first quarterly earnings report was for Q2 of 2000. It had a top-line of 8.8 million and a bottom line of 22 million in losses. Nine months later, it was in chapter 11 bankruptcy. It was such a wonderful wipeout and partly because those are pretty amazing numbers. I mean, they started at a 300 million valuation and of course, ended at zero. That all happened in the space of a year. The other part of it, folks will remember that there was a 25 million dollar television campaign to promote the talking sock puppet. Many of us HBS have sock puppets from Pets.com in our offices as humbling reminders of what it means to ride a wave in the wrong way. In all seriousness, this created such an impact, especially on the venture community as well as founders…

BRIAN KENNY: Sure.

JEFFREY RAYPORT: … that nobody touched this space for over 10 years. It was like a nuclear winter of e-commerce in this one sector of the online commerce universe where just people looked at it and said, “Nobody can make any money there.”

BRIAN KENNY: Wow.

JEFFREY RAYPORT: To learn from that, one issue is this issue of the pet becoming a member of the family, humanization. The increasing price points based on human-grade product premiumization and then on top of that, the fact that at the time of Pets.com, there were maybe 250 million people around the world shopping online. I mean around the world. By the time Chewy started, there were five billion.

BRIAN KENNY: Let’s talk about the four different options that Ryan and his team are considering and the pros and cons of each. Maybe you can tick through those. We have three hours.

JEFFREY RAYPORT: We have three hours. Of course, we’re going to give away all the drama of the next time we discuss this case in our classrooms. In a sense, it’s one versus three so the issue of whether you slow down is a critical one that we find well worth debating and very fun to debate in the classroom. Needless to say, our MBAs many of them are very gung-ho about growth, but some of them have a sobering reaction to the fact that you’ve got a board that is categorically against you, is saying, “Clean up the relationship, get your gross margins in shape, stop buying below cost. You’ve got a lot to do before you should be growing a double digit or triple digit year on year rates.” In any event, we normally make quick work of that first option, which is simply that if you believe scale is the way you prevail, and you also believe that you’ve got competitors hot on your path, it’s not terribly realistic from a competitive standpoint to slow down. Hence, that focuses you if you will, on doors number two, three, and four and so the idea of adding a three PL is attractive, partly because Chewy is only doing business in the eastern half of the US, which is interesting. The site is clearly available across the country anywhere in the world, but they’re only taking orders from eastern half of US, so they can do one to two day order fulfillment. This is Ryan’s view that if we’re going to do it, if it’s worth doing, it’s worth doing well, so it’s tempting to say if you have a three PL that’s under stress and you want to move to a national footprint, find another three pl, see if you can build a better relationship with them, put it on the west coast, do national distribution. That’s interesting. Door number three, which is don’t just do that but actually start your journey to learn how to in-source logistics and fulfillment is to go build a fulfillment center somewhere. Understanding that it may take 12 to 18 months to get it up and running. You may stub your toe, it may actually be an existential risk, but at least you haven’t put the entire business at risk because you’ve got the safety net of the existing three PL.

BRIAN KENNY: Interesting.

JEFFREY RAYPORT: The final option across these three growth options of the four choices we present to the students in class is simply to say the business, if we’re right about the projections, is only going to get larger. It will only become more complex with every passing day to move from an outsourcing to an insourcing arrangement for fulfillment. The time to start is actually yesterday, not tomorrow, so let’s do it now.

BRIAN KENNY: Uh-huh.

JEFFREY RAYPORT: That would mean severing relationship with existing three PL. Enormous risk in doing that because you’re not only doing a switch over, which is risky enough to another facility, but you’re doing it to a facility that you haven’t even built yet. That one is a really tough one because industry experts are telling Ryan and his team that it’s a 10 million dollar capital expenditure to stand one of these things up.

BRIAN KENNY: Yeah.

JEFFREY RAYPORT: That it’s then going to cost you the better part of a couple million dollars a month in operating expenses to run this thing, and that all the best consultants they could tap in the industry are essentially saying, “You can’t just flip a switch. It really will be best case 12 to 18 months before you’re actually up and running.”

BRIAN KENNY: Yeah. I’m curious as to how Amazon started on this. Did they use a three PL when they first began selling books? How did they do it?

JEFFREY RAYPORT:

It’s a great question. Arguably the Seattle location was part of the secret to the answering that question. Amazon in the beginning located in Seattle because quite proximal to their own modest warehouse was a large fulfillment center operated by the largest book distributor in the United States called Ingram.

BRIAN KENNY: Uh-huh.

JEFFREY RAYPORT: Amazon, in the early days kept the top 11 to 12,000 fastest moving titles in its own warehouse, but nonetheless put seven million titles on the site with the understanding that they could send a truck driving over to Ingram and pick up one of those titles at any time. Obviously not all seven million, but point being that Ingram did have hundreds of thousands of titles sitting in that facility, and Amazon essentially could do reasonable order fulfillment time without actually taking title to owning or storing all of that merchandise.

BRIAN KENNY: Yeah. What a great strategy.

JEFFREY RAYPORT: Great strategy, so to your point avoided the vagaries of three PL worked with a world class fulfillment center that happened to have comprehensive inventory and they didn’t have to take title and they didn’t have to manage it.

BRIAN KENNY: Yeah. I’m also curious about how involved the board gets into these conversations. This is maybe more general for entrepreneurs. They’ve all got boards that they have to answer to and advisors, and now the board here clearly had some strong opinions about what Ryan and the team should do. Is Ryan… Does he have to listen to them or is this his call? How does that play out?

JEFFREY RAYPORT: Nobody was against this idea of growth, but they were looking at this business and saying, “It is not making a lot of economic sense right now.” Everyone was waking up in the middle of the night thinking about Pets.com because nobody wanted to see a wipe out like that. The presenting problem was, was there some middle area Goldilocks answer, meaning you don’t stop growing, but could you slow down growth enough to improve the existing relationship and de-risk the fulfillment situation to some extent versus what Ryan and his co-founders wanted, which was to swing for the fences because they viewed any step back from this meteoric double, triple digit growth as essentially a concession as waving the white flag and acknowledging that they would not win in the category.

BRIAN KENNY: Yeah. I know you wrote a B case. Are you allowed to reveal what decision they made? Can we let our listeners in on this?

JEFFREY RAYPORT: I think we can.

BRIAN KENNY: Yeah, okay.

JEFFREY RAYPORT: I think we can. It’s not easily Googleable, but interestingly, Ryan and the team prevailed in the boardroom.

BRIAN KENNY: Mm-hmm.

JEFFREY RAYPORT: By that, I mean that everyone ultimately agreed to disagree and did commit to a path forward. The path forward was to the riskiest of all of those options, and that was door number four, which is essentially just sever relations with existing three PL and go all in on fulfillment. That turned into exactly the nightmare situation that you and our listeners might expect. I mean, the first thing that happened is as they were standing up the facility in the same town in eastern Pennsylvania where the three PL was located, it did not take long for the “secret” to get out that Chewy was establishing its own fulfillment center facility.

BRIAN KENNY: Mm-hmm.

JEFFREY RAYPORT: When that happened, the company they were dealing with, their current three PL partner said, “Gee, we have no contractual relationship. We’re charging $3 a package shipped. How about we go to nine?”

BRIAN KENNY: Oh my gosh.

JEFFREY RAYPORT: They tripled prices on Chewy while Chewy was sitting there saying, “We can’t take 12 to 18 months to get this thing up and running.”

BRIAN KENNY: Mm-hmm.

JEFFREY RAYPORT: The logic was the one we talked about, which is, if you’re going to do this and if it’s a core part of your proposition, and again it comes back to what you were talking about earlier, Brian. If you believe that part of getting it right for customers is establishing this human connection through the call centers with these handwritten notes, sending flowers when a pet passes away, sending beautiful fine arts oil portraits, which Chewy does as well for people who send JPEGs or images into the call centers after a wonderful chit-chat with somebody down in Fort Lauderdale.

BRIAN KENNY: Amazing.

JEFFREY RAYPORT: It’s hard to argue that a core element of getting it right for customers isn’t for lack of a better term, the out-of-the-box experience, meaning the whole issue of does the product arrive in time? Is it nicely packaged? Is the order accurate? Does your dog or cat or goldfish like what they shipped?

BRIAN KENNY: Yeah.

JEFFREY RAYPORT: The view was that this actually was not peripheral, this was core and if it was core from a competitive differentiation perspective, then it was something they had to ultimately own and operate.

BRIAN KENNY: Yeah.

JEFFREY RAYPORT: The other is that all four of these choices are awful. Each one, as we said earlier, has just powerful arguments against it. This idea that you’re in a situation where you want to save the company, you’ve got some pretty well-defined paths forward, but no one of them is attractive. What puts me in mind, I often say this to the students, is that in the normal world of business, we talk about necessity being the mother of invention.

BRIAN KENNY: Mm-hmm.

JEFFREY RAYPORT: In the startup world, and this is an extreme case, you could argue the opposite is true. Invention is the mother of necessity. The fact that they’d created a business that had gone from just a few million of dollars in 2012 to a business that ultimately closed out 2013, the year of the case we’re at in December 2013, at 73 million. That’s invention.

BRIAN KENNY: Yeah.

JEFFREY RAYPORT: Something was working in a way that it wasn’t working for anyone else who’d ever touched this sector either brick and mortar or online, but that created this, in a sense existential moment in which the demand would either crush you or you could capitalize on it intelligently and save and make the business.

BRIAN KENNY: Yeah. Not for the faint of heart those kinds of decisions.

JEFFREY RAYPORT: Not at all.

BRIAN KENNY: Sure. Well, Jeffrey this has been a great conversation as usual, so I expected nothing less than a great conversation with you. I’ll give you an opportunity to finish up by telling our listeners if there’s one thing you want them to remember about the Chewy.com case, what is it?

JEFFREY RAYPORT: Let me start by answering that with just a quick update on where they are.

BRIAN KENNY: Great.

JEFFREY RAYPORT: This is a business, of course that took a massive gamble, but as we said, any one of these choices would’ve been huge risk. They ultimately sold the company for 3.35 billion dollars to one of the big boxes, PetSmart. It was an all-cash transaction that represented the largest US e-commerce exit in history at the time.

BRIAN KENNY: Wow.

JEFFREY RAYPORT: PetSmart, laboring under enormous debt from an LBO they had done with a New York- and London- based private equity firm, needed some way to get their hands on cash, and so was a bit of a Hail Mary. They spun out Chewy in an IPO just a few years ago, Chewy went on to become at the IPO, a 17-billion- dollar public company with the uplifter in COVID, it reached 40 and 50 billion. Even now, with the down markets we’re living through today, it’s still in the range of 15 to 20 where it IPO-ed.

BRIAN KENNY: Yeah.

JEFFREY RAYPORT: Just to reassure listeners that there are times when people do crazy stuff as entrepreneurs, when if they’re smart and savvy and a bit lucky, things can really work out. But for us, from the standpoint of lessons for our students, one of the big things that scaling startups face is that moment when you make the big bets converting what are variable costs into fixed costs, which is ultimately what this fulfillment decision is all about, and those are very risky decisions for the simple reason that if you don’t make them and you outstrip your partners, you can’t deliver for customers. If you do in-source and convert variable to fixed and you don’t deliver on your revenue targets, you crater the venture.

BRIAN KENNY: Yeah.

JEFFREY RAYPORT: Back to what you said, not for the faint of heart.

BRIAN KENNY: Jeffrey Rayport, thank you so much for coming on to discuss the Chewy.com case with me.

JEFFREY RAYPORT: Brian, thank you so much for having me here.

BRIAN KENNY: If you enjoy Cold Call you might also like our other podcasts: After Hours, Climate Rising, Skydeck, and Managing the Future of Work. Find them on Apple Podcasts or wherever you listen. Be sure to rate and review us on any podcast platform where you listen. If you have any suggestions or just want to say hello, we want to hear from you. Email us at coldcall@hbs.edu. Thanks again for joining us. I’m your host, Brian Kenny, and you’ve been listening to Cold Call, an official podcast of Harvard Business School, brought to you by the HBR Presents network.

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