Arnie Katz, President of Relay Foods, speaks with GrowthCap CEO RJ Lumba.  Relay Foods is a leading online source of local and organic groceries. It uses logistics to bring even fresher groceries to consumers.

RJ: Arnie, great to chat with you again. As I may have mentioned, our next issue of GrowthCap Insights is focused on healthcare. I thought it would be interesting to chat with an entrepreneur in the organic food and nutrition space given the significant role food plays in healthy living and preventing conditions such as obesity and diabetes. To start, perhaps you could give us some background on Relay Foods and a walkthrough on its evolution.

Arnie: Sure. In early 2007, Relay got started in Charlottesville, Virginia. At the time, Relay’s founder, Zach Buckner, was working in consulting and traveling a lot. With such a busy schedule, he realized that it was hard to find time for grocery shopping. He wanted to have food delivered to his home, but realized that this service was unavailable to him and most other people in the United States.

Zach immediately began researching the online grocery industry and analyzing previous business models. He realized two things about these companies. First, the businesses that tried to get too big too fast before figuring out the unit economics lost. Secondly, home delivery in US suburban communities is extremely expensive and there simply aren’t enough customers willing to pay that premium.

Our solution was the pick-up location. Basically, a pick-up location creates density where there is none. The location is a colorful box truck, made to look like a farm stand. The model is simple. The customer orders online and decides among provided locations (think schools, large employers, gyms) where she would like to pick up. With home delivery, you can only serve about 3 customers an hour. Our model brings customers to one convenient location, allowing us to serve as many as 20 customers an hour.

RJ: So clearly there’s a logistical and pricing combination that you’ve found to work. Now, how does your quality of food compare to what is readily available at grocery stores or even a Whole Foods?

Arnie: Once we solved the delivery problem with the trucks, we had to figure out the specifics of what we would sell. The possibilities were endless. Really, though, the answer was simple. What excites us at Relay is healthy food.

We set out to create a sustainable online grocery, and, in the process, found that online food creates efficiencies for the local food system that never before existed. Our model allowed us to partner with local farmers and artisans (bakers, pasta makers, etc.) on a small and personal scale unattainable for the traditional grocery store. Farmers who might have otherwise struggled to stay in business were incorporated into a distribution supply chain. We were able to partner with them and deliver their goods to market effectively and profitably, so these mom and pops make money, and Relay makes money. I’m proud to say that’s one of our biggest achievements.

RJ: It sounds like you’re really enabling this trend of farm-to-table, especially in households that typically wouldn’t be able to access this level of food quality. Would you say that your time between when the farmer first produces the product to getting it in front of the customers is a lot shorter than what is available at grocery stores?

Arnie: Definitely. The difference is significant. Our farm-produced goods reach the customer in a tenth of the time they would in a traditional grocery store. Relay’s customers can pick up their carrots and have them for dinner the day after they were harvested. The food is definitely fresher.

We’re trying to bring back the old connection between consumer and farmer. One hundred years ago, farmer’s markets were found in small cities all over the US. The consumer relied on farmer’s markets and stands for their produce. At the market, they were able to shake the hand of the farmer and buy produce harvested a day earlier. There wasn’t the disconnect between the farmer and consumer that there is today. The consumer knew the farmers and artisans personally and could choose their produce providers based on quality and consistency. This market model ensured good quality through healthy competition.

As time progressed, corporations got in the middle of that transaction. These corporations made the food industry more efficient and reduced cost, saving the consumer time and money.

The problem is that grocery stores mostly care about reducing prices. One of the ways to do that is to eliminate the farmer’s brand from the equation. This way the farmer isn’t
able to withstand any pricing pressure and the grocery store can negotiate him down. The other advantage for grocery stores of keeping produce detached from farmers is to ensure a lack of customer loyalty to the producers. This allows the grocery store to deal with whomever they want, whenever they want, to negotiate the lowest prices.

This model is great for commodities, like gold or copper, where there is no differentiation. But food varies widely in quality and variety. Tomatoes are not all equal. The pale, mealy variety found in grocery stores in January are not equal in flavor or nutritional value to field-grown tomatoes harvested in July. When you treat the tomato as a commodity, people will gravitate toward lower cost, and therefore, lower quality. The commoditization of food has led to a significant decrease in the quality of produce and meats over the past 100 years.

What we’re trying to do at Relay is break down the commoditization of the whole supply chain. We believe you have the right to know which farmer produced your tomatoes.

Now we know that this means that we can’t put price pressure on Kevin Kirby as effectively, but we think it’s the right thing to do. Now Kevin has to compete either on price or, more importantly, by providing higher quality produce. So, we’re looking back 100 years, taking notes from the old farmer’s market model when farmers had to demonstrate the quality of their products and convince the consumer that they were worth their price. We give Kevin the opportunity to effectively communicate his value proposition, and that’s one of the reasons why we are growing so quickly and why customers are so connected to us and to our producers.

RJ: Could you talk a little about the current scale of your business – perhaps what cities you’re situated in, and how quickly you’ve been expanding?

Arnie: We officially launched our first Charlottesville pick-up location in January 2009. In 2010, we expanded to Richmond. We opened markets in DC and Baltimore in 2012 and have since expanded into several “satellite” markets. These are places like Williamsburg and Stafford, Virginia, where there is a significant population, but not one large enough to draw a Whole Foods. These are markets that are often longing for access to healthy, sustainable, local food. We are able to serve them profitably from our larger markets and distribution centers. Currently, we have eight satellite markets and have plans to expand these significantly in the coming months and years.

As of June, we are in the Triangle area of North Carolina.

RJ: Excellent. When you decide to expand into a market, I imagine there is quite a bit of research that goes into the demand you’d see from consumers in that area. Have you found that you’ve been able to, more or less, predict demand and are able to meet it?

Arnie: Yes, we know what to look for in the next city and the potential customers. That being said, the beauty of this model is that it can really work anywhere. I’ll give you an example. Lynchburg, Virginia has a population of a quarter-million. While it isn’t the first city that comes to mind in a conversation about organic food interests, there are plenty of people there who do want to buy organic and local foods. Out of 250,000 people, you can find a set of customers who are really passionate about the quality of food they put on their table. Although Whole Foods won’t move in to serve that customer base, we will.

Each week, we send a truck and serve a steady line of customers. Even though some would say that Lynchburg is the “wrong” city to expand to, it’s working beautifully for us. That’s one of the advantages of this model.

RJ: Are you seeing growth from increased penetration in current markets, or from expansion into new markets? I’d be curious to see if you’ve seen some tapering off in your existing markets.

Arnie: We haven’t seen tapering off just yet. We see growth in both our existing and new markets. The truth is that our growth is almost completely dependent on our marketing spend. If we took our entire marketing budget and allocated it in one market, it would grow significantly more than the others. As long as we spread our marketing dollars equally, they will grow equally.

RJ: Got it, thanks. To put your company and its stage into context, can you share with us your current financial backing?

Arnie: We are mostly angel backed. We have one institutional investor, Battery Ventures.

RJ: And as you continue to expand your geographic footprint, will you be funding organically, or will you be seeking to do another round?

Arnie: We have raised $20 million so far. We are not profitable just yet. Since we can’t fund expansion with our revenue alone, we need investments to both cover our losses and expansion. Our unit economics are quite profitable, but we’re not big enough quite yet for those profits to cover the fixed costs. We’ll be there soon. In about half a year, we expect to be profitable on a markets level.

RJ: So we talked about the genesis of the business, your target market and how you scaled, your backing and how you’re going to continue to grow. But in terms of traction, are you finding that customers are really migrating over to your model, and do they stick with purchasing from Relay? Talk to us a little bit about the consumers’ behavior.

Arnie: We find that customers are happy to move their spending from brick and mortar grocery stores. When they begin using Relay, they stick with us. This is not a scheme where we bring customers in, one, two, or three times and then they go away. We have customers who have ordered hundreds of times, once a week steadily for the last four or five years. Once we capture a customer, retention is key, and we are more about helping consumers break a deeply ingrained habit and pattern of consumption. That’s where a lot of our energy goes.

RJ: How do you regard customer experience when they actually interface with Relay? It seems like the customer reads about the products and the farmers online, but then just goes to pick it up from the truck.

Arnie: There are two elements to it. One is that actually delivering the information about the produce online is much more efficient and effective. Even when people go to the farmer’s market and meet their farmers, they probably won’t learn much about what the farmer’s life looks like day to day. We can do a good job at telling that story once for hundreds of thousands of people to see later. The kind of scale and the quality that you can achieve is high. The second element is that when they go to pick up from the truck, it’s not just a truck. We have a well-qualified operations associate that is delivering the groceries to the person. These people know the food; they’re passionate about the local movement, know some of the farmers personally, and can recommend to you what to do with the food. It’s meant to be a very personal experience. Our employees are passionate about this movement and we treat them well, so they treat the customers well.

RJ: I think many people understand the necessity of eating better; they understand that buying fresh and organic foods pays dividends down the road. And you guys are doing something that’s very unique. I appreciate you taking the time here.

Arnie: Thank you, RJ. Really appreciate the compliment and your passion for the topic.