The low penetration of online grocery never fails to surprise people. The UK has the second highest online penetration in the world, after South Korea, but it remains under 9%. If we look to the US, Western Europe, and Canada, online share of the grocery market sits around the subdued 3% mark. Growth has failed to meet expectations, but developments in the online grocery market suggest that this is about to change.
Ocado’s share price has risen 57% in two weeks following news that it had signed a deal with Kroger to provide its online grocery logistics across the USA. The Kroger deal is the fourth international deal that Ocado has announced this year (following Casino, ICA and Sobey’s) and assuages the market’s concern that Ocado’s international growth was unlikely.
But why has online become more appealing now, after Ocado struggled to secure partners for so long?
There are three reasons that we identify for the move towards online internationally.
Firstly, safety in numbers. The first pioneering steps into online grocery were based on the in-store pick model, which just adds incremental cost to each order, eroding already thin margins. However, to increase profitability in online grocery, it would require a dark store model, where groceries are held in a central warehouse (like Ocado does), but this requires substantial investment and unless volumes to reach capacity, or signs of quickly reaching, capacity exist, supermarkets are unlikely to take the plunge without the promise of return on investment. Supply is just as much of a limiting factor in online retail as demand is, and the grocers have been historically unwilling to heavily invest in online capability.
Recently, however, there has been a shift in grocery shopping globally. Primarily when Amazon bought Wholefoods to extend its bricks-and-mortar presence to increase the penetration of online grocery shopping in the US. Amazon has dominated general retail over the past five years, and retailers have suffered from its growth. Now, grocery retailers fear that Amazon will take the same level of market share from the supermarkets. This is a fundamental shift in the grocery market, and although Amazon’s global grocery market share is small now, its tactic of aggressive growth via intensive investment and margin sacrifice puts other players at risk.
In addition, Google and Walmart partnered to make online grocery shopping simpler; Aldi partnered with Instacart in San Francisco; and Tesco and Sainsbury’s added to their dark store capacity in the UK. While these may seem like small-scale deals, and for the most part they are, they signal a shift in attitude toward online grocery shopping, and Ocado’s success in the UK will have appealed to grocers internationally.
Now that there has been a clear signal from global competitors that online is worth investing in, those who were previously underdeveloped in their online offering will see investment as lower risk. In a way, the first steps are a self-fulfilling prophecy.
Secondly, demand and ubiquity. Consumer demand for online grocery has been low, as grocery shopping is a very habitual process. People enjoy the act of going to a supermarket, browsing, and picking up products more than had been previously assumed. In addition, the simultaneous rise of convenience shopping has detracted from online growth. The lack of planning required for convenience shopping appeals to time-poor millennials and those who live on their own, and the shift of millennial buying habits has been the main perpetuator of convenience growth. However, now that millennials are having families of their own, planning to be in for a delivery becomes easier and eating out becomes less frequent, and the barriers to consumers buying into online grocery are slowly eroded.
As more consumers shop online, the resulting volumes precipitate higher levels of investment, thus removing the other barriers to online uptake. Order accuracy improves, website functionality advances, delivery speed grows, and the issues of substitution and product availability become less severe. Additionally, as online penetration grows, it moves towards becoming a consumer norm, and the power of word of mouth and consumers replicating others’ behaviour can’t be underestimated when it comes to retail. The growth of online, albeit slow, is encouraging a glacial shift in consumer buying habits, which will only increase as the prevalence of online rises.
Thirdly, the need for efficiency in the long term. The intensely competitive environment in retail globally has encouraged short-term considerations over longer-term investment. With margin erosion, growing competition, increasingly discerning consumers, and geopolitical uncertainty; survival and short-term gains have become the focus. However, a short term attitude to online will see online operators, such as Ocado and Amazon, overtake the incumbents’ market share of online very quickly.
The only way to make online profitable and sustainable is to invest in dark store capacity, removing the high levels of labour and inefficiency of non-centralised stock holding. The increasing number of retailers investing in online sends a clear signal that online will grow, and thus investment can’t be done by halves. Ocado’s relative success in the online grocery market in the UK shows that the model’s efficiency works, and efficiency is essential in countries with lower population density than the UK, as delivery becomes more expensive. This realisation of growth and the need to commit to online has benefitted Ocado internationally, as it is not viewed as a global competitor due to it only operating as a grocer in the UK. Internationally it is a technology and logistics provider.
So what does all of this mean for supermarkets internationally, and the future of grocery shopping?
The problems with online grocery remain the same. It’s an inherently unprofitable model versus consumers physically shopping in store. However, investing early in centralised warehousing to keep the cost of fulfilment per order as low as possible will allow retailers to realise as many gains as possible from growth in the market.
As retailers remove supply-side constraints, such as delivery availability and poor substitution, consumer demand will improve. Simultaneously, as more convenience-shopping millennials have children, demand will shift online for its family-friendly convenience and demand-side constraints shrink.
While the growth of online has been subdued both internationally, and in the main developed markets, the uptake of Ocado’s dark store technology signals the recognition of online grocery as an important area to invest in. Now, unless competitors want to be left behind, they will have to invest in online capability too.
Online has the potential to change grocery shopping, particularly with available range and the procurement of local/artisan produce. Centralised stock holding means that a small number of items can be held, either because they are being trialled, or because they have lower order frequency. When it comes to non-perishable items, this is a huge advantage for online operators, as they can hold stock which would just be too costly for bricks-and-mortar stores.
In addition, the level of customer data gleaned from online orders will allow retailers to be more responsive to demand, as well as better at targeting consumers and encouraging impulse purchasing. Dynamic pricing could become a reality as real time demand would be possible to measure; price elasticity of individual consumers could be easily measured; set order lists and deliveries could be scheduled; and promotions would be far easer to manage.
Overall, Ocado’s string of partnership signings shows a serious commitment by grocers to invest in online. Although four deals may not seem material, once one retailer moves in each country, the others must move to keep up. The barriers to online growth are slowly being removed.
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