Online grocery — is there light at the end of the tunnel?
It has been a quarter century since the dawn of ecommerce, and online grocery is still — to put it mildly — an unsolved problem. Estimates on penetration in the US vary between 3 and 5%. The number, even at the upper end of the range, is an order of magnitude less than that in fashion or consumer electronics. It has not been for want of trying. Those with long memories will recall Louis H. Border’s Webvan experiment in 1997. And Webvan was an experiment that happened under the aegis of the luminaries of epoch making technology shifts, Sequoia and Softbank. It didn’t work. Things have gotten better, certainly; but still, online grocery is not accretive to margins for most omnichannel retailers. It is a defensive strategy at best.
What ails grocery ecommerce?
Low online penetration of grocery is due to a single inalienable truth: In a business already challenged by low single digit margins, digital replaces two free line items in the cost structure by paid equivalents. These two line items are picking and delivery. Picking costs are 5 to 10% of sales, and delivery costs are 10–12% of sales.
Picking is a paid activity in both BOPIS and home delivery scenarios. Also, grocery is a high purchase frequency category and therefore the number of picking trips per unit dollar of goods sold is high. One might think automated picking is the answer. But distribution center-based fulfillment does not really work in low population density markets like the US, because of the need to be closer to the customer. Delivery from a multi-purpose, omnichannel store, and not a warehouse, precludes picking with a high degree of automation.
In addition to costs, store-based delivery is beset with all kinds of problems. You need up to the minute inventory data, a nightmare of technology, process, and people nobody has solved yet. The state of the art thus far — in Litmus7’s experience — is 12 minutes. The lag impedes the ability to present inventory information with any degree of confidence to the online buyer. Due to the problem of up to the minute inventory, there are often errors in the order, and substitutions.
What’s more — store-based delivery hurts in-store experience. It has been said when fulfillment of online delivery becomes 10% of the store’s operations, shopping becomes a drag for the store’s primary constituency — customers physically shopping. “Over-congestion” has become a real problem in Europe.
One solution often proposed is that of carving out a 8,000–10,000 square feet micro-fulfillment center out an existing store. This capacity serves, and only serves, the online customer. Picking is automated, enabled by one of the robotics companies that have emerged in the last several years — the likes of Ocado and Commonsense Robotics. Does the idea stand to scrutiny? It isn’t clear. First, experts are divided on whether automated picking can happen to any meaningful degree without a square footage of at least 25,000. Second, the actual efficacy of picking automation and its impact on number is apparently still up for debate. Two sets of data points need to be summoned — a comparison of Ocado’s number’s versus manual picking numbers, and second, Ocado’s margins.
In 2016, the pick rate at an Ocado facility measured in units per labor hour was exactly the same as a manual picking rate at Albert Heijin, a Dutch supermarket chain. And, the Ocado facility cost GBP 200 million for GBP 1 billion (annual sales capacity) and the Albert Heijin facility cost EURO 10 million for EURO 180 million (annual sales capacity). So the benefits in accuracy and operational cost savings would most likely be offset by an order of magnitude increase in CAPEX. And there would be no significant improvement in order processing rate. And this after 16 years in operation.
Coming to Ocado’s margins, EBITDA was 5.55% in 2018, which isn’t much of an improvement on the typical offline grocery margins of 4 to 8%. However, the number is much better than the typical online grocery margin of 0.5 to 1.5%. Of course, few incumbent retailers can invest the way Ocado can, which is valued more like a tech company.
That was just picking. The other big impediments to online grocery is delivery costs, currently addressed by crowdsourcing. Instacart, Shipt (now a part of Target), and Doordash solve the labor cost problem arguably, and allegedly, through questionable means. Replacing full-time workers with benefits by gig workers pushes effective hourly payouts to close to minimum wage. A recent study found that the average Instacart worker is paid, after insurance and mileage, (which the “independent contractors” pay out of pocket) a mere US$7.66 an hour. This will become more problematic as retail wages rise. Amazon hiked its minimum wage to US$15 in 2018, which was followed by a similar move by Walmart. The din is getting louder on the idea that the gig economy is fundamentally exploitative, and legislation could put at risk the full time employee-crowdsourced partner arbitrage. In California, a law that came into effect in 2018 mandated cannabis delivery workers to be recognized as full-time employees and not contractors.
The two levers on delivery costs are the ability to charge a delivery fee (and/or a subscription) and increase drop density — which follows from a small set of delivery slots. Expectations on delivery costs continue to hunkered down by Amazon. Most retailers charge an annual fee in the range of $90 to $120 dollars and offer free delivery for value exceeding $30 to $60. However, it’s also true that most make losses through this model. About drop density, a Dutch grocery delivery company called Picnic offers only a couple of delivery slots a week, which has raised drop density to 14, 7 times the UK average, and makes possible free delivery above order value of EURO 25.
Due to the range of problems described above, online grocery buyers currently accept a standard of customer experience that is lower than that in other categories. The situation has led to a kind of truce — a cessation of hostilities, and an equilibrium among retailers. However, this is a ceasefire that can be broken any minute, and an unstable equilibrium at best. Any retailer — possibly Amazon — that builds a critical mass of highly automated points of presence across the US, would force everybody to shape up.
The challenges are numerous, but the prize for solving them is commensurately high. Your grocery customer is likely to stick with you during your offline to online transformation — in a survey study by Bain & Company, 85% of customers said if they were to buy groceries online, they would choose their current retailer.
There are indeed a few more levers to pull up margins at least a few basis points higher. The silver lining in grocery ecommerce is basket size, which at just over US$90, is 26% higher than that of curbside pickup, and a whopping 64% higher than the brick and mortar grocery basket. This gives the online grocery some room to nudge the buyer to a few higher margin items — with better data, better data science, and better recommendation engines. A successful nudge could spell the difference between positive unit economics and negative unit economics.
Another, contentious lever is dynamic pricing. While no grocer would want to come across as unfair or profiteering, and most wouldn’t want to come across as expensive — dynamic pricing has gathered enough momentum to warrant serious evaluation. The perception problem can be managed, by careful benchmarking of prices on key value items (whose prices are well known among customers). There are now published cases of dynamic pricing increasing margins by over 4%.
Despite all of the above, online grocery might remain a margin dilutive, even cannibalising channel. For many, it would be a defensive strategy, pursued while keeping an eye on the technology because things could change rapidly with a disruptive move by Amazon. It’s best to continue doing whatever it takes to draw crowds to the store, and keep experimenting with automation, various fulfillment formats, pricing, and delivery strategies.
