Corporate venturing for European online groceries.
A case study for corporate unfair advantages in European online groceries.
Quick summary
Selling groceries online (online grocery) is a difficult business. The traditional retail business of selling groceries (retail grocery) is a highly competitive and low-margin business. To move that business online successfully, a critical mass of consumers will need to adopt for the cost of the business operations to make sense. Even then, only online grocery ventures with sufficient scale will be able to survive in the long term, offering competitive prices while maintaining some level of profit, just as it has evolved in the retail segment.
For these reasons, we believe online groceries is a prime example of an opportunity best suited for corporate venture building; incumbents not only have a significant unfair advantage of scale resources to outcompete a startup “in the wild”, but may be the only long term sustainable player in the space.
Consumers want it all
Consumers demand low prices on a broad, diverse, and ever-changing selection of fresh and packaged food products. In just that one statement is a set of requirements that when combined, compounds the complexity of the business’ operations to a high degree. But really, only by meeting these requirements will we reach a tipping point for consumer adoption.
A difficult proposition to achieve online, so far
Whereas retail groceries have gone through decades of innovations to optimize and achieve profitability, online groceries require a new set of still-evolving technologies and processes that are far from optimized.
E-commerce fulfillment — case in point, where much of the recent innovation has been driven by Amazon and other major e-commerce marketplaces globally. Amazon has invested billions in fulfillment centers and the technologies that control, process, and automate its fulfillment operations. Amazon started in books and now sells just about everything online. And even then, it seems Amazon continues to struggle sustaining its grocery business, shutting down Amazon Fresh businesses in many cities in the US as well as in Germany.
Groceries is a difficult e-commerce category because consumers want a broad and diverse selection, which means a massive number of inventory SKUs and a labour-intensive pick-and-pack process. Perishable products add to the cold chain infrastructure requirements as well as complexity of inventory management and risk of inventory loss. Furthermore, the desire for new and seasonal items means a constant updating of product pages and promotional content. That’s quite a higher intensity of operational requirements than selling books, shoes or candles. Alibaba’s Freshippo, which operates in China, carry 50,000 products SKUs online. Tesco carries 30,000 product SKUs online.
Groceries are generally lower margin products, and so optimisation is crucial to achieve profitability. That’s the context and rationale for the application of robotic technologies in e-commerce fulfillment of online groceries. Outside the massive operations of e-commerce players like Amazon or Alibaba, the lack of scale and complexity of most other e-commerce businesses means they can run just fine without robotic automation. But to make online groceries even feasible, robotic automation is the table stakes. Check out Ocado’s automated warehouse in Andover, which can process up to 190,000 customer orders per week (Ocado reported 345,000 average weekly orders in the third quarter 2020). This might be the cutting edge, but it’s the scale and efficiency of fulfillment operations required to make online groceries possible.
This might be the cutting edge, but it’s the scale and efficiency of fulfillment operations required to make online groceries possible.
Last-mile delivery — National post services and global parcel delivery companies are mature players in the space, meanwhile a recent crop of on-demand delivery companies have emerged. As a product and service, though, delivery is basically a commodity, with price and product differentiation mainly around speed of delivery.
The challenge with online groceries is the delivery requires a controlled cold chain, a significant infrastructure challenge for even the leading global logistics companies. There’s also the hard requirements for convenient and narrow delivery windows. And this is significant — if you miss the delivery it has real consequences for a family’s evening that other product categories simply don’t.
What is needed for online groceries is essentially a premium, on-demand delivery service.
What is needed for online groceries is essentially a premium, on-demand delivery service. Combine that with the low margins of products, the consumer’s reluctance to pay a premium for something that can be easily pick up at the corner store, and you find a business between a rock and a hard place.
Today, cold chain infrastructure is underdeveloped and on-demand delivery services are still growing up. For the latter, these are billion dollar market cap businesses including Deliveroo, Grubhub, Postmates, DoorDash, Uber Eats, but compared to traditional logistics businesses these businesses are very much in the early stages. Many of these companies are struggling to turn a profit, despite all of them primarily focused on a comparatively higher margin product in restaurant meals.
Corporates can tip the scales
A critical mass of consumers will need to adopt online groceries for the cost of the business operations to make sense. Even then, only online grocery ventures with sufficient scale will be able to survive in the long term.
This is where corporates will have an unfair advantage.
Infrastructure — Online groceries will require fulfillment warehouses and last-mile delivery networks. In terms of scale, there’s the number of warehouses and the size of warehouses, which will vary in need depending on the region’s geographic features and population distribution. For example, the UK is highly centralized in the south with London, so you would need a smaller number but much larger warehouses, whereas Germany is distributed across several smaller cities and so will require many more but perhaps smaller warehouses.
Corporates with existing infrastructure assets, be it warehouses, driver fleets, existing retail chain network, will have an unfair advantage over startups in the wild. Supermarkets and other incumbents with existing networks of retail stores have also the specific advantage of doubling their in-store inventory for e-commerce. In-store fulfillment, though, can be operationally complex and experientially quite disruptive to a shopper. Tesco in the UK have gone through various iterations of fulfillment models for online groceries, experimenting with in-store fulfillment and then shifting primarily to dedicated depots during the mid- to late-2000s. Today, in-store fulfillment or “dark stores” are making a comeback.
Integrated operations — Crucial to deliver a seamless shopping experience. From last minute basket changes, to replacing a sold-out item, to rescheduling a delivery, the business needs to be responsive to changes in real-time. A business that fulfills through one third-party partner, and delivers through another third-party partner, will be unable to deliver that experience.
An integrated operation is also crucial to deliver on profitability. With low product margins, it is important to consolidate functions and remove the margins paid to intermediaries and partners.
Amazon has been at this for some time now, investing billions into its own fulfillment networks in many regional markets, a truly global logistics networks, and local last-mile delivery fleets. And as Amazon Fresh continues to struggle to find a foothold, we can’t imagine how a new entrant would delivery a vertically-integrated online grocery business. But we can imagine how a large incumbent with unfair scale advantages might be able to.
There’s still time
The pandemic has led to a huge surge in first-time users as well as more frequent use by existing users, but even then, we’re still quite early in the adoption curve. In the UK, online grocery spend accounts for 7% of total grocery spend, pre-pandemic (up to 13% during the pandemic). This compares to all online retail spend as a percentage of total retail spend of 22% (up to 32% during the pandemic.
Meanwhile, in Germany online grocery spend accounts for just less than 2% of total grocery spend, pre-pandemic. This compares to all online retail spend as a percentage of total retail spend of 14% in 2018.
Regardless of how much user adoption will sustain in the near-term, the long-term trends of convenience shopping are hard to ignore. Compared to more advanced e-commerce markets in the US, China, and certain Asian cities, and it’s clear there’s still a lot of upside for UK and European markets.
In short, there’s still time to break into online groceries. And it’s an opportunity reserved for an exclusive set of highly scaled companies.
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