The Moment Of Truth For Online Groceries Has Arrived

Its undeniable that the current COVID-19 crisis will be a huge (albeit tragic) boost for online retail. How online grocery retail fares is a different matter. The virus will likely shake down how the different existing operating models fare. The end result will depend on how technology and labor are combined to provide the best customer experience, largest efficiencies and profitability. Let us analyze how the current crisis is likely to affect the different business models.

The first model is labor intensive. It is the ‘Instacart’ business model; an outsourced (for retailers) digital online platform puts together consumers, shoppers and retailers. It extracts a small margin from consumers, retailers and vendors (mostly advertising and promotional fees) in order to support Instacart itself and the personal contracted shoppers it relies upon. The model will see a huge boost as it will benefit from the sizeable jump in demand, the abundance of unprepared retailers, the sudden excess labor, and the relatively social distancing it provides. The only potential downside to the business model is that on the face of increased demand, retailers cut back on the margin they are willing to give up to Instacart. Yes, there will be a net increased demand for groceries in the short and medium term as a big portion of restaurant consumption shifts to in-home consumption. This author believes that the current year will see outstanding results for Instacart as well as its close competitors Ubereats, Grubhub, Doordash and Deliv.

The second model is the highly automated online grocery model. It is the ‘Ocado’ business model (named after the purely digital online UK grocer); a digital platform backed by a highly robotized in-house supply chain. The limitation of this business model is already evident. Despite the much-vaunted argument that it would certainly reach profitability when sufficiently large economies of scale were reached, Ocado announced last week that it was no longer taking new customers and that it would limit orders for existing customers (please read Ocado’s official policy here). Why? The official corporate line is that on the face of above normal demand, Ocado decided to prioritize its existing customers. It sounds logical. This author believes, however, that there are also strong financial arguments to support such a restrictive move; when a business loses an estimated $ 5.00 – 7.00 per delivery, it simply cannot let the order flood gates open. It must restrict orders to those contemplated in the annual budget. So much for the economies of scale argument. The strategy would surely be different if the company made a healthy profit on each delivery. Additional resources would be quickly mobilized and reallocated. This is not the case, however. Expect Ocado to thus continue piling loses in 2020.

The third model is based on the Walmart click and collect groceries business model, that we are going to call ‘Pickup’ (after the namesake service provided by Walmart). This model, currently has two variants; manual in-store fulfillment and automated micro-fulfillment centers (MFC).

Manual in-store order fulfillment is the preferred model of most retailers who use this service including Walmart itself, but also Amazon and its Whole Foods division. It is based on store personnel literally manually fulfilling online orders to be delivered to customers curbside (like in Walmart’s ‘Pickup’ service) or front door (like Amazon’s Fresh). The main issue with this fulfillment variant is that it not only primarily cannibalizes its in-store customer base, but does so at a higher cost and lower efficiency levels than the traditional brick and mortar model. Resources have to be re-allocated from store duties to fulfill online orders. The end result is a substantial decrease in net margins. There are signs that Walmart is already trying to minimize this effect by undertaking a massive cost cutting initiative at store level in order to preserve online orders and thus keep a fighting chance against Amazon’s online groceries growth. Even if Walmart successfully defends its net margins, it is very likely that the in-store experience will continue to suffer. Walmart is in effect following Amazon’s bidding; actively deteriorating its in-store experience trying to chase the rabbit of online grocery delivery rather than enhancing its in-store experience. Expect higher revenue than expected for Walmart in 2020, albeit at much lower profitability levels.

Amazon’s vantage point is radically different than that of Walmart. Subsidized by the tremendously successful AWS division it can easily afford to ‘featurize’ online groceries (letting retail groceries become a ‘loss-leading’ category in its constellation of Amazon services). Amazon’s growing online groceries can only increase the addiction of its loyal household customer base. In the context of things, small delays and shortages of key products will be a small price for households to pay in order to reduce the risks of contracting COVID-19. The Amazon revenue bulldozer will continue moving forward in 2020.

Other retailers, will face a difficult decision ahead; manual fulfillment of online orders come along with a significant loss per delivery. Unlimited order fulfillment will drive unlimited losses. Expect many of them to cancel online ordering, under varying pretexts in the weeks ahead, in order to preserve their viability. Most will see sales increase beyond estimates at much lower profitability levels.

The second variant of order fulfillment is being piloted by a handful of retailers nation-wide. It consists of automated MFCs, usually unseen by the public but located in the back of stores or in ‘dark stores’ in densely populated urban areas. These highly robotized MFC can fulfill orders much more efficiently than their manual competitors. The increased efficiency should translate in increased profitability. These retailers will thus also experience a significant increase in electronic orders. As opposed to the ‘manual fulfillment’ brethren, and barring lasting crippling supply chain shortages, these pilots should thus quickly justify their investment. The time of reckoning will have arrived for these projects; having reached critical ordering mass, most of them should be profitable.

The next few weeks will thus see a shake down of online grocery players and operating models. Most will face difficult dilemmas; stop taking online orders or face mounting loses. A few will come out of this crisis relatively unscathed. As always, only the fittest and strongest will survive. This author believes that by the end of 2020 only a handful of online grocery players will remain. Interesting times for online grocers indeed.