Tesco has built up a substantial 48% share of the UK online grocery market

Tesco has built up a substantial 48% share of the UK online grocery market

Tesco, the UK's largest retailer, has had some difficulties in recent months in its domestic market. However, the company accounts for almost half of all grocery sales online and, as Michelle Russell writes, it is looking to tighten its grip on the channel.

Given that online grocery sales in the UK are set to almost double over the next five years, it is no wonder then that retail giant Tesco is intent on capitalising further on this growth.

Having entered online grocery in the mid-1990s, the retailer has been built a substantial 48% share of the UK online grocery market.

UK industry analysts IGD forecast that online grocery sales will hit GBP9.9bn (US$15.72bn) by 2015, compared to estimated sales in 2011 of GBP5.9bn.

In the first half of Tesco's current financial year, six months that ran until 27 August, online grocery sales increased at a "high single-digit" rate and the retailer is investing to ensure it remains strides ahead of its main rivals.

The retailer recently spent around GBP30m in a "dark store" in Enfield, the same level of investment it would make in big store development, demonstrating the importance of online to Tesco.

The dot.com store is its fourth in the UK, its first opening in Croydon, south London in 2006. This latest 115,000sq ft store, however, is its most automated to date, allowing staff to pick twice as many products per hour as the existing three.

Such stores explain how Tesco is managing to close in on grabbing almost half of the market for food on the internet in the UK. And with the retailer set to open "at least one more" facility in London early next year, competitors will need to work hard if they are to stand a chance of creating any serious competition for Tesco.

Shore Capital analyst Clive Black believes the retailer has built its dot.com business up to the point where it is not immaterial to the group in the UK.

"To my mind, it's an important part of customer retention if nothing else, in making sure the customers who wanted to shop online didn't leave Tesco," he tells just-food. "It has been quite a disciplined venture from a capital expenditure perspective and not particularly debilitating from a loss-making context."

Black believes Tesco has been reasonably effective in "squeezing out as much as it can" from online grocery, in London, in particular.

"These dark stores have opened, so they are taking the disruption of dot.com out of stores and looking at a lower cost model again," he says.

Aside from the Enfield site, Tesco has three other 'virtual' stores in Croydon, Aylesford, Kent, and Greenford, Middlesex, to meet soaring demand in densely populated areas. The fifth is reported to be in Crawley, although Tesco has declined to give specifics on location.

Simon Chinn, lead consultant at retail research agency Conlumino, believes online retail has become "massively important" to boosting Tesco's performance in the UK. The UK's largest retailer has had challenges in its domestic market in recent months, with underlying sales falling for four successive quarters.

"As you look at the way that the retail sector is going now, it's gradually moving online, it's not just non-food categories, we are seeing a growing increase in spend of food going online as well," Chinn tells just-food.

"And in terms of its online food and grocery offer, Tesco has got that quite established in the UK. With the announcements of the dark stores opening, it is expanding its capacity to supply new catchment areas, and is also becoming quite innovative in trialling new concepts with Click 'n Drive, so it has put quite a lot of investment and focus on this area."

Competition, however, has appeared to be less innovative, with Ocado in particular having a less well engineered model.

Ocado's share of the UK online retail sector is understood to be around 14% but analysts have voiced concerns about the online retailer's prospects, even after it posted a reduction in full-year losses. Neil Saunders, managing director of Conlumino, said Ocado was "moving in the right direction" but expressed concern over "thin" profitability and increasing levels of competition.

Black says: "Too much capital has been applied to the Ocado model. Tesco has pretty much used a common sense approach."

On Tesco's other competition, Black says: "Bear in mind that Asda has got a relatively immature online grocery proposition still, it is not as authoritative and is not as well set up as Tesco and Sainsbury's. Morrisons and Marks & Spencer aren't in the game yet and Waitrose has only just started. I think we should expect that 48% to come down but for online grocery to still grow at a faster rate than store-based sales of Tesco."

Chinn believes increasing competition will mean Tesco will have to focus solely on improving all aspects of its online offering, from website functionality and shopping lists, through to the fulfilment of orders, and making sure deliveries are made on time.

"It's an all-round online package that needs to be good in order to get people to use the service on a regular basis and not switch around."

There is no doubt that Tesco's dark stores will form a major part of its growth in online food retail, as it increasingly moves towards the dedicated warehouse model.

"There is a lot of work that Tesco has got under way at the moment, which I think will take two, three, four years to fully come through," Black says. "But for some products, particularly non-food, these will go completely online and we see multi-channel gaining emphasis. In major urban areas where stores are disrupted by online, then we can expect more dark stores."

Chinn shares this view. He believes Tesco's virtual stores can be used to support non-food and grocery.

"The model works profitability for them. I think we will see a strategic roll out of these stores in larger catchment areas to support that online demand for grocery. There could be scope for others to trial a similar concept, so competitors like Sainsbury's and Waitrose."

The internet accounted for 3.8% of total grocery spend last year. By 2015, online is set to have a 5.4% share of the UK grocery retail market, a larger share than that of the discount channel, according to IGD.

For all Tesco's recent challenges in the UK, its strong foothold in online food retail means it is in a prime position to capture the lion's share of this growth.