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  1. Analysis
July 27, 2011

Online food retail – managing cost is central to success

This month's exclusive just-food management briefing looks at online food retail, a growing sector but one that operators have found a tough nut to crack. In part one, Glynn Davis argues that the cost of running an online service has stymied a number of ventures and will be a key factor in determining where the channel flourishes.

This month’s exclusive just-food management briefing looks at online food retail, a growing sector but one that operators have found a tough nut to crack. In part one, Glynn Davis argues that the cost of running an online service has stymied a number of ventures and will be a key factor in determining where the channel flourishes.

When Tesco chief executive Philip Clarke announced in June that the UK retailer’s grocery home delivery service was being extended into Prague and Warsaw and would then hit Shanghai, Bangkok, Budapest and Bratislava, it signalled how important online grocery is to the company.

Such has been its success in the UK, Ireland and South Korea that Tesco realises it can roll out its service to a global audience of consumers who want to shop for food online. Their shopping habits are changing as they embrace technology and Tesco is the world leader in sating this appetite.

“The digital revolution is turbo-charging globalisation. New technology is breaking down the old ways of doing things and successful retailers need to be multi-channel,” Clarke said.

David Smith, managing director of IMRG, the industry association for global e-retailing, says Tesco’s ambitions suggest it is one of the extremely rare beasts in the food industry that have worked out how to make money from online food retailing. 

“You have to admire them for their long-term game. Its profits [from online] are hidden but if it was not successful in the UK then they’d not be doing it overseas. If they’ve cracked it and nobody else has then clearly they’ve decided to roll out,” he says.

Online grocery shopping has certainly been problematic over the years. Webvan was a particularly big flame-out in the US after losing billions of dollars of investors’ money. Safeway Inc’s GroceryWorks.com needed an injection of funding from Tesco when it hit the rocks. And Ahold-owned Peapod has had big ups and downs. In the UK, Asda and Sainsbury’s have made strategic U-turns since the dotcom boom and numerous newcomers have bitten the dust.

As with all internet-based businesses at that frenzied time, there was some over-hyping and the reality failed to catch up with overblown expectations. But, on the tenth anniversary of Webvan closing its virtual doors, there are now a modest number of successes in the global marketplace.

A recent report from Research Farm – “Online Grocery Retailing in the EU and the US 2010” – pointed to three European players that have made online grocery work. Tesco, Chronodrive in France and LeShop in Switzerland. These may well be the models for others to adopt [see section on case studies].

The big inhibiting factors in online grocery growing is the crucial “last mile” – the point of retailer contact with the consumer – and the core issue of cost. There is no doubt the running of a delivery service is much more expensive than operating a store.

This issue of fulfilment is therefore very much at the heart of online grocery retailing. The big question for retailers is whether they offer a full home delivery service or take the more cost-conscious approach and go with a click-and-collect proposition [see section on key operating models].

Daniel Lucht, senior consultant at Research Farm, says click-and-collect models are akin to a McDonald’s Drive-Thru with orders made online and customers then pulling up at the depot to collect their goods the next day. 

“Click and collect has been massively successful as it’s removed delivery charges, there’s no delivery slots to consider, no fulfilment costs, no vans, and a lot of the frustration of [the last mile of] home delivery has been taken away. The depots require few people and can be positioned on the edge of towns,” explains Lucht. 

For those retailers who prefer to offer the home delivery option, Will Treasure, director of operations and technology consulting at Javelin Group, says food presents additional complexity compared to non-food. Treasure says the nature of food – with its ambient, frozen and chilled products – means retailers are unable to use third-party carriers and so need to develop their own costly delivery networks.

The model chosen is very much down to the local markets. One of the reasons the UK is at the forefront of internet shopping is that the high population densities help reduce delivery costs (through having less distance to travel to deliver a full van of orders) and the high commercial property costs in the country, which leads to higher gross margins being charged for food in the UK – typically 30% compared with 25% in the US and the rest of Europe.

The technical infrastructure is also a factor. Jake Hird, senior analyst at Econsultancy, says Australia has had little investment put into broadband and education about the internet. The infrastructure for internet grocery shopping is “lacking” he says and it only started to appear two years ago.

However, there is lots of activity now taking place in Australia, according to Jamie Trust, senior business analyst at grocery experts IGD, who points to Coles Group as having launched a click-and-collect service that uses its forecourt stores as order collection points.

Another critically important aspect is the affluence of local populations as this helps ensure there are regular customers who will order large average basket sizes. Treasure argues that, in mature markets like the UK, orders need to include at least 60 to 70 items at an average price of GBP1.50 (equating to a total order of around GBP100) to make home delivery profitable for retailers. According to Lucht, the reality is that, for price-sensitive markets, the click-and-collect model might be the only viable option.

With success depending on such finely balanced financials, it is likely that decisions to launch online grocery services will be determined on a city-by-city rather country-by-country basis. This is why Tesco announced its roll out to specific cities and why US online retailer FreshDirect works well in New York. And why the Amazon Fresh delivery service in Seattle might not stack up quite so well financially, according to Treasure.

At IMRG, Smith agrees and believes this is why it is unlikely that the full national delivery coverage offered by various players in the UK will be replicated in other countries. However, even with the country’s near-100% coverage, he says online grocery still represents only 6-7% of total UK retail sales.

This could signal caution for other countries, Smith suggests. “We think online grocery shopping is large but actually it is quite small. Lots of overseas operators around the world will be looking and thinking is it worth it when you need to spend so much money on a huge infrastructure.”

The level of online sales is much lower elsewhere in the world – representing less than 1% of total retail sales across the EU and in Germany specifically it only accounts for 0.5% of sales, according to Research Farm. Meanwhile in the US, online sales account for a much heftier 5.7% of total retail sales – equating to $10bn in 2010, according to market research firm Forrester.

The decision by food groups to move into the market is therefore largely predicated on future growth prospects. And, according to Research Farm, there is growth on the cards as it predicts online sales within the EU will grow to account for 3.6% of total grocery sales by 2015. 

These sorts of numbers appear to have been sufficiently attractive for Wal-Mart Stores to finally dip its toe into the online grocery pool. It has launched a Walmart to Go service in San Jose that uses a store-picking and home delivery model, while it has made a push into China with the purchase a minority stake in online supermarket Yihaodian.

The appeal of the Chinese market is obvious. Trust says there are currently 500 million people in China using the internet and the technology is now “firmly embedded” in people’s lifestyles.

For more of this just-food management briefing, click here.

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