Tesco is set to unveil its choice of US partner to take its fast growing online service overseas. The latest news from the US suggests that making money out of online grocery retailing is still proving difficult. But, unlike its warehouse-based rivals, Tesco believes that its store-based model will succeed where they have failed, perhaps drawing a line under the recent dotcom failures.
On the face of it, the outlook for online grocery retailers in the US looks bleak. Webvan is likely to exhaust its cash reserves by the end of Q2, Peapod is retrenching to the East Coast and GroceryWorks is locked in a battle with its bricks-and-mortar partner, Safeway.
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So what is going wrong? The crucial issue is that although Americans have high levels of Internet access, home delivery grocery services have failed to capture their imagination, resulting in a severe revenue shortfall against the plans of most operators. At the same time, most US operators have chosen to build expensive dedicated warehouses to fulfill customer orders, entailing high start-up costs. Webvan for instance spent $25m on its original warehouse, a level of investment that requires 3,000 orders per day to begin to cover its costs because of the notoriously thin margins on groceries.
Tesco, however, relies on a different distribution model, believing that warehouses are not an intrinsically efficient way to fulfill customer orders, as they replicate the functions of supermarkets. Moreover, because consumers’ willingness to buy online is still low, Tesco has calculated that a catchment area of 2 to 3 million consumers is necessary to support a single warehouse. But such a large catchment area means that delivery vans have to travel long distances to reach far-flung customers, increasing delivery costs and threatening reliability.
Tesco’s solution is to use its own stores to fulfill customer orders, a system that maximizes the capacity of its existing stores and distribution infrastructure. Tesco has yet to reveal the identity of its US partner, saying only that it is a Top 20 retailer and that the venture would involve the sharing of technology, management and software. Rather than buy a struggling pure play, a joint venture of this nature is a low risk way of entering the market and one that may mark a turning point in the fortunes of US grocery eTailing.
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