If you have been reading this blog for a while, you might have concluded that we have a thing for grocery stores. In some ways it’s an occupational hazard. It is a low-margin, high-volume business that touches millions of people. Consequently, it is a setting where even small operational innovations have big payoffs. Thus an article on Ocado in the current Economist caught my eye (Keep on trucking, Jul 15). Ocado, for those who missed Gady’s earlier post on the firm, is a British online grocer that is on the verge of going public. They have built a honking huge automated warehouse outside of London that features 10 miles of conveyor belts (according to the article) and sells as much as 25 supermarkets do. Unlike 25 brick-and-mortar stores, however, Ocado doesn’t yet make money.
Online grocers that lose money are about as unusual as Cubs’ seasons that disappoint. What makes the article interesting are some of the numbers it gives about why they lose money:
Grocers, on the other hand, sell perishable products that have to be kept frozen or cool and that must also be delivered at specific times. To make matters worse, online grocery shoppers tend to want their food delivered at the beginning or end of the week, leading to a crush of orders.
All this is expensive. Some analysts reckon it costs £20-25 to deliver groceries to a British house. In large parts of America, where population densities are lower, it would be much costlier. And although customers currently bear the expense of going to stores themselves, they are reluctant to pay for their shopping to be brought to them instead. Nielsen, a research firm, found that the two most common reasons Americans gave for not buying groceries online were delivery costs and the desire not to have to wait for a delivery.
Part of why the costs are high, of course, is that this becomes a fairly capital-intensive business. The fact that everyone orders in a relatively limited window complicates matters. Effectively, Ocado has to size its operations to handle the peak load of Saturday morning and then watch trucks sit idle on Tuesday afternoon. The average cost of each delivery is then high and may well stay high even if there is greater market penetration as long as new customers still prefer limited delivery windows. This also suggest that filling orders from regular stores — as Tesco does — is not a perfect alternative. Tesco’s aisles are going to be crowded with Tesco employees trying to fill online orders at roughly the same time Tesco shoppers want to be in the store.
It will be interesting to see whether investors buy Ocado’s story and shares when they have their offering.