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Opinions expressed on this blog reflect the writer’s views and not the position of the Capgemini Group

Profitability in online grocery: is the refocus too late?

Last year, Tesco announced the minimum online grocery order value for home delivery was increasing from £25 to £40 (or an extra charge would apply). This was a real departure from Tesco’s previous strategy, and one that Asda had already made several months earlier. There appears to be a focus shift away from volume-based growth to one of profit-driven.

The race for market share

During the early days of online grocery shopping, retailers regarded the internet as an innovative opportunity to reach customers through a new channel. However, it divided opinions: would it cannibalise in store sales, or drive the next wave of growth? Eventually, it drove a ‘must invest’ mentality.

This led the big UK retailers into a ‘race for market share’, with the aim to serve a growing customer base. Over time, improvements to the customer proposition have been tremendous, and so have been the large investments in logistics (new van fleets, dotcom centres, etc.). This made it clear that online grocery retailing was there to stay.

A hardly profitable operating model

To prepare, process and deliver groceries, retailers incur greater costs than with the classic store model. Traditionally, retailers spend money to display items (labour costs), customers pick them, and this results in a simple responsibility split. However, with online retailing, many stores now assume both the roles of ‘pseudo’ customer as well as retailer. This shift incurs additional costs, not all of which are handed on to the customer.

For most deliveries, retailers impose delivery charges; but do these cover the true and total cost of additional retailer effort in the picking, packing, despatching and delivery of online groceries?

Not even close. Average prices applied by retailers are not high enough to cover the costs incurred. When considering the fully loaded cost of all activities involved in the end-to-end process of online grocery deliveries, where do you start and finish your calculations? Retailers already have their stores, with fixed costs (ie rent, lighting, etc) that do not vary with the creation of a new sales channel. Ideally, the online sales channel would cover the online operations costs and contribute to covering the fixed costs of physical stores. However, numbers show that this balance has yet to be reached.

What can be said is that the very low charges (which are sometimes free) of home delivery services were understandable in the early days, when retailers were focusing on creating demand, growing sales volume and developing customer loyalty. Fast forward to the present day, and question whether this model is still relevant. Shareholders demand greater return on their investments, and the ever tighter margin squeeze is increasingly unforgiving.

A refocus on profitability?

Reasons for the new focus on profitability could be numerous. It goes from changing shopping habits to ‘little and often’, meaning online retailers deliver smaller baskets (which are less profitable); to the rise of discounters in the UK. Furthermore, the costs of property, fuel and the pressure to control food inflation have seen retailers tighten their belts and be increasingly cautious. Margin management is a greater challenge than ever, and retailers simply cannot afford to invest in capabilities, products and services that are unprofitable, or that make less profit than other investment options.

To enable profitability with such an operating model, retailers have to be creative, continue to evolve, and invest only where they can afford it. No easy feat once customers’ expectations have already been set quite high.

So, what are the options open to retailers?

  • The obvious is to increase the price of delivery. It will help to cover operating costs and encourage larger basket sizes (if a minimum order value is stipulated). The price to charge is a question in its own right: finding a balance between the costs covering and the drop off in order volumes won’t be easy, and increased charges are a sure way to drive your customers into the waiting arms of your competitors.
  • Consider how to drive a better margin-mix in each customer basket. Enable vans to deliver a mixture of basket types on each run to allow for greater profitability overall.  Driving better up- and cross- sells would be crucial here, as well as what not to offer.
  • Bring food service deliveries and online grocery together. Takeaway delivery companies show how home delivery of low-margin products can be made in a profitable way. Is there a potential for the development of strategic partnerships that would maximise the profitable use of vehicles and journeys?
  • Further invest in the Click & Collect format: Remove the delivery element of the online grocery proposition, charge a premium for home delivery and instead encourage customers to collect themselves. The ‘drive-through’ format took off across Europe and more recently in the UK. Understanding why customers use grocery online and their preferences around charging, convenience and location for delivery may drive out surprises – how convenient is home delivery really when tying yourself to a time slot? What do customers really value and what are they prepared to pay for?
  • Use the new network capability to be open to third party retailers. Having built their delivery capability, retailers could leverage it further to deliver items from other retailers/ businesses. Could this be a way of covering costs a different way, enabling the low cost of online grocery deliveries to remain?
  • Develop partnerships with pure delivery companies:  If the deals were structured correctly, maybe outsourcing delivery could be a mean of providing the same service, at a lower rate.
  • Crowd-source or leverage new services such as Uber: Aside from the health & safety questions this would raise, an element of crowd-sourcing could help reduce last mile delivery costs, as well as inject capacity to a somewhat crowded market (particularly within the M25).

 

As volumes show no sign of slowing down, retailers have no choice but to change their approach. They must refocus on a business fundamental – profitability. Growth at all costs is no longer sustainable, and the future approach must move on from current thinking.

About the author

Justine Fargin
Justine Fargin
Justine is a Consultant within the Retail Operations capability for Capgemini Consulting UK. Justine has retail experience at a leading international groceryretailer, specialising in eFulfilment and project management within IT services.

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