Can the technology-based Ocado hold its dominance in an increasingly crowded market, as its delivery base shifts from one supermarket chain to another?
If two words could strike fear into the hearts of procurement and supply chain executives at Marks and Spencer (M&S), they would probably be Castle Donington. When the fully-automated 900,000 sq ft distribution centre (DC) opened in 2013, it was part of a plan to consolidate a network of small warehouses for the retailer’s clothing and home products and the growing number of online orders. At the time, M&S said the flagship DC was big enough to hold 2.392bn Percy Pigs – its signature sweets – and capable of processing 1m products a day.
But within 18 months, Castle Donington was processing a third fewer items than expected, according to reports, and in 2018, M&S admitted in its annual report: “Castle Donington was built at great expense but is never likely to achieve planned capacity, lacks resilience and cannot currently meet peak demand.”
It is perhaps not surprising then that, when launching an operation in 2019 to meet the UK’s growing appetite for online grocery orders and home deliveries, M&S opted for an off-the-shelf solution, in the form of Ocado, the UK-based technology company with an online smart platform that sits behinds its own Ocado online supermarket service.
“M&S royally messed up its non-food home delivery services,” says Darren Smith, former category manager and founder of training provider Making Business Matter. “They couldn’t get the IT system to work and had invested in very expensive automated warehousing. The Ocado deal hands all the technical and logistical problems to Ocado, who have a proven track record of making this type of operation work smoothly and effectively.”
M&S paid £750m to form a joint venture (JV) with Ocado in which M&S acquires a 50% share of Ocado’s retail business. “For M&S the rewards are enormous,” says Smith. “They are years behind Tesco, Sainsbury’s and Waitrose in offering home delivery. It is one of the fastest-growing segments of the market and is forecast to grow substantially in the future as our shopping and eating habits change. The tie-up with Ocado gets them in the game within 18 months with a fully tested, respected system.”
However, it’s unlikely to be all plain sailing for those working behind the scenes in procurement and supply to make a success of the partnership, which comes into effect in September 2020. At this point Waitrose steps away from Ocado and M&S takes over. With Ocado planning to stock 6,000 M&S products, against the 4,000 it sells under its deal with Waitrose, range expansion may be an issue, says Will Hayllar, partner in the consumer goods practice at strategy consultants OC&C.
“The basket size and shopping mission of an online grocery shop is quite different to the more convenience-focused missions, which the majority of M&S food stores have been serving,” he says. “Can their current suppliers do that, are there gaps where they need to find new suppliers?
“I don’t think it will be a task of having to go out and find lots of new suppliers, but it will still require development of range, approval of products and specifications, designing packaging, making sure the technical details are clear. It’s a significant amount of work.” Dave Howorth, director at consultancy Scala, agrees the JV will present challenges. “Product availability is a critical success factor and M&S has tended to lag behind other grocery retailers in this area. M&S’s procurement and supply chain functions will certainly need to adapt and step up their game.
“The partnership is likely to bring with it more delivery points for suppliers to consider, which will bring an increased cost-to-serve. Because of this, understanding their cost-to-serve will be vital for suppliers when considering their capabilities to service particular distribution centres more frequently.”
For Ocado, a big plus from the M&S deal will be the disappearance of the “sourcing fees” it pays Waitrose, which totalled more than £15m in 2018. And the £750m injection of capital from M&S will also be appreciated after the Ocado group posted a £214.5m loss for 2019. These results were not helped by the fire at its high-tech automated warehouse last year – thought to be caused by an electrical fault – which cost £111.8m.
Ocado plans to spend £600m on new customer fulfilment centres in locations that include the UK, Canada and France, and to roll out its Ocado Smart Platform – the digital system underpinning its operation – to more retailers including Kroger in the US, Coles in Australia and Aeon in Japan. “Ocado’s motives were pretty much financial,” says Smith. “M&S were willing to sink a whole load of capital into the business to get this deal away.”
Throughout all this, Waitrose has not been standing still. It is reported to be working on 5,000 new or reformulated products and Waitrose.com, which claims to deliver to nearly 84% of active UK postcodes, has received more than £80m in investment over the past five years. The firm is also trialling “Rapid Delivery” in London, where they deliver within two hours of ordering, and “While You’re Away”, a service that delivers groceries to customers’ homes when they’re out and puts them away in fridges or on countertops. In case you’re wondering, the service relies on customers installing keypad door locks and delivery staff wearing chest cams.
“It’s been a long time coming for Waitrose and they’ve been planning for it – a multi-year decoupling from Ocado,” says Hayllar. “I’m sure they will see this switchover as a point in time when they market heavily to try and capture Ocado shoppers that they hope are still keen to buy Waitrose products.” And despite the arrival of Amazon into the UK home delivery market, Waitrose is possibly the biggest challenger for M&S and Ocado, the latter of which currently boasts a customer base of 795,000 and a 14% online grocery market share. Is customer loyalty with Ocado or Waitrose?
That’s the fundamental question, says Dr Gordon Fletcher, director of business 4.0 at the University of Salford: “Waitrose makes clear statements about the provenance of their food. ‘This is cheese from a remote corner of Umbria’, rather than, ‘This is cheese’. M&S relies on their badge.” Hayllar says Ocado’s ability to offer like-for-like alternatives to customers will also be critical. “For many consumers, M&S is high quality but more limited and skewed towards convenience in their minds, so actively demonstrating that is no longer the case and there is a full range of products available will be pretty important.
“With online shopping, people are pretty reliant on favourites and frequently-shopped items, so the more cleverly they help people work out what the equivalent product is, the more likely they’ll retain those customers.” But he believes M&S has a bigger picture in mind. “Part of M&S’s motivation is not just getting access to an online channel; that channel also creates demand for a broader range of private label products. That complements what they’re trying to do with Food Halls. They are increasingly trying to offer a full shop experience, rather than topping up on specialities and convenience items.”
This would appear a sound strategy, as food is the one area of M&S’s business showing sales growth. In the results for Q4 2019, food sales grew 1.5% to £1.7bn, while clothing and home sales dropped 3.7%. Supply chain problems in clothing and home are well documented, with senior level departures last year leading to the appointment of Paul Babbs from Adidas as chief supply chain officer. Meanwhile, M&S has a long-standing target to achieve cost savings of at least £350m by 2020-21.
In a video to investors, CEO Steve Rowe said: “I have always believed that our food business could and should be online. Our investment in a fully aligned joint venture with Ocado answers this and accelerates our food strategy by enabling us to take our food online in an immediately profitable, scalable and sustainable way.”
But Howorth sees danger. “An online food offering is highly likely to reduce in-store footfall in favour of online food shopping in local M&S stores. This in turn means there is a danger that sales of non-food items, such as clothing, will fall further, which would have a knock-on effect on total company revenues.”
Smith adds: “Food is the only bright part of M&S’s business and has been for the past five years or so. This deal could improve the overall business sales and profitability, but will do nothing to obviate the structural problems they have in their clothing business, which is being literally eaten alive by smaller, more responsive, cheaper newcomers and rivals.”
He believes the deal will create “huge competition for Waitrose and may impact Tesco and Sainsbury’s”, but sees something else cooking in the market. “Longer term, it is the growth of home-delivered ready to eat – takeaway food – that is the massive growth sector and opportunity. Just Eat and Uber Eats will be joined by some or all of the big supermarket players as this market blossoms. M&S would be best-suited to grabbing a slice of this emerging sector, given its procurement expertise in high quality, innovative and convenient food.”
David Read, chairman of consultancy Prestige Purchasing, is less convinced. “There is little doubt that the lines are blurring between retail and foodservice. The bit I cannot imagine at this stage is how a retailer might mix a ready-to-eat hot-food service with their grocery deliveries. Food supply chain speeds vary: very fast – home delivery; fast – fresh product; or slow – ambient or frozen. Mixing these often destroys the economics, so I think it will be some time, if ever, before we see M&S or Tesco competing with Deliveroo. But it will be interesting to see how far existing foodservice brands become fashionable in a chilled retail environment for finishing in the home kitchen.”
A problem with the basic economics of home delivery cannot be overlooked, according to Hayllar, who says big shopping baskets of £80-£100 are required for supermarkets to turn a profit. “If home delivery hadn’t been created with a relatively low cost of delivery [to the customer], or no charge, which is partly because Ocado was formed and started offering it as an insurgent, then the incumbent supermarkets wouldn’t have been compelled to offer it anything like as significantly or quickly because it’s an economically harder model for them to fulfil,” he says. “It is expensive to pick individual items, basket them up and then drive them to an individual house, compared to normal grocery shopping where the shoppers do that part for free.”
Fletcher sees some even more fundamental issues around sustainability and buy-local. “The business model for the large physical retailers is perhaps being challenged because their supply chains rely on volume and aggregation to be efficient. [Shoppers] want reassurances at the till that there is a degree of support for ethical consumption. I think that’s still underappreciated within the sector – the very core of the business model is being questioned by millennials and younger generations. What M&S has bought into is an old business model.”
Fletcher questions where Ocado’s innovation is coming from. “We now have home delivery mechanisms for takeaway food, grocery shops, for Amazon, for all sorts of things and they’re all delivered by different forms of logistics companies. There is an opportunity for aggregation and a degree of efficiency that would satisfy sustainability credentials. Ocado’s got robotics in their warehouses but where’s the innovation in how they deliver, what they deliver and when they deliver?” However, anyone considering entering this sphere would do well to learn the lessons of Webvan, an online grocery delivery service launched in the US at the height of the dot.com boom in 1999. It raised $375m in an initial public offering and reached a peak stock market value of almost $8bn. Within three years it was bankrupt.