Online food shopping RetailEconomics

The Market of Online Grocery Retail

THIS IS CHAPTER 1 (GROCERY MARKET) OF THE “TEN BATTLES OF ONLINE GROCERY” REPORT

READ MORE ABOUT THE OTHER 17 CHAPTERS

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1.1       The international “Law of Food Spending”

The grocery market is one of the largest segments in global retail, in which established international players lead the way with significant market share. In the US an average household spends $3.971 per year (2014) on food at home and $2.787 per year (2014) on food away from home. Total food expenditure is 9.7% of disposable income.

The food at home expenditure (part of the grocery market) is rising, but total food expenditures and food at home as share of disposable income is declining since 1960. See the next diagram.

Grocery market in the US

Grocery spending is income dependent. There is a worldwide relationship between food spending and income. The higher disposable income:

  • the higher absolute food spending
  • the lower food spending as percentage of disposable income.

I call this relationship of income and food: “the International Law of Food Spending”.

House and car. What happens with the rest of high or rising disposable income? People are spending it on a bigger house they can hardly afford, and they are spending it on a more expensive car they also can hardly afford.

Comparing cross sections. The “International Law of Food Spending” also becomes clear by comparing cross sections of US consumers. Low income Americans spend only $4.000 per year on food, but almost 35% of their disposable income. High income Americans spend $11.000 per year on food, which is only 8% of their income.

grocery market and income classes

Comparing different countries. The “law of food spending” becomes also very clear by comparing caloric intake and household spending on food of different countries. People in the US and the UK have high calorie intakes, but spend less than 10% of disposable income on food. Households in India and Kenya have low calorie intakes, but spend on average more than 30% of their income on food.

international grocery market expenditures

1.2       The grocery market revolution

The state of the grocery industry is changing rapidly. Traditional grocery retailers must deal with price wars, reduced margins and growing consumer appetite for organic health food. And digital trends are forcing retailers to adapt their business models.

Consumers are shopping for groceries at multiple channels. The trend of shopping at different types of stores is not new. Consumers are easily switching between supermarkets, hypermarkets, discount stores, convenience stores, specialty stores and online stores. It is no problem anymore for consumers to visit a service supermarket and a discount store in one trip. And supermarkets with mainly organic foods (example: WholeFoods) are becoming popular.

Private label is gaining market share. National brands used to be the traffic-builders of grocery stores. And when a popular national brand product was out-of-stock, consumers were inclined to look elsewhere (and stay there).  But private label products are becoming more popular, because they are not only cheaper, but the quality perception of private labels is also improving. This is a great opportunity for grocery retailers, since private label products offer excellent gross margins and make prices less transparent.

Private Label essential for profitability. In chapter 12 we will show, that the mix of high gross margins and low price transparency of private label products is essential for online grocery retailers to be profitable.

Large supermarkets are becoming smaller. Supermarkets in the US used to be extremely large. But there is a clear downsizing trend. 5.000 m2 (50.000 square feet) used to be a normal size in the US, but the average size is declining to 46.000 square feet (source: Food Marketing Institute).

Chad Arnold (CEO of Door to Door Organics): “When a customer walks into a supermarket of 40.000 items and only wants to buy 30 of them, that is a terrible customer experience”.

Small supermarkets are becoming larger. In my home country The Netherlands, a large supermarket is 1.500 – 2.000 m2 (about 17.500 square feet), and the trend is that many supermarkets smaller than 1000 m2 (10.000 square feet) are disappearing. In the US the convenience store format is becoming more and more popular. Kroger is opening a new Turkey Hill Market store of 6.800 square feet, while the old ones were 4.000 square feet.

1.3       Internet penetration is high and growing

A major social change is the fast advancement in technology and how this has impacted our daily life. Wider internet access with personal computers, mobile devices, apps and increasingly faster broadband speeds, enable people to use technology more than ever before.

Internet penetration sky high. Internet penetration has grown sky high in USA, Australia and Europe, and is growing with a high rate in other regions of the world:

Internet penetration rates per country

Source: Internet World Stats

Internet penetration is still relatively low in Asia, but 50% of all internet users in the World live in Asia!

E-commerce is the fastest growing retail market in Europe. In 2015, overall online sales are expected to grow by 18.4% (same as 2014), but 13.8% in the U.S. on a much larger total. These figures relate only to retail spending, defined as sales of merchandise to the final consumer. At present, Germany has the fastest-growing online sector (23.1% forecast for 2015, compared with 25.0% in 2014).

About the statistics of “retailing”. The retail figures in this book are based on a strict definition of retailing: only “merchandise” or “tangible goods”. Not included are some large online sectors as:

  • retail banking
  • retail travel agents and holidays
  • tickets
  • insurance

Motor fuel is also not included, because fuel cannot be sold on the Internet.

In Europe the online sales differ per country. The average online market-share of all merchandise categories (including groceries) in the UK is high, due to the relative high market share of online groceries in the UK.  See the next diagram.

Grocery market and online market shares per country

USA: $349 bn online sales in 2015. In the USA 60% of the population regularly shops online. Online sales are expected to rise from $349.20 bn in 2015 to $398.78 bn in 2016.

1.4       Online retail is disrupting many industries

Different commodity sectors experience a different influence from online retailing. The competition of online retailing can be:

  • destructive: for digital products
  • disruptive: for physical non-food products
  • only incremental: for food products (groceries)

DESTRUCTIVE COMPETITION IN DIGITAL PRODUCTS

Digital products. Online retailing is very destructive for physical stores selling products that can be digitized and sold as downloads. There are three sectors that are hit the hardest: travel, tickets and multimedia.

Booking vacations online is now the norm and travel agencies are disappearing. Buying tickets for concerts is a booming online business. And downloading music, films and videogames is now made possible by popular new sites and apps. Online retailer Amazon.com is the largest seller of books worldwide and is selling more e-books than physical books.

I started buying books at Amazon.com as early as 1998. In the last 18 years I bought 640 books online and only about 50 books in traditional stores. And the last 2 years’ half of my purchases are e-books.

Testing at home is convenient. A special characteristic of digitized products is the fact that testing at home is even more convenient than testing in a physical store. Also downloading is fast and buying digitized products online does not involve expensive stores handling and logistics. Above all: looking for the right book on Amazon is easy, informative and fun.

DISRUPTIVE COMPETITION IN NON-FOOD PHYSICAL PRODUCTS

Competition from webshops. Physical stores selling non-digitizable non-food products are suffering from increasing competition from web shops. Large sectors like clothing and consumer electronics are experiencing a substantial shift of sales volumes from physical stores to online stores. Physical stores have to adapt to the reality of new online competition. Waiting for customers to visit their stores and buying their products is no longer a sustainable business model.

In the week I wrote this paragraph on disruptive competition, a large department store chain filed for bankruptcy after 80 years of existence. It is now more fun to shop online for consumer products than to shop in low-end department stores.

Orientation is key. A special characteristic of many non-food products is the need for orientation by consumers before they buy. Consumers want to have sufficient choice and information before they buy so-called shopper goods. And during orientation, consumers might visit several websites and physical stores. After orientation the actual buying takes place in the physical store or online.

Price transparency. Easy orientation at different web shops makes prices very transparent. And new price comparison websites and mobile phone apps make comparing product prices easier, even when visiting physical stores. This price transparency causes a pressure on prices, gross margins and ultimately net profitability of retailers.

The weakest stores will disappear. Successful non-food retailers will have to close their weakest stores to maintain overall profitability. And weak traditional retailers will have a hard time surviving the new online competition. Unless they change into a strong omni-channel business model.

ONLY INCREMENTAL COMPETITION IN GROCERIES

Groceries are different. The grocery sector is the focus of this book. Groceries is the largest retail sector with the lowest online share. Competition by online stores in the grocery sector is not very disruptive and certainly not destructive. This sector is very different from other sectors: it is very large and online shopping plays a much smaller role than in other sectors. The low online share is the result of the typical characteristics of groceries.

Online plays a small role in grocery shopping as a result of a number of characteristics that are specific for grocery shopping and retailing:

Routine shopper behavior:

  • hardly any orientation necessary (routine products)
  • customers know and trust their grocery stores (routine shopping)
  • high frequency shopping and short lead-times

Relatively high costs and low margins for retailers:

  • many different products in one shopping bag
  • low value products
  • low margin products and price pressure
  • three different temperature zones

Boring and expensive. These characteristics of groceries make online shopping rather boring for consumers and very expensive for retailers.

In this book I will explain why pure online retailers will have a hard time developing an online grocery store from scratch and make it profitable.

Omni-channel growth. In the meantime, traditional supermarket chains are using their web shops to counter the competition from pure online players and other omni-channel grocers. And they use their web shops to defend and enhance their physical stores to grow their market share.

Opportunities for special products. Not all grocery categories are insusceptible for online retailing. Some products thrive on product information (wines), other products are small and expensive (cosmetics, razor blades and supplements) and some products are light and expensive (diapers).  New online stores are successfully selling these special products.

1.5       The online grocery market hype in 2000 was a disaster

In 1999 and 2000, online grocery shopping was a disastrous hype. Some major e-commerce consultants were very optimistic about market potentials. Andersen Consulting predicted a market share of online grocery shopping of 20 % in the year 2010. Cap Gemini was even prepared to predict a percentage for online grocery retailing between 30 and 40 %!

From big hype to big investments to big fiasco. The overly optimistic predictions of online market shares were used by Peapod in 1999 to explain its high potential. And in 2000 the new online grocery retailer Webvan made a nationwide investment program of one billion US$. But Webvan became the biggest dotcom flop ever.

My prediction in 1999 for mainland Europe was a market share of online grocery retailing of less than 1,5 % in 2010. My low predictions for online grocery retail were in sharp contrast with the extremely high predictions of major consultancy firms, leading to much debate.More realistic expectations. The influential Verdict Research tuned the market potential of online retailing in the US down to 3 % in 2004 for the total retail sector and 2.33 % for the grocery sector. But even this prediction was too optimistic, as was shown in par. 1.4

Halfhearted efforts for online. Some of Europe’s grocery retailers have ventured into online selling in the early stages, but in general their efforts were tentative and half-hearted and thus have failed to win customers. The exceptions in Europe in the early stages were Tesco (UK) end Albert Heijn (NL). Both companies succeeded in building online businesses, that were examples for their competitors and new pure players.

The examples of Tesco and Albert Heijn are described in chapters 5 and 6.

Many retailers were put off by the economics of the business. Selling groceries online means taking on additional costs—in labor, delivery vehicles, and fuel—that are higher than the delivery fees customers are willing to pay. Profitability seems to be unattainable. This is particularly problematic for retailers in markets like Germany and The Netherlands, where gross margins are low and labor costs are high relative to the United Kingdom.

1.6       The online shopper revolution

Technology is the most bullish thing possible for the standard of living of human beings. Many people living below the poverty line in developed countries have televisions, refrigerators, medicines, and luxuries that even kings and queens of only a hundred years ago could not have dreamed of. That trend is going to continue and accelerate.

GROCERY SHOPPING BEHAVIOR

Grocery shopping is mainly routine. Much of what you are buying now is the same as last week. And grocery products are on average rather inexpensive. That makes grocery shopping very specific and different from buying other consumer goods. Grocery shopping must be fast, efficient, convenient and fun. Groceries are “convenience goods”.

Other consumer goods have their own specific characteristics, that make shopping behavior more complex and less routine. Price is important, but also the product life cycle and the need for product information:

  • Software (apps) are bought to produce an easy solution and a new “experience”
  • Clothes buying requires comparison, look, feel and fitting. Clothes are “shopping goods”.
  • Non-fiction books buying requires rich information about its contents, that must fit your information need of the moment
  • Car buying is a complex decision process with a lot of emotion involved: an “exploration phase”.

Health food shopping is less routine. But there are new developments that ask for different grocery business models. A good example of a major trend is the popularity of health foods. This trend makes food shopping a different, less routine experience.

THE DIGITAL TOOLS REVOLUTION SHAPES OUR RETAILING

Digital tools for shopping are changing rapidly:

  • Before 2000, you needed a fax machine or telephone to go grocery shopping online
  • 2000: you still needed to walk to your PC for online shopping
  • 2007: the smartphone and mobile internet surfing made a breakthrough
  • 2010: the iPad was the first of many tablets, that made “lean forward” multitasking possible for everybody
  • 2015: consumers are always online with laptops, smartphones, iPads and yes, also with their PC’s
  • The next step is the use of smartwatches and other wearable devices
  • And “non-clickable devices for grocery shopping are introduced by Amazon and Ocado.

THE DIGITAL MEDIA REVOLUTION SHAPES OUR ENTIRE LIFE

Social media are taking over our lives. Facebook, Twitter and WhatsApp are now the most important means of online communication. US president Trump gave Twitter a new boost. And Instagram, Pinterest, Snapchat and Vine are attracting more young users each year. Consumers share their experiences with retailers and manufacturers online. Price and quality of consumer goods become more transparent every day.

Facebook still the greatest. 35% of worldwide internet users are using Facebook every day. Facebook is also becoming a significant competitor for Google Adwords for online advertising.

Social media are discussed in chapter 13, as part of the battle for branding and traffic building.

Social media still growing. In 2010 1.8 billion people worldwide were active on social media. In 2015 this number is 2.7 billion. And these billions are not only teenagers. In The Netherlands 81% of baby boomers (45-65 years old) are using social media, half of them on a daily basis.

YouTube and Netflix. Also “watching TV” is changing into the YouTube and Netflix experience: watching films and series on demand, when and where we want. My two nieces of 6 and 4 years old are not “watching TV” anymore; they ask for their favorite shows when they have time in their busy schedules.

1.7       Online grocery market still small

Poor supply and low demand. With a few exceptions (such as in the United Kingdom, where Tesco and pure-play retailer Ocado have made assertive moves), Europe’s online-grocery market has been stuck in a vicious cycle: poor supply drives low demand, which in turn justifies the poor supply.

grocery market and other online categories

Source: PayPal, Harris Interactive, June 2014

The facts in 2014. The online food market share in the UK is 4,5 % in 2014, in the early stages pushed by Tesco Direct and later by Ocado. In France online food market is 3,5 %. The online food share in The Netherlands is still not higher than 1,5 %. In the US and Germany, the market share of online food retail is even lower.

Still few consumers buy groceries online. In a survey in the US (2014) 15% of consumers said they had purchased general food online. Of the same consumers 69% said they had purchased clothing online.

55% of consumers say they will buy groceries online. In an international survey of Nielsen, 25% of interviewed consumers said they order groceries online, and 55% are willing to do so in the future.

NB: these percentages are NOT actual and future online grocery market shares, because the actual buying is always divided over online and traditional channels. In the US, 15% of respondents say they purchased general food online, but the national online food market share is not more than 1,5%.

Supermarkets are defending market share. Once a retailer makes an assertive move in online grocery, others are likely to follow suit. But at that point, the business case for investing in online grocery will be a matter of defending market share and preventing further losses. Not delivering incremental profit.

The supermarket is a fantastic business model. Consumers will shop for groceries online only if the offer is right: they are not willing to sacrifice the price, quality, and range of products that they have grown accustomed to in the supermarket, and they avoid inconvenient delivery or pickup arrangements. To date, few European retailers have given consumers a compelling reason to switch from the neighborhood supermarket to the Internet.

Skepticism about product quality.  Another factor keeping online demand low is consumer skepticism about product quality. Consumers who have not yet tried grocery shopping online say their biggest concern is not being able to see or touch the actual products before buying. They want reassurance that their groceries will be fresh and high quality—no bruised fruit, no wilting lettuce.

Ocado (UK) has found the solution to prove to customers that their fresh products are actually very fresh. See par. 5.4 about this transparent company.

There is latent demand. In France, 33% of consumers who have never bought groceries online say they would “probably” or “certainly” begin to do so within the next six months, if the service were available in their area. In Spain, that figure is even higher, at 49 percent.

 

THIS WAS CHAPTER 1 OF THE “TEN BATTLES OF ONLINE GROCERY” REPORT

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Online food shopping RetailEconomics

Online grocery retailing report

A must read for:

  • supermarket entrepreneurs
  • grocery retail companies
  • professional consultants
  • retail students and professors

With best cases: Webvan, Peapod, Walmart, Amazon, Instacart, Tesco, Asda, Ocado, Albert Heijn, Picnic, HelloFresh and India online grocery retail.

Solutions in detail: Direct Home Delivery and Pick-up Points, Full Range Online and the Food Box, pricing strategies and traffic building, delivery fees and subscriptions. And last but not least: the updated Online Cost Model of RetailEconomics.

E-book The Nine Battles of Online Grocery

THE REPORT IS FREE. DOWNLOAD IT HERE


DO YOU RECOGNIZE THE FOLLOWING CHALLENGES?

Price transparency. How to deal with extremely high online price transparency

Pure players have high entrance costs. High investments in software and acquisition

Competing in a difficult market. How to compete with traditional supermarkets

Additional costs higher than value. Customers prefer (expensive) home delivery

Margins are low. Gross margin is not sufficient to cover home delivery

Smartphones. The use of smartphones is rising, but a smartphone needs an app

Critical customer demands. Customers prefer (expensive) short delivery times


JOOST VAN DER LAAN WROTE THE REPORT

Drs. Joost van der Laan is director of RetailEconomics. During his career he worked as manager and consultant with many retail companies, international brand suppliers, consultancy firms and universities. He developed the first online grocery cost model.


E-book Nine Battles of Online Grocery

THE E-BOOK ANSWERS MANY QUESTIONS

In eight information-rich chapters:

   √  The 2000 hype. What can we learn from the online grocery hype disaster in 2000?

   √  International markets. How fast are markets growing of online grocery retailing?

   √  Triggers. What are the dynamic triggers of online grocery retail?

   √  Membership in the US. How is the membership model a success in the US?

   √  Home delivery in the UK. How is high quality distribution a success in the UK?

   √  Drives in France. How are “drives” a success in France?

   √  Dutch competition. Omni-channel retailers are competing with new pure players

   √  The Food Box dilemma. How is the Food Box potentially profitable but losing money?

   √  Success factors. The most important success factors of marketing, logistics and IT?

   √  Costs models. Intelligent cost modeling in each step of the online process


E-book of Joost van der Laan

THE “NINE BATTLES OF ONLINE GROCERY”

Nine information-rich chapters:

   1. The starting point. Business development of traditional retailers and new pure players

   2. Assortment. The four successful assortment policies online

   3. Presentation. Effective web design and product presentation

   4. Pricing. Solving the dilemma of low online prices and high distribution costs

   5. Growing and trust. Online opportunities for branding and traffic building

   6. Customer retention. Keeping your customers happy and the impact on profitability

   7. Ordering. Easy online ordering, check-out and dealing with substitutes

   8. Order-picking. Organizing efficient and high quality order-picking of consumer orders

   9. Home delivery. The last mile: efficient direct home delivery or cheap pick-up points


THE REPORT IS FREE. DOWNLOAD IT HERE

 

Not convinced yet? Read the complete chapter 1 (of 18) about the Online Grocery Market.

Online food shopping RetailEconomics

Online Retail Glossary

In online retail economics we use terms you may not know. Then you will benefit from this glossary. It will provide clear definitions and also understanding why these terms are important for your online retailing business.

Big Data

“Big Data” refers to massive sets of data about consumer behavior, that take intelligent data analysts and sophisticated programs to make sense of it all. Big Data is not just traffic or conversions, but also the pairing of behavior (clicks, open rates, time spent on site), demographic (age, gender, income, family composition, address), social information (tweets, shares, etc.), timing, and much more.

Big Data allows businesses to personalize each customer’s experience / preferences and even lets them predict consumer behavior, by turning different data about the same topic into an actionable insight.

Online grocery retail RetailEconomics

Bricks and Clicks

“Bricks and Clicks” refers to retailers that integrate their traditional store with their ecommerce website. Most Bricks and Clicks companies offer web-to-store services such as in-store pick ups and returns: the website acts a traffic builder for the store. A Bricks and Clicks business also has the advantage of aligning store branding and online branding: the store brand acts as confidence builder (and traffic builder) for the website. And product information on the website is a welcome addition to instore and packaging information.

The synergies between physical stores and the online retail site, allow Bricks and Clicks retailers to (at best) break-even on their expensive delivery activities, and still make a profit overall.

Click and Collect

“Click and Collect” is a service that enables shoppers to purchase items online and pick them up in the physical stores. Consumers can make a purchase from their home, and pick up the order whenever it’s convenient for them, instead of paying for shipping and waiting for the order to arrive.

But the most important driver for “Click and Collect” is efficiency for the online retailer, because direct home delivery is the most expensive process in the online chain: the “longest mile”.

Content Management System (CMS)

A “Content management System” or “CMS” is a software solution that makes it possible to create, edit, maintain, publish, and display content on the Internet from a single interface or administration tool.

In the online retailing context, a CMS may be used to manage a stores product catalog.

Conversion in online retail

“Conversion” is a marketing term that describes when a user or visitor completes some action or achieves some marketing goal. More specifically, conversion is often used to describe when a site visitor converts to a customer, making a purchase.

In online retailing “conversion” is more important than in physical stores, because the easy access to websites makes it also easy for visitors to leave and visit another store.

Drop shipping

“Drop shipping” is the arrangement between a retailer and a manufacturer/distributor, in which the retailer transfers customer orders to the manufacturer, who then ships the merchandise directly to the consumer. The retailer does not keep products in stock. Drop shipping is popular for small online retailers selling expensive or big ticket items.

But drop shipping is less popular for online food retailing, because of low item prices and low margins, high fixed delivery costs and the necessity to combine products from many different suppliers.

Fulfillment in online retail

In ecommerce, “fulfillment” is the process of completing an order. The term may also apply to third-party companies that inventory products and ship orders on behalf of an online store.

Fulfillment of online food retailers is a set of expensive activities, that in physical supermarkets is done FOR FREE by consumers. Orderpicking of single SKU’s and home delivery may cost more that 15% of the retail price, but consumers are often not willing to pay more for home delivery than 5% of the basket price. And when added costs are three times added value, the business model is unprofitable.

Internet Retail Site

An “Internet Retail Site” is a website where visitors (consumers) can purchase products. They do NOT include shopping domains that provide free downloads, product reviews or purchasing incentives such as coupons. They also do NOT include e-commerce sites such as auction, travel reservation or financial sites.
online retail mobile ordering

Mobile shopping

“Mobile shopping” is the practice of purchasing goods or services using a mobile device. Mobile shopping is an increasingly common trend due to the popularity of smartphones and tablets. It is shopping online using a computer, only with a smaller screen and often with a special app. Mobile shopping apps are also used to enhance the in-store shopper experience, by providing product information and consumer specific suggestions.

Mobile food shopping is also increasing, but retailers have to find ways to prevent small orders and high delivery costs.

Niche retailing

“Niche retailing” is the practice of specializing in a particular type of product and selling to a specific market segment. Niche retailers have to identify market segments and deploy unique and targeted strategies to address their market’s needs.

For online food niche retailers it is possible to select product categories that are profitable, because delivery costs are lower than gross margins. Examples of profitable online niches are:

  • wines: high absolute margins
  • vitamins: small and light
  • complete fresh boxes: high margins, inexpensive production and pricing premium

Omni-Channel retailing

“Omni-channel retailing” means selling to consumers on several channels and platforms: physical stores, mobile, online, catalog etc. An example of omni-channel retailing is: giving the customer the flexibility to purchase an item with your shopping app, and then letting them pick up the merchandise in your store, plus allowing them to process a return via your website.

Omni-channel retailing is more than being on multiple channels or platforms. Just because you have a website, a mobile app, and a physical store doesn’t necessarily mean that you are an omni-channel retailer. You must combine all channels in marketing, logistics and information technology, to give customers an ideal experience.

Planogram

A “Planogram”  is a visual representation showing how merchandise should be arranged on store shelves. This “space-management” tool is a model that indicates the best placement and positioning of merchandise, in order to drive sales (by minimizing out-of-stocks) and optimize gross margin (by  placing high-margin products on eye-level). A well known space-management software for supermarkets is Spaceman.

spacemanagement and online retailing

Online retail does not use planograms for websites, because the space-management algorithms calculate the minimal product stock necessary to prevent out-of-stocks. But on websites product presentation and storage of goods are separated.  

Shrinkage

“Shrinkage” is the difference between theoretical stock (in the inventory system) and physical stock (in store or warehouse). Shrinkage is the reduction in inventory, not caused by legitimate sales. Common causes of shrinkage include: employee theft, shoplifting, administrative errors, and supplier fraud.

Online retail entrepreneurs do not suffer from the (largest) problem of shoplifting by customers. The other causes of shrinkage will also be lower due to inventory control systems, professional order-picking and delivery processes, and checks and alarms by consumers receiving the goods.

Stock Keeping Unit (SKU)

“Stock Keeping Unit” or “SKU” is the unique identification of a particular product. SKU data represent all attributes of an item, including price, style, brand, size, color, and more.

Online retailers have the advantage over physical stores to display all information per SKU on the site as so called “rich data”: descriptions and numbers:

  • SKU descriptions are used by online shoppers as selection filters (example “organic” or “gluten free”)
  • SKU numbers are used by shoppers and the online system for calculations (example: calories or total price). 

Webrooming and Showrooming

“Webrooming” is the practice of looking at products online before buying them in physical stores. It’s the opposite of “Showrooming”, where customers look at products in physical stores only to buy them online.

Webrooming and showrooming are typical for non-food retailers. Food retailers sell familiar items that normally need little research by consumers. Exceptions are: wines, vitamins and other product categories that thrive on product information. But webrooming is used by food buyers to compare product prices in order to choose the favorite retailer store.

Online food retailing

Online Grocery Retailing

This article will: prevent you from going bankrupt, demonstrate Internet opportunities for traditional retailers and show cost/profit modeling for effective e-business planning

Motivation for this article is the analysis of commercially successful and commercially failing online grocery retailers. And the experience as wholesale supplier of two well managed but failing online grocery businesses.

Management Summary

Success of online grocery shopping depends on market potential and distribution costs.

These key issues are interdependent. If market potential is high, distribution costs are moderately high. If market potential is low, distribution costs are extremely high. Because market potential of online grocery shopping appears to be low, online grocery retailers try to gain market share by lowering consumer prices (and margins). Result is a low margin operation with extremely high operating costs: the ultimate nightmare of every entrepreneur.

It is the ultimate challenge to develop an exception to this rule and the solution to this dilemma. There are three possibilities:

  1. Niche marketing: focus on a small, affluent and service oriented consumer group
  2. Focus on margin rich products, that sell well on the internet
  3. Focus on information distribution

These three solutions should be combined into a powerful Internet strategy, that should be executed in an excellent way. But there are many pitfalls and critical success factors. The pitfalls and success factors cover the entire marketing mix, the logistics system, information technology and internal organization.

 

High expectations but low online grocery penetration

In 2000 online grocery shopping was a hype. Some major e-commerce consultants were very optimistic about market potentials. Andersen Consulting used to predict a market share of online grocery shopping of 20 % in the year 2003. These optimistic predictions were used by Peapod.com to explain its high potential, and in 2001 defunct Webvan.com as support of a nationwide investment program of one billion US$.
Cap Gemini was even prepared to predict a percentage between 30 and 40 %, but the influential Verdict Research tuned the market potential of online retailing down to 3 % in 2004 for the total retail sector and 2.33 % for the grocery sector.
Fact is that in the year 2012 the online food market in the USA and in Europe is less than 0.3 % of total food sales. Potential for the next five years is not more than 0.3 – 0.5 % in the USA and not more than 0.2 – 0.4 % in most countries of Europe.

This low percentage of online grocery shopping is remarkable, because Internet penetration has grown sky high in USA and Europe and is growing with a high rate in other regions of the world:

Online grocery shopping

Why online grocery shopping is not popular

There are four basic reasons why online grocery shopping will never become popular by consumers. Home-shopping of groceries is no fun, it adds complexity to your lifestyle and it is more expensive than buying at the supermarket. On top of those disadvantages: traditional supermarkets are fighting for consumer loyalty by improving their marketing mix and increasing their efficiency.

1. Online grocery shopping is boring. In my view online shopping for dry groceries and perishables is boring. It does not even come close to the fun of buying books at Amazon.com the joy of buying clothes and shoes at Zappos.com, or the excitement of ordering exotic products in China by Alibaba.com. There is absolutely no advantage here over the weekly trip to the supermarket. I dare you to try online grocery shopping a couple of times and see for yourself. Only when an online business focuses on special products and on rich information content, online shoppers will become interested and stay interested.

2. Online grocery shopping is complex. Online shopping is less time consuming than traditional shopping, but it adds complexity to your lifestyle. Let us assume in an optimistic mood that every “household manager” will master the skill of shopping online. After ordering online you first have to be at home and make sure that the goods are properly received. Second you often have to go to the store anyway for miscellaneous articles. Third you have to check proper billing and payment. Fourth you have to follow up on order-picking mistakes and delivery errors.

3. Online grocery shopping is expensive. The distribution costs of home-shopping are twice as high as the costs of traditional food retailing, and most consumers are not willing to pay the extra 15 %. Internet startups will first try to gain market share with low prices and low service fees, but when the shareholders cash is consumed they will have to ask higher than “normal” prices to cover the costs and survive. Of course there is a small niche market for expensive home-shopping services: affluent PC-minded and service oriented consumers and consumers with no easy access to a nearby store.

4. Online grocery shopping is not competitive. In recent years Efficient Consumer Response and Category Management had a significant and positive impact on quality and efficiency of traditional supermarkets. Food retailing has always been a very competitive business, and in recent years super-marketing has become a professional science that is constantly improving the value to the consumer. In the USA, Europe and now also in India, China and South America very competitive stores with Every Day Low Prices and high service levels are gaining market share and are making the food business a war zone for new entrants.

Conclusion: the average consumer – with access to a good supermarket – does not have a good reason to go grocery shopping online.

 

High Distribution Costs of Online Grocery Retailing

Distribution costs of online grocery retailing are twice the distribution costs of traditional supermarkets. Traditional channels are extremely efficient, because consumers perform most of labor intensive work for the retailer: order-picking in the store and transportation of goods to the home. Costs of these activities are approximately 10 % of consumer price. Online retailers have to pay well trained and professional employees to do this work without errors. An additional 5 % of costs are spend on information technology, order management and after sales service. The additional costs are even higher in case of low market penetration or sub standard execution.

There are roughly three scenarios for online food distribution:

  1. Distribution from an existing store
  2. Direct home delivery from a dedicated central warehouse
  3. Home delivery from a central warehouse via satellite stations

Each scenario has its own specific benefits and value chain characteristics. Distribution from an existing store is appropriate for a small online business. Direct home delivery from a dedicated warehouse is appropriate for an online business with a high market share in a medium size densely populated area. Home delivery from a central warehouse via satellite stations is appropriate when the area is larger and the market share is lower.
The next table is an overview of supply chain activities and cost structure of each scenario, including traditional retailing. The figures are costs per activity as a percentage of consumer value.

Online grocery shopping
Cost/profit analysis by RetailEconomics.
[This cost structure is an indication only. In every country and each situation the costs per activity will be different. Outsourcing the delivery process to logistics service providers may add efficiency but will also increase complexity costs].

Example 1: Peopod.com

Peapod.com is the oldest and best known online food retailer in the USA. Peapod once delivered from local stores, but in 1999 the company switched to direct delivery from central warehouses. In this case the delivery fee changed from US$ 16. (very high) to a minimum of $ 6.95 and a maximum of $ 9,95. Nowadays Peapod.com is a full subsidiary of Dutch Ahold, and turnover and profit figures are no longer published.
In the first 9 months of 1999 turnover was US$ 57.305, excluding additional income of
US$ 14.453. Gross margin was extremely low: 5.9 % of turnover. Distribution costs were exactly 30 % of turnover, in line with the cost/profit analysis table.
Other costs were: marketing and sales (13.2 %), information technology (5.9 %) and other overhead (19.7 %). The result was a loss of 37.6 % of turnover. Note that this is not a recent startup, but that this company has been in business since 1989.
The “about us” section of the website of Peapod.com made in 2000 a remarkable referral to “industry experts” who predicted a 20 % share of online groceries in the year 2003.

This example shows two things very clearly. It proves the fact that distribution costs of online grocery retailing are very high. But it also shows that in order to gain market share over traditional supermarkets the company had to invest heavily in price reduction and sales promotion. On top of that: overhead costs of Peapod.com exceeded the total distribution- and store costs of any well managed traditional supermarket chain.

Example 2: Webvan.com

Webvan.com was in 1999 a new player in the American market. The company planned to develop 26 automated warehouses in populated areas all over the USA. These warehouses would deliver groceries to consumers via satellite stations. The Webvan case is interesting because it was a combination of high investments in buildings and equipment, and high customer service like a 30 minute delivery window.
The very professional “help section” of the Webvan website explained the pricing policy (“prices up to 5 % less than in local grocery stores”), and the product policy of a large and high quality assortment of groceries, perishables and drugstore items. Webvan offered free delivery for orders US$ 50 and over and a delivery fee of US$ 4.95 for orders under US% 50. The handling costs were “50 % less than the grocery industry average”.
The problem was that Webvan.com had based its business plan on the same optimistic online grocery market estimations as Peapod. The company filed bankruptcy in 2001.
Webvan.com was caught in the same trap of every dedicated online grocery retailer: reducing the extremely high order fulfillment costs means high turnover; high turnover means low prices and high service. And when turnover stays low, the combination of low prices and high service means a very negative bottom line.

First Solution: Niche Marketing

“Niche marketing” is focusing the marketing mix on a special target group. This strategy is particularly effective for traditional retailers with a high market share and an affluent customer base. These retailers can develop an online channel as service offering, as market development strategy and as barrier against new entrants. In the USA this would be the recommended approach for successful local chains, in the UK for Tesco and in The Netherlands for Albert Heijn.
Niche online retailers use their quality image to reach for example 10 to 15 % of their own customers and 5 to 10 % of the rest of the market. Customers will spend on average 20 % of their grocery shopping online. In this way a company like Albert Heijn has the potential to reach about 10 % of total customers and win 2 % of total market share online.
The niche target group will consist mainly of affluent service oriented double income families, who are willing to pay the extra service fee. The other niche group are consumers who do not have easy access to a supermarket of choice. Every target group must have affinity to shopping on the Internet.

Second Solution: Focus on Margin Rich Products

A focus on margin rich products is the most debated solution for online food retailers.
Many e-commerce analysts assume, that consumers will prefer to order their heavy bulk products online, and visit the store for the rest of their grocery needs.
This assumption about consumer behavior is not supported by practical findings. In practice consumers will try to order enough products to avoid the delivery fee, in most cases set at an order amount of above 100 US$ or the equivalent in Europe. For online grocery retailers the sale of mainly bulk products is the quickest road to bankruptcy, since these products are the loss leaders of the grocery business.
There are already many examples of a clear product focus in online grocery retailing. The best example is wine, because successful wine selling requires professional information about the product and its use. Another important online food group is vitamins and supplements. In the USA there were some very attractive examples: vitaminworld.com, nutrimart.com and swansonvitamins.com. I personally order my favorite brand of vitamins at essentialorganics.nl.
Online food retailers are also differentiating their business to financial services like banking, insurance and mortgages. Other service areas are video/DVD rental and dry cleaning, but the most attractive product development is non-food. This category is related to food and is therefore an expected extension to the online food business.

Walmart USA concentrates its Internet venture on its large non-food assortment, and use online food retailing as traffic builder. The Belgian food retailer Colruyt used online non-food retailing not only as an important margin rich extension of the food assortment, but also as a traffic builder for the supermarkets. Consumers could order the non-food articles online, but had to collect the merchandise at the store.

Third Solution: Focus on Information and Communication

“Information distribution and communication” is the name of the Internet game. Internet is the perfect channel for targeting different consumers and other stakeholders of the company.
In traditional advertising every commercial message is targeting a specific consumer profile with a specific message. Alternatively an Internet site has a menu structure, which makes it possible to communicate a whole range of messages to a wide range of interested target groups.
The other major advantage of Internet is the ability to really communicate in two directions. This important feature of Internet already has a great impact on the internal and external organization of any company. David Siegel, the author of “Creating Killer Web Sites” explained the impact of web communication on the organization in “Futurize your Interprise”.

Communication with different customers may focus on special products, like low fat or sugar free assortment. Allergy information gives the opportunity to add rich content to specific consumers. Other products that benefit from information are wines, private label products, vitamins and food supplements.

Retail organizations also use their website to inform their customers about their internal processes. Randalls.com (Safeway) is an excellent example of a description of the distribution process, and it enhances the professional image of the company.
In the USA the Internet is frequently used to distribute coupons. A good example is Pathmark.com. However the disadvantage of Internet distribution of coupons is fraud: the possibility to change rebate figures by the PC.

The most promising communication feature is the possibility for customers to respond to the retailers information and marketing mix elements. A retailer may solicit assortment suggestions and complaints. Internet makes it possible to use customer complaints as powerful drivers for quality improvement in the company.

Communication with other stakeholders of the company requires much attention but opens many opportunities. Most professional websites already have a special section for shareholders (annual and quarterly reports), potential employees (vacancies and working climate), suppliers (category management approach) and the media (latest news). Each target group gets maximum attention without annoying the others.
In case of communication with other stakeholders each target group must have a professional contact in the company, who is responsible for content and direct response. If this is organized in a professional way, the Internet communication will strengthen external relationships and internal responsiveness to the market.

Running and winning the “Longest Mile”
Physical distribution of goods ordered online has been called the “Achilles heel” of e-commerce. It is the week spot of a powerful development.
In the USA physical distribution is now referred to as “the longest mile”. It is an old trade, that was mastered by an ex Wallstreet investor like Jeff Bezos of Amazon.com. Jeff Bezos solved the sore knees of employees (and himself!), who were packaging books sitting on the floor, by issuing knee protectors. His partner suggested the idea of purchasing some packing tables, so he told with laughter on TV.

When the home shopping market increases, professional service providers will develop distribution networks for general use by different online retailers. This will reduce the transportation costs by approximately 30 % and the total additional online grocery shopping costs by approximately 1.5 % points. Amazon.com is using this concept by sending books by mail, but a 1.5 % point reduction of food distribution costs is too small a gain to change the less then positive outlook of online grocery shopping for the best.

 

Cost/Profit Modeling

Costs of order management and distribution alternatives can be evaluated from a distance using “cost/profit modeling”. It is even better to use this tool in the business plan preparation situation. Cost/profit modeling was used to develop the value chain presented in the table at the beginning of this article.
A good example is the home delivery process. This is a major element of order fulfillment. Online retailers have to optimize the following cost elements of distribution:

  • The average distance from the warehouse to the customers
  • The average distance between customers
  • The stop time at customers
  • The loading- and unloading time
  • Handling efficiency
  • Cost per hour
  • Vehicle fill rate and utilization
  • Capital investment

The optimization process of distribution elements will be covered in a different article. The point is that every distribution decision has an impact on all eight elements. It is interesting to show the most important effects of some home delivery alternatives on these distribution cost elements.
The decision of Peopod to change delivery from stores to delivery from central warehouses improved handling efficiency but also increases capital investment and the average distance to the customer.

The semi automated warehouses of Webvan.com required huge capital investments, but were intended to increase handling efficiency. The use of local satellite stations increased capital investments but also had a positive effect on vehicle fill-rate and vehicle utilization.
The very narrow 30 minutes delivery time window of Webvan.com greatly increased average distance between customers. This service element was impossible to maintain, because it tripled the already extremely high transportation costs.

 

Critical Success Factors of Online Grocery Retailing

Any successful online retailer has to work hard and intelligently on a large number of critical success factors. These factors are critical because failure to excel in one of them may damage the company considerably.
We already covered the critical success factors customer targeting, focus on margin rich products and focus on “information distribution” and communication.

Other critical success factors are:

Trust. Online customers must have absolute trust in the retailer, because the retailer takes control of most of the shopping process. It is a good start if the retailer has an excellent reputation to start with, but when new channels are used, the retailers must be certain that this trust is not violated

Tailoring. The site should be tailored to the individual customer. An excellent example is Amazon.com, that greets you personally when you open the site, and gives you a choice of products that match your personal preferences

Choice. Each target customer group must have excellent choice within every product category. The online retailer must exceed the product offering of traditional competitors in order to create loyalty to the business. The best strategy is to add high end products to the assortment, and promote these products heavily on the site

Quality. Each service element of the online retailer must have excellent and predictable quality. Mistakes in online retailing have a much bigger impact than in traditional retailing

Price. Internet makes pricing very transparent and this is a great concern for online retailers. Most American online retailers charge prices 3 to 5 % lower than traditional retailers, with the effect that gross margins do not cover the costs. European online retailers tend to charge 5 to 8 % higher prices than normal, but they will be exposed by price comparing websites. The solution is to charge market conform prices and an additional service fee

Promotion. Each marketing mix element must be promoted on the site, and the site must be promoted in traditional promotion channels. This emphasis on site promotion is a substitute for the physical store and the physical signals in the store

Information Technology. Web technology features many commercially attractive possibilities like feedback on input, preference lists, cross-selling, inventory checks, differentiating service and cost structures, and professional order management

Payment. This is a major subject in itself. Basic is error free and easy payment. Optional is the service of payment alternatives

Economies of scale. High investments in information technology and marketing must at least in the long term be covered by high turnover. Even more important is the necessity of a high market penetration and a dense customer network, in order to optimize delivery costs.

Take the Challenge Seriously

Earlier publications on which this article was based have already evoked much discussion. The author invites readers to supply feedback, constructive criticism and new scenario’s to make online food (and non-food) retailing profitable.

 

drs Joost van der Laan
RetailEconomics.com
J.W. van der Laan Marketing & Logistics BV
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3852 DA Ermelo, Netherlands
Tel.: 0031-6-53846927
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