The crucial difference between selling food and non-food online - the 4 Cs

For brick and mortar retailers of general merchandise, selling online has the potential to add more incremental gross profit than costs. The opposite holds true for grocery retailers. Until the latter face up to this unfortunate fact and start looking for new ways of doing business, the growth of online will only increase pressure on margins. 

It's worth breaking down the variety of obvious and somewhat less obvious factors that make selling groceries online so much more challenging than general merchandise (GM). These can be listed under the "Four Cs" heading.  

  • Cost. Starting with the obvious, it's pretty clear that picking and delivering a single customer order consisting of 40-50 grocery items of varying size, weight and handling and temperature storage requirements with a total sales value of around £100/$150 is always going to be a whole lot more complicated and costly than fulfilling an order consisting of one or two GM items with the same total value and on average higher gross margin. To make matters worse, there are dis-economies of scale in online grocery fulfillment, as once sales get to a certain level (c10% of a store's sales in the UK), picking has to be moved out of stores to dedicated warehouses, implying new capex and de-leverage of stores' fixed and semi-fixed costs. 
  • Cannibalisation. Moving to the slightly less obvious, the relatively high sales value and gross profit per item means that most GM categories can be shipped to quite distant locations using existing third party distribution networks (i.e., postal service or courier companies) in a way that is economic for both the retailer and customer. This enables retailers to significantly expand their catchment area without adding new stores, and to leverage any advantages they have in price or range to gain incremental share. Multi-channel grocers on the other hand are far more restricted to their local catchment areas as a result of the much lower sales value/gross margin per average order weight/volume. This naturally results in higher levels of cannibalisation for grocers. 
  • Concentration. At the national and especially regional level, the grocery market tends to be much more concentrated than for the majority of GM categories. For example, in the UK the top four supermarket chains account for nearly three-quarters of the market. This means that even for those with scale advantages, the potential for market share gains via the online channel is limited. 
  • Competition. Though grocers tend to have lower margins and more importantly lower return on capital than GM retailers, it's not necessarily fair to say that grocery is more competitive than GM - levels of competition tend to vary according to regions and cycles. Nor have pure etailers such as Amazon proven as disruptive in grocery as they have in GM, so far. However, the crucial difference is that Amazon does not need to make money from selling groceries per se. The main purpose of Amazon Fresh is to help sell more stuff to more people more regularly and hence lower the cost of delivery by bringing it in-house and increasing drop densities. Meanwhile Google, in its battle to regain product search supremacy from Amazon, is willing to subsidise fulfillment costs for grocery items, hence driving up the cost of doing business online for those not willing to team up with it. At the same time, the space race is moving online and service fees falling as a result of brick and mortar food retailers' natural urge to grab or defend share wherever they can (however unprofitable or dilutive to margins.) These three factors will continue to put pressure on the fees grocers can charge to recoup the high cost of fulfilling online orders.

It took time for GM retailers to respond to the disruption online caused to their businesses and many of those that were too slow didn't survive. However, as with natural selection, those that responded most effectively to change are now starting to thrive. Though it is likely to take longer to become fully evident, the structural challenges facing food retailers from the growth of online are even greater than that faced by the GM players. Hence the need to start thinking outside the box now - by the time the wave hits it could be too late.  


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