A recent report from Nielsen & FMI projects that 20% of grocery sales in the US will be made online by 2025. What I find amazing about this prediction is not the figure itself - which is really anyone's guess - but that no-one has commented on the impact this would have on sector profitability. The unfortunate fact is that unless there is a significant reduction in physical floor space and/or major change in order fulfillment methods, and assuming home delivery becomes the dominant model as it has in the UK, a 20% online shift would result in supermarket industry profits falling by up to 50% due to i) the incremental costs of running dedicated picking centres and ii) deleverage of store fixed assets and costs. (Note the detailed modelling behind this estimate was one of the last pieces of work I carried out as a financial analyst and was one of the reasons I changed career to try to bring some solutions to what I call the "online cannibalisation conundrum".)
That such a future is just too bleak or remote for industry executives to admit publicly or even contemplate privately is understandable. However, one would think that external industry consultants and commentators could apply their critical facilities to alert others to the glaring elephant in the grocery room - i.e., the fact that for the grocery market as a whole online adds cost and complexity but not sales and hence will inevitably dilute margins. (This applies even to first-movers, whose advantage tends not to last very long as competitors react aggressively to prevent their high spending online customers from defecting.) Their collective failure to do so reflects either a lack of understanding of the economics of multi-channel grocery, or a fear of offending current or potential consulting clients by being the first to bear such bad news without being in a position to provide a solution. Either way, the silence is unhelpful for the industry and needs to be broken.
These days most of the commentary regarding threats to traditional grocers relates to the expansion of limited assortment discounters Aldi and Lidl (the LADs). There is indeed a link between the growth of the LADs and online. One of the reasons the big Four UK supermarket groups failed to cut prices quickly enough to stem the LADs' growth during the post 2008 recession was the increasing extent to which they were having to subsidise the fulfilment of online orders. In the battle to attract/retain high spending online customers, the average fee for home delivery fell from £6 in 2008 to just £2 by 2013. Meanwhile, market leader Tesco was busy building large dedicated order fulfilment centres in order to ease the pressure on in-store picking (which Tesco found starts to impact the store experience for regular customers when online sales penetration reaches around 8-10%). Whatever gains were made in picking productivity were far outweighed by the additional costs of running these new facilities, and longer, more expensive delivery routes. Furthermore, this increasing investment in making it easier and cheaper for customers not to come into their stores was being partly funded by cuts to staff and hence service in stores, thus narrowing one of the mainstream supermarkets' main points of difference against the LADs.
With Amazon now accelerating its move into grocery with not just Fresh but also Prime Now, Pantry, Dash, and plans for various types of physical locations, it is high time for food retailers' online strategy to include more than just connecting with customers digitally and allowing them to order online for pickup at store or home delivery. They need to start thinking about the longer term financial implications and looking for solutions for a problem that has already decimated the profitability of UK supermarkets and still has a lot further to go: the simultaneous growth of LADs and online.
Is anyone listening I wonder...