Click and cash: How to profit in online grocery shopping
Online grocery shopping still hasn’t caught on in Europe, due to both supply and demand problems. Rather than replicating what they have done offline for decades, retailers need to develop specific online value propositions. By choosing the right one — and developing the operating model to support it — retailers can profit from online grocery sales.
Click and cash How to profit in online grocery shopping
About the authors
Amsterdam Coen de Vuijst Partner +31-20-504-1941 coen.devuijst @strategyand.pwc.com Marco Kesteloo Partner +31-20-504-1942 marco.kesteloo @strategyand.pwc.com Marc Hoogenberg Principal +31-20-504-1924 marc.hoogenberg @strategyand.pwc.com Copenhagen Per Hannover Senior Executive Advisor +45-3318-70-22 per.hannover @strategyand.pwc.com
Frankfurt Benedikt Schmaus Partner +49-69-97167-437 benedikt.schmaus @strategyand.pwc.com London Richard Rawlinson Partner +44-20-7393-3415 richard.rawlinson @strategyand.pwc.com Andre Medeiros Principal +44-22-7393-3407 andre.m.medeiros @strategyand.pwc.com
Coen de Vuijst is a partner with Strategy& based in Amsterdam. He specializes in growth strategy, go-to-market models and organization design, and commercial capability development for clients in the consumer goods and retail industries. Marco Kesteloo is a partner with Strategy& based in Amsterdam and leads the firm’s global retail practice. He has more than 20 years of consulting experience in strategy, organizational and commercial improvements, and the collaborative value chain between retail and consumer goods organizations. Marc Hoogenberg is a principal with Strategy& based in Amsterdam. He has more than 12 years of consulting experience, helping retailers and consumer goods organizations improve their commercial capabilities using advanced analytics and customer insights.
Online grocery shopping still hasn’t caught on in Europe, for two primary reasons. One is a demand-side problem: Consumers don’t like paying delivery fees, don’t like waiting for deliveries, and sometimes receive items that aren’t fresh. The second is a supply-side problem: Most online grocery transactions lose money. We believe profitability remains such a vexing issue because most retailers continue to use the “mass convenience” value proposition from their offline stores. This model is designed to increase sales volume to overcome high fixed-store operating costs in order to achieve profitability. Online shopping, by contrast, has high variable costs, which means that the profitability issue remains largely in place as retailers are growing their online business. Retailers need to develop specific online value propositions, rather than replicating what they have done for decades offline. We see three new value propositions emerging: premium convenience, basic stock-up service, and predefined shopping basket. We believe that by choosing one of these — and, critically, designing a tailored operating model to support it — retailers can achieve profitability from online grocery.
A slow start
After 15 years, online grocery shopping still hasn’t caught on in Europe. Even where it’s most popular, in the United Kingdom, online accounts for just 5 percent of total grocery sales. In France, it accounts for 2 percent of the total, and no other country is even close to 1 percent. As a percentage of retailers’ revenue, the e-commerce share is similarly low. At leading retailers such as Asda, Leclerc, Sainsbury’s, and Tesco, e-commerce today represents 4.5 to 7 percent of total grocery sales. There are two primary reasons for this low adoption rate — a demandside problem and a supply-side problem. The demand-side issue is lackluster consumer demand. Shoppers don’t like paying delivery fees, especially when the time slots for deliveries are often wide and inconvenient. The freshness of perishable items is often an issue as well. These are not insignificant problems, and the industry needs to address them satisfactorily in order to stimulate demand for online buying. The second, supply-side dilemma is that online grocery sales remain unprofitable. Setting up a technology platform and an initial distribution network can cost tens of millions of euros. Supply chains are complex, involving multiple temperature zones, low-value bulky items, and fragile products. Order assembly is time-consuming, and if the online orders are picked in the store, they can interfere with otherwise efficient in-store operations.
In the United Kingdom, online accounts for just 5 percent of total grocery sales.
Stimulating consumer demand
Our research has found that current rates for online grocery shopping are very low (only a few percent of shoppers per year). However, shoppers that migrated from strictly in-store purchases to a mix of in-store and online purchases increased their total spending with that retailer by as much as 60 percent (although also reducing their in-store purchases by 25 percent). This leads us to believe that if a retailer could solve the profitability challenge, and persuade more people to adopt a multichannel grocery shopping approach, the additional sales volume could propel growth significantly. Stimulating demand is easier said than done. In many non-grocery e-commerce categories, online shopping offers various benefits that either don’t exist for online grocery shopping or are offset by downsides. For example, in most retail categories, online shopping offers a price advantage to consumers. However, a costly supply chain requires online grocers to charge a premium, either as separate delivery fees or as a markup on product prices. So there is no price advantage. Similarly, online shopping offers convenience to shoppers in most product categories: They don’t need to travel to a store, and don’t need to queue up. However, online grocery shopping is not necessarily more convenient, as it requires consumers to commit to specific delivery times and/or plan around pickup options. Traveling to a grocery store is typically not a major ordeal because there are often several grocery stores within a small radius (as opposed to categories like apparel and electronics stores, which are often less convenient). In most product categories, the online assortment is much broader, so shoppers have more choice and access to items that are not available in stores. The risk of out-of-stocks does not exist with online shopping in non-grocery categories; at worst, the delivery will be made not the next day but in two to three working days, which is acceptable in most cases. Online grocery assortments are often identical to, or a subset of, the range offered in stores. With online grocery shopping, the out-of-stock risk is reduced (although not completely removed) when orders are
If a retailer could persuade more people to adopt a multichannel grocery shopping approach, the additional sales volume could propel growth significantly.
picked at a distribution center, but with in-store picking, the usual risk remains. In addition, out-of-stock online grocery items are not replaced by alternatives. Shopping in the store at least provides shoppers the option of finding alternative items when faced with out-of-stocks. In most product categories other than groceries, online shopping offers near complete product information: features and specifications, as well as user and expert reviews. Moreover, as a shopper, you can expect that the product you receive is what you ordered, and it performs as expected given its specifications and user comments. With online grocery shopping, particular problems arise with ordering fresh products: fruits, vegetables, fish, meat, bread. Such products have varying degrees of quality, freshness, and ripeness. What you see online isn’t always what you get. In-store shopping allows people to handpick these items. Online grocery shopping does not, which is a significant barrier. These various financial and psychological barriers pose a threat to online grocery growth. Mitigating them without incurring higher cost-to-serve is a significant challenge. The answer is likely to be different by situation, depending on local shopper needs, demographics, retail landscape, and geography.
The profitability challenge
The second component that grocery retailers must address is the supply side. We believe profitability remains such a vexing issue because most retailers continue to use traditional business strategies that, when applied to online operations, can actually drive losses. The problem is this: In the traditional store-based shopping model, operating costs — such as store rentals, staff costs, and utilities — are mostly fixed. This means that the company can grow into profitability; once a store reaches the break-even point, any incremental gross profit made on additional sales flows straight to the bottom line. In contrast, e-commerce operating costs — order processing, picking of orders, loading/unloading the truck, and transportation to a dropoff point — are mostly variable. Our research shows that 90 to 95 percent of these costs are variable. This means that every euro in online sales needs to generate profit in its own right. To make matters worse, online supply chains are costly. Supply chain costs for a typical €100 basket are €13 higher for home-delivered e-commerce orders than for the traditional store shopping model (see Exhibit 1, next page). As a result, most retailers don’t make a profit on online transactions, and simply increasing the number of orders will not create a business with profit levels comparable to those of physical stores.
Most retailers don’t make a profit on online transactions.
Exhibit 1 Cost-to-serve for traditional store shopping and e-commerce
Delivery costs for a typical €100 basket Store shopping Inbound and distribution Store operations Shopping Transport to home
Online order with home delivery
Inbound and distribution
Delivery to region
Delivery to customer
Source: Strategy& analysis
A fundamental reset
The economics of online category management are different from those of offline operations, yet many retailers treat the online proposition as a mirror image of the offline proposition. They extend the “mass convenience” value proposition offered in-store to the online experience: broad range, same prices, and same promotions. But, as noted, this merchandising approach is designed to generate volume and overcome high fixed costs; when applied online the result is at best breaking even, and often an operating loss. Instead, grocery retailers need to develop alternative tactics for range, pricing, and promotions. In other words, a fundamental reset in thinking must occur, and that starts with the metrics used for online category management. Today, gross margin is a popular metric in the offline world, but gross margin can be misleading when applied to e-commerce; that’s because two items with similar gross margins can have widely different picking costs (how the item is physically picked in the warehouse or store) and distribution costs (how the item gets to the customer). We believe that a better metric for online category management is net margin contribution (NMC). NMC is the gross margin minus direct picking and distribution costs. (Together these costs are calculated using “activity-based costing.”) Large bulky items, frozen goods, and slow-moving product groups such as nonfood incur relatively high handling costs. Exhibit 2 (next page) shows the change in product ranking based on the gross margins and net marginal contributions of 8,000 grocery items. For example, a four-pack of soda (in 1.5-liter bottles) drops considerably in the margin rankings because of relatively higher picking and distribution costs. We found that unprofitable baskets tended to have a higher than average number of bulky items (such as crates of beer, multipacks of soda, and family packs of toilet paper), along with lower absolute margin items (such as low-end, privatelabel goods), slow-moving items, and items with promotional discounts.
A fundamental reset in thinking must occur, and that starts with the metrics used for online category management.
Exhibit 2 Gross margin vs. net margin rankings
Net margin contribution Median
Fresh fish High margin (>median) Yogurt Frozen fish Median
Low margin (
Multipack of soda Gross margin
Low margin (
High margin (>median)
Source: Strategy& analysis
Emerging value propositions
Net margin contribution varies not just across product categories but also across customer segments, which means that some customer groups are more profitable than others (see Exhibit 3). To us, this is further evidence that the mass convenience model used by most retailers is the wrong approach. Instead, they should design value propositions that target specific customer segments and/or shopping occasions — meaning a basket composition with a tailored merchandising mix (assortment, prices, and promotions) — in order to achieve profitability. We see three such online value propositions emerging (see Exhibit 4, next page): Premium convenience. This model provides premium products or services to a small group of target customers at a premium price. For example, Instacart in the United States aggregates a grocery order
Exhibit 3 Net margin contribution by customer segment (indexed, high-income pensioners = 100)
High-income pensioners “Double income, no kids” Singles ages 40–65 High-income households with children Less affluent pensioners Singles younger than 40 Young families Less affluent households with children -131 -20 -25 -34 Source: Strategy& analysis 3 11 68 100
Exhibit 4 Current and emerging grocery e-commerce models
Basic stock-up service
Target consumer segment
TESCO Chrono Drive Amazon Waitrose Fresh Ocado
Hello Fresh matkassen.com
Focused Predefined shopping basket Focused
Scope of shopping trip
Source: Strategy& analysis
from several different retailers by actually visiting the stores and pulling items from the shelves, and then delivers the order to the customer’s house on the same day (and sometimes within just an hour or two). These consumers value the service component and are willing to pay for it. Basic stock-up service. This approach provides basic staple goods at regular intervals for a price comparable to in-store or at a slight premium for home delivery. For example, Amazon and Walmart provide a limited assortment of non-perishable staple items online. This allows for efficient picking, not just because the range of products is limited, but also because the products are all non-fragile and in a single temperature zone (for example, non-refrigerated). Delivery of these staples is less time-critical, which makes it easier to coordinate with a third party to use an efficient, low-cost delivery network. Predefined shopping basket. This proposition provides a solution for a specific shopping trip to a small group of customers. For example, Matkassen.com (literally, “grocery bag” in Swedish) targets mass affluent families with five easy-to-prepare meals each week. There are
three options to choose from: basic, premium, and organic. Bundling the price of several meals together, instead of pricing individual ingredients, tends to lower the price sensitivity among consumers. What’s more, a prepacked basket allows retailers to tailor meal bundles based on the discounts they receive from suppliers without needing to pass along those savings to customers. This gives them full control over the margin mix and keeps the order assembly process simple and efficient. Last, it provides an element of convenience, overcoming the shopper’s problem of “what to cook for dinner tonight” and ensuring a well-balanced, easy-to-prepare dinner, which is worth a premium price to some consumers.
Tailoring the operational model
Whatever value proposition a company chooses, it must tailor the operational model accordingly. Amazon’s basic stock-up model would not be profitable without a fully automated warehouse that creates a low cost-to-serve. But a fully automated warehouse is too expensive and impractical for Instacart or Matkassen, given the scale and type of orders they handle. When designing the operational model, the two main considerations are cost-efficient picking and delivery. Picking methods range from manual in-store picking (e.g., Instacart) to fully automated darkstore picking (e.g., Amazon). In recent years, efficiencies at picking facilities have improved significantly, thanks to pre-replenishment automation, order assembly, and optimized truck loading. However, investment costs for these automated systems are significant and require high order volumes to be profitable. The other major design consideration is delivery and how to keep these costs low. A big driver of these costs is the so-called last mile: the final leg of the item’s journey to the customer’s home from the company’s previous distribution point. To reduce or avoid last-mile costs, retailers are experimenting with a number of alternatives to home delivery: pickup in store (“click and collect”), pickup at a specific central location (including the use of refrigerated locker systems by companies like Waitrose in the U.K. and Coles in Australia), and trucks that drive by office locations.
When designing the operational model, the two main considerations are cost-efficient picking and delivery.
Getting it right versus getting it fast
In traditional bricks-and-mortar retailing, being first was a great competitive advantage. It meant you could occupy prime real estate, secure a certain amount of foot traffic, and generate good profits. Merchandise had to be good but not necessarily great, since location was the main driver of sales and customers couldn’t easily compare all competing retail offerings. But prime locations don’t exist online. It’s more important to get the e-commerce business model right than to be first. Being first in online grocery retailing is irrelevant if competition follows with a better value proposition. Retailers should focus on carefully designing a profitable e-commerce business that combines a tailored value proposition and operational model. This takes time, but it’s time well spent.
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