TABS Analytics Blog

The Fundamental Failures Behind Online Grocery

Chances are that when it comes to eCommerce, one of the biggest trends you may be hearing about is the rise of online grocery. Some of the biggest names in grocery retailing are adopting online services, and many others in consumer-packaged goods (CPG) are considering branching their operations into this area of eComm. However, much of the data that TABS Analytics has collected suggests that online grocery not only doesn’t have the explosive future potential that some may believe, it is also inherently economically flawed. Yes, some retailers may be making money off of it now, but for the vast majority of them, online grocery will never work.

With so much buzz - and misinformation - about the world of online grocery, it is a prime subject to which TABS can apply its analytical approach and weigh in on the matter, as we did in our April 2019 webinar, Online Grocery, Are We There Yet?. As an industry leader in outsourced CPG analytics and consulting, our goal is to give our clients and the industry at-large analyses to drive fact-based, effective decisions.

Read on to learn about our findings in online grocery. 

The Major Online Grocery Players

One of the biggest counterarguments that’s likely to come up when discussing the idea that online grocery is doomed to fail is “but Walmart’s doing it”. The same goes for any other retailer currently operating in online grocery.

To explain why this argument doesn’t apply, we need to take a look at all the major players in the online grocery space, and what our data tells us about their success (or lack thereof.)

Walmart: When we looked at Walmart’s global annual revenue reports over the last few years, it has been steadily growing revenue around 1% a year. On the surface, all looks well there. However, in this same time frame, profits have declined around 5% per year. If we look at when this trend started, it begins around when it acquired jet.com. This led to a huge drop in 2018, and a comeback this year, but ultimately, that’s around 5 billion less in profit from 30 billion on revenue, and the attempt at eCommerce is largely to blame.

Target: Target is an interesting case in that its major financial struggle largely revolves around a failed expansion into Canada a few years back. Profits have leveled off since then, but we can glean some interesting information about its eCommerce efforts. While publicly available data from Target shows that eCommerce shopping is up 35 to 40%, profits haven’t increased overall as a result. In addition, compounded annual growth is trending downward. Was eCommerce the best investment to make?

Reported-Operating-Results-For-Top-U.S.-Retailers2 (1)Kroger: Kroger made a major investment in robotics last year, trying to add technological enhancements to its workflow. However, this was immediately followed with a $1.3 billion decline in profits as well as a compound annual growth decline. Why is it losing so much compared to other grocery eCommerce companies? A lot of it has to do with operating margins, which we will discuss later on.

Reported Operating Results For Top U.S. Retailers1 (1)

Trader Joe’s: While we didn’t break down Trader Joe’s annual revenue the way we did the other retailers on this list, it warrants mentioning here because the company is responsible for one of the most mainstream indicators that online grocery may have problems: it had to pull out of delivery in Manhattan. Part of the reason this is troublesome is that in many ways, Trader Joe’s seemed to have the perfect business model for a tightly-packed urban space, and your average Manhattan resident likely would have an interest, need, and means to use online grocery. If it couldn’t work in Manhattan, there must be a fundamental issue underlying the situation.

Amazon: To close out the discussion, let’s talk about Amazon. According to our data, Amazon is the most popular option when it comes to online grocery shopping, with roughly 25% of shoppers in our data reporting purchasing from them in some capacity in 2019. However, what’s disconcerting about this is the fact that the number hasn’t risen at all from 2018. This means the “forerunner” in the category is running flat. Considering the massive recent purchase they made to acquire Whole Foods Market, the lack of any demonstrable ROI in online grocery is concerning.

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Our Data and Methodology

At this point, it’s important to talk about how exactly we obtained the data to arrive at these conclusions. As experts in the CPG space, we use a specialized methodology to make sure we’re gathering the most accurate, pertinent data possible. This comes from four main sources.

Annual Financial Reports From Top 4 Retailers: In this case, this references Walmart, Kroger, Target, and Costco. We haven’t mentioned Costco yet, but we’ll discuss its status later on.

TABS Analytics Industry Surveys: We’ve put out annual industry surveys for the last six years in grocery and other CPG sectors. These surveys generally focus on what types of products people are buying and where they buy them. Note that when we discuss grocery, our data is focusing on the top 15 consumables categories, with a high volume and high purchase cycle. These represent roughly 20% within the food sector alone.

Share of Mentions: It’s important to understand the numbers of different channels behind larger channels, like Whole Foods through Amazon. We accomplish this through something called the “share of mentions methodology.” By combining how often people mention shopping at certain places and the intensity of their buying in certain categories, we can use share of mentions as a proxy for the panel data measure, share of purchases, to estimate how much consumers are buying from online grocers.

Industry Publications and Studies: There are a variety of resources out there to discuss major CPG developments that are related to this story. For example, the recent Trader Joe’s pullout from Manhattan shows that it may not just be a matter of online grocery only being suitable for certain areas.

Going back to some of the major players in grocery, if you were to look up Costco and eCommerce, you may see a lot of think pieces wondering why it is so slow to get on the boat. However, our data shows that Costco is actually experiencing a steady rise in revenue without having to make any major overtures towards online grocery. In addition, the all-important CAGR is trending upwards for Costco, something that sets them apart for the other three major retailers. How is this the case? We need to take a closer look at how and why online grocery is failing, from concrete examples to economic theory.

 

Online Grocery’s Weakness: The Data

Share of mentions is one of the key metrics that we built our data on, and it’s also what exposes how online grocery can be growing and non-viable at the same time. Certain items with a long purchase cycle and high prices are seeing the bulk of the share of eCommerce purchases.

  • Baby products
  • Vitamins
  • Cosmetics

In fact, baby products had 23.1% of the total share for all grocery in 2018. By comparison, food products were down at 3% to 4%. So, when someone says that they bought goods from Amazon and had them delivered, it’s far more likely they were buying diapers and wipes than trying to fill out their grocery list.

To follow this up, we also asked in surveys where people were doing the bulk of their grocery shopping. The two largest outlets we saw were traditional grocery stores at 75% and Walmart Supercenters at 57%, though both had small declines in 2018. Small format stores like drug stores or Aldi showed the most growth. Why are we not mentioning online grocery? Because the footprint was so small, with only 1 in 6 customers reporting shopping online grocery at least six times a year. To give you a comparison, your average number of grocery transactions per year is closer to 40. If people aren’t even shopping six times, this is a clear indicator of how small the audience really is.

 TABS ecommerce grocery growth 2019-1

 

Part of the problem here is that people, by and large, prefer having their groceries delivered when they shop online. Customers have a right to want what they want, but on the company end, it opens up a whole new set of expenses, and 1 in 6 customers isn’t enough to cover those expenses.

To establish the percentage of online customers that can be considered “loyal customers,” we divided the amount of people who purchased any items by those who purchased regularly. This gave us a loyalty number of 44% of all online shoppers. To give you perspective, even the weakest brick-and-mortar grocery stores have 75% as a baseline. While 44% is an improvement, online grocery is starting extremely far behind the line of what would make them financially viable.

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Why does this matter? When the customer base for online grocery is so small, replenishment becomes a serious issue. If 56% of your base isn’t coming back regularly, what happens if the customers leaving eclipses the new ones you can bring in? In the U.K. we’re seeing some examples of this, with online grocery shoppers having dropped 4 percentage points since 2016.

 

Online Grocery’s Weakness: The Theory

Now, let’s take a moment to address the fundamental problem with online grocery, in economic terms. As production increases, things begin to become less efficient. Your goal should always be to try and keep marginal revenue above average variable costs. This is a basic economic lesson.

Let’s look at brick and mortar. Your average brick and mortar stores has fixed costs of around 25% to 35%, and some, like Costco, can go a bit lower. ECommerce has a major issue here, all because of shipping. If the customer doesn’t pay for shipping, eCommerce becomes very unprofitable, and this is exacerbated when it comes to grocery.

How Is E-commerce Growing-Fine_but wheres_the_scale

The reason for this is that your average grocery purchase online is $30 or more. Even with the cheapest rates possible, that order still needs to be packed, fulfilled, boxed, and delivered. In essence, the retailer now has to pay for something that the customer would normally do for free by going to the store and picking up their groceries. The fact that your average grocery order’s bill is smaller than something like hardware or home improvement equipment only makes this worse.

So, what is keeping online grocery down is the fact that it needs to pay more just to function in a way that customers would use, while having a far smaller base of regular customers to rely on. In addition, there aren’t a lot of areas in the supply chain to increase scalability.

What Would Online Grocery Need To Succeed?

So, at this point, we’ve established all the different factors that are keeping online grocery not only from succeeding now, but ever succeeding. But is there a hypothetical world where there would be a way to make this model work? Technically, yes, but it’s not likely anything that we will ever see. Here are some hypothetical changes that could make online grocery more feasible, and what’s holding them back.

More Transactions: Some people may think that it’s a marketing issue, and that getting more transactions will end up making things profitable. Not necessarily. If we look at smaller grocery orders, the operating margins are deep in the negatives, -30% to -40%. Some of the bigger companies, like Amazon or Target, can sell bigger-ticket items, like expensive hardware or other items, to offset what they are losing on these smaller orders. However, online grocery specialists just end up losing on every transaction. This is part of why we saw Kroger lose so much so quickly.

Technology Investment: You may see a lot of mainstream publications talking about drones and autonomous cars and how they are going to change the way that we approach delivery, but the fact of the matter is that these are band-aid solutions at best. No matter how many of these you buy, it’s still an enormous investment for a smaller audience. Online can’t beat brick and mortar spending of that type of money.

Raising Prices: Let’s hypothetically say that a company decided to invest in a drone fleet and raised their prices to compensate. While they would be making more from each order, the number of people shopping through grocery would just decrease. This would neutralize any benefits you see from the tech investment.

Pickup over Delivery: Many of the issues we’ve been talking about could be alleviated if more buyers were interested in pickup online grocery rather than delivery. However, this will likely never happen. For one, you would need to make a massive infrastructure investment to make this feasible, and there isn’t the scale to justify said investment. Converting in-person shoppers to pickup shoppers is equally difficult because statistics show people like shopping in their grocery stores. Companies like H-E-B, Wegmans, and Publix are topping customer satisfaction surveys. This includes all brands, not just grocery brands.

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There are a few lessons we can draw from this data and what it represents, but there’s one overarching fact that we should discuss, and that’s how essential data is for the grocery world and CPG industry at-large. For smaller businesses that don’t have significant distribution or retailer relationships, it’s easy to see their mega-competitors making forays into online grocery and think that it’s the promised land, when this doesn't appear to be the case. This makes it essential for CPG manufacturers and professionals, in any category or niche, to make the data and analytics investments to properly understand the macro-trends in online grocery.

Be sure to follow TABS Analytics for more insights on important CPG trends and developments. 

TABS Analytics 2019 Online Grocery Study

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