Morrisons has entered into a 25 year agreement with Ocado to licence its technology, logistics and delivery platform to launch an online grocery business. Fulfilment will be from Ocado’s recently opened Dordon Customer Fulfilment Centre in the Midlands, with customer deliveries made through a Morrisons fleet.

What it means for Morrisons

• The deal enables Morrisons to launch a long-awaited online grocery business so that it can better compete with its rivals
• By launching online, it opens Morrisons up to a new customer base, particularly in the south of England where it is underrepresented
• Morrisons will be able to immediately tap into Ocado’s “state of the art distribution system” avoid the headaches of setting up its own
• Morrisons will benefit from Ocado’s industry-leading customer service
• However the investment will hit Morrisons’ bottom line initially, with the online business not expected to deliver profit until 2017/18. Full year debt guidance has been increased to £2.7bn.

What it means for Ocado

• The deal will mean an additional revenue stream for Ocado, which will take an upfront fee and a share of the profits. In its first full year the deal will contribute to mid-single digit growth to Ocado’s top line and add a mid-teen million pound improvement to net profit. The EBITDA impact is likely to be £4-5m higher, “significantly” improving its balance sheet according to analysts.
• The deal is expected to improve Ocado’s economic model by allowing it to share costs with Morrisons and use its warehouse capacity more efficiently. Morrisons has agreed to invest in Ocado’s technology, research and development to continue improving its operations and therefore its customer proposition.
• Ocado is now not just a grocer but also a logistics and warehouse operator, showcasing its expertise in online retail, operations and distribution. Ocado chief executive Tim Steiner said the deal should “support the internationalisation of our model as well as the growth of our UK business by increased market use of our operating model”.
• But current partner Waitrose is likely to end the agreement with Ocado in 2017 after Waitrose managing director Mark Price earlier this week said: “I would never knowingly sign a contract with Ocado that agreed to them working with another retail competitor.”

Terms and Conditions

• Morrisons must only operate its online grocery business in Great Britain through Ocado, and Ocado will not provide similar online grocery services in Great Britain to more than one competitor of Morrisons at any one time.
• Morrisons will make an initial capital payment of up to £170m to Ocado to acquire Dordon and associated mechanical handling equipment, as well as a licence and integration fee.  Within that a payment of £30m will be made to Ocado to license current technology and IP.
• A further £46m will be invested to expand Dordon in order to accommodate Morrisons’ range, integrate with Morrisons’ systems and establish a network of delivery spokes. 
• Ocado will receive an annual IT payment of 1% of Morrisons.com revenue initially, with a minimum of £3.5m, to cover the maintenance, operations and infrastructure costs of IT services.
• Ocado will also receive a share of the positive EBIT of Morrisons.com. For the first 15 years, this is set at a minimum of 25% of the positive only annual EBIT of Morrisons.com, which reduces to 10% after 15 years. If Morrisons.com EBIT increases above 6.6%, the services bonus fee increases to 50% of incremental profit. 
• Morrisons will pay an annual fee in respect of future R&D commencing in 2014/2015, calculated as one third of Ocado’s relevant annual R&D spend with the fee being fixed at £8m for the first two years and capped at £8m thereafter.
• Morrisons will use 50% of the Dordon centre, which is projected to have a total capacity of 180,000 to 190,000 orders per week at peak.  Once the Dordon CFC becomes insufficient for the parties’ projected needs, the parties will expect to agree to develop new CFCs, to be built and operated by Ocado for either joint or sole use.
• There is an obligation under the agreement that Ocado will provide the same standard of services to Morrisons as it provides to Ocado.com, expected to be the best end-to-end operating model for the grocery industry in the UK. 
• Ocado is liable to pay Morrisons a break fee of £7m if Morrisons terminates the agreement before completion by reason of Ocado failing to hold a shareholder meeting by October 14 2013, Ocado’s board withdrawing its recommendation to the etailer’s  shareholders to approve the arrangements, or a third party making an offer for Ocado which offer is recommended by its board. 
• Morrisons is obliged to pay Ocado a break fee of £7m if it terminates the agreement before completion by reason of a third party making an offer for Morrisons which offer is recommended by the grocer’s board.