Ocado ups ante as online food battle hots up

Ocado co-founder Jason Gissing tells a good yarn. He laughs when he recalls a story he heard about the opening of the first large self-service supermarket in 1950 – a Sainsbury’s in Croydon.

“The women were very irritated and upset at being given metal baskets and told to walk around and pick their own food,” he says. “Normally, they would go into a shop, there would be a guy behind the counter and they would say what they want, he would get it for them, wrap it nicely and they’d put it in their basket. They found the concept of having to walk around rude and offensive.”

For Gissing, the self-service supermarket marked a step in the evolution of food shopping that has since led to his own venture, Ocado. “Customers were outraged by self-service but it was the most efficient way of food shopping,” he says.

He explains that over the following 20 years the majority of the small food shops disappeared, high street supermarkets became the norm, then fast-forward another 20 years and grocers moved to out-of-town locations.

“Moving out of town was absolutely the right thing to do and the car was the enabler for that,” he says. “And now the internet, and broadband in particular, is the enabler for online food shopping which is the next big thing.”

While online food shopping is only worth around £2bn to 3bn in sales compared with the total grocery market of £120bn, Gissing is confident of its potential. He points to a report from OC&C that forecasts that in another 20 years’ time 40 per cent of the grocery market will be online. “40 per cent is a £50bn market,” enthuses Gissing. “And that is a growth of 20 per cent every year until 2025.”

Ocado – which distributes Waitrose products, and now accounts for around 10 per cent of Waitrose’s sales – is aiming to grab as much of that growth as possible. This week it launched its “Internet Only Prices” deal whereby it has cut the price of almost 4,000 Waitrose products, making them cheaper than in a Waitrose store. Ocado has also recorded average year-on-year sales growth of 30 per cent and this year expects sales to hit £450m.

While Gissing is clearly excited by the growth potential, he knows both Ocado and the online market as a whole have a long way to go. According to TNS, for the year ending March 2009, online grocery – from the four biggest players Ocado, Tesco, Sainsbury’s and Asda – represented 2.3 per cent of grocery sales.

“We are tiny compared with the rest of the grocers and the UK is an incredibly competitive market,” says Gissing. “But after nine years of banging our heads against the wall, we’ve got something that actually works and other people are starting to believe in it.”

Gissing believes the difference that will set Ocado apart from the online offer of its supermarket competitors is its efficiency. Picking from stores instead of a distribution centre is, “much less efficient” he says.

Gissing claims the cost of Ocado delivering groceries to a customer’s house is “materially lower” than the cost of that customer going to a supermarket and picking the goods themselves. “We have made our model work and it delivers world class customer service,” he says. “And our carbon footprint in terms of grams per pound of sales is around 10 per cent lower than a supermarket.

“Supermarkets are not something we have a need for,” he says. “We don’t go shopping for food because of any emotional attachment to a store, we need to eat. What we actually want is to wake up in the morning and our cupboards are full – there is food in the fridge, wine in the cupboard and beauty products in the bathroom. And that’s where we come in.”

He maintains that while shopping for some products – clothes, luxury items, even certain gourmet foods – is fun, “who would find it fun to go out and stock up on Buxton water?”. He adds: “If you know what you want then we offer the perfect service.”

And the reason shoppers pick Ocado over online shopping with a traditional supermarket such as Tesco or Sainsbury’s, according to Gissing, is that it can offer more.

The upper hand

Gissing boasts that being a pure-play grocer limits the amount of substitutions in its orders. He says Ocado customers have to shop with the e-tailer six or seven times before they receive one substituted item, whereas rivals substitute between two or three items each delivery. “We know what we’ve ordered, we know what’s there to pick and we know what’s gone out,” he says. “When grocers pick from stores they can’t be that efficient.”

Ocado has introduced several new elements to its site that Gissing says is “undreamt of with a supermarket”. It now offers a “life guarantee”, which tells customers what the use-by date of a product is both on its website and on the receipt. “We are the only retailer in the world to offer a life guarantee,” says Gissing. “In a shop, you don’t know what’s on your shelf so can’t give the product life span.”

The site also boasts an “instant shop” button whereby it will put together a list of items it believes the shopper wants. Gissing says: “The technology is clever enough to know that it’s three months since a customer bought Marmite, or three months since they bought floor cleaner. And pick up the fact they buy milk and eggs every week.”

The level of customer knowledge Ocado has built up is allowing the e-tailer to start doing some “really clever” things, says Gissing. He is researching how best to get nutritional information to customers. Ideas include being able to tell customers what their weekly salt content is, or how to budget each week if a household wants to limit its spend to a certain amount a year.

Ocado can tailor its offer because it has a loyal customer base. For the last week of March, more than 80 per cent of its sales were to customers who had shopped more than 10 times with the e-tailer previously. Ocado has 65 per cent coverage of the UK and six depots alongside its main Hatfield distribution centre. It expands by postcode areas and Gissing points out that in some locations, with up to 3,000 houses, it delivers to 9 per cent of the market.

These innovations have helped Ocado up its sales growth from as low as 13 per cent at one point last year. “We surveyed our customers and they told us we were a bit expensive, they were concerned about product life span, and they wanted us to do something about our range,” says Gissing.

So Ocado introduced the life guarantee, launched its Tesco Price Match initiative across around 5,000 products, and expanded its range – up from 9,500 SKUs when it first launched to 16,500. Gissing says Ocado already stocks more than any Waitrose shop in the country, and will ultimately up the number of SKUs to 25,000.

By the end of this year Ocado’s range will increase to around 18,000 and while the e-tailer has expanded beyond food to products such as toys, magazines and flowers, Gissing says the focus will remain on food.

“If you speak to Jeff Bezos, he will tell you he wants to grow Amazon from £17bn to a £100bn company,” says Gissing. “And he will tell you that the only way to do that is to sell food, as food is half of all retail spend. He will say that if you can deliver fresh tuna steak to someone’s house in perfect condition, then delivering general merchandise is pretty easy.”

So while Gissing says he will explore other general merchandise categories, there remains huge scope for additional food ranges. “We can look into all kinds of food such as Japanese or French specialities to have the largest breadth,” he says. “We want to be for food what Amazon is for general merchandise.”

Potential rivals such as Amazon are thought to be mulling entry into the food arena in the UK but Gissing says, “people will copy us but we have a head start”.

The nine-year journey hasn’t been easy, remembers Gissing. “It’s been hell at times,” he says. “This [central hub in Hatfield] used to break down once a week for the first couple of years.”

Keeping the faith

The technology that Ocado first had in its central hub has all but been replaced – and now delivers some 75,000 orders a week to everywhere from Windsor Castle and Downing Street to terraced streets in Hertfordshire. “For the longest time it didn’t work,” remembers Gissing. “I used to pull an all-nighter once a fortnight and Tim [Steiner, co-founder] probably once a week. We were killing ourselves. We could see we were almost there but so many things were still going wrong. And it wasn’t like a car plant where you could switch it off for a few hours and work out the problem. We had Mrs Smith waiting for her order.”

Gissing jokes he used to tell his wife it felt like he had decided to swim across the Atlantic and he had got about halfway and was under a storm. “I would tell her I could turn around but it’s just as far to swim back so I might as well keep going,” he laughs.

He says the belief that a significant percentage of the market would start to shop for food online kept the team going. “Tim has an IQ that is almost unmeasurable and he had the ability to see the end product, and now we have the most efficient way of food shopping,” he says.

Ocado became EBITDA-profitable in November 2007 but has yet to make a profit at an EBIT level. Gissing says: “The reason we are loss making is because of our size. If we double our sales our fixed costs don’t double.”

He says the e-tailer could go into profit “within two to three months” but is also carrying a lot of costs for its future development, such as embarking on international expansion and potential projects around licensing. “If you look at companies such as Vodafone or BSkyB they spent many years reinvesting cash without making a profit and they wouldn’t be where they are today without doing that,” he says.

He also believes international opportunities are huge. “If you look at great businesses like Amazon there are other companies doing the same thing in different markets,” he says. “But there isn’t anyone in the world who can do this so the potential is massive.”

He believes when Ocado opens in another country it will be profitable “within two or three years” as the model “has been tried and tested in the UK”. He sees grocers starting to license the technology.

“Even discount grocers will use this method as there will come a time when this is the lowest cost option,” he says. ”Then, in the UK, should we choose to we can cut our prices and undercut everyone when we’re at scale. The total grocery market only grows about 1 to 2 per cent a year so in terms of the big players, it’s just a case of moving chips around. You don’t need shops when you’ve got a warehouse doing the same thing more efficiently, so when online becomes a third of the market, what the hell are they all going to do with their shops?”

As the meeting room starts to shake during our interview as the Ocado orders whizz around the track beneath, it is evident that costs are paramount. “We’re so cheap we built the meeting rooms above the depot. Every now and then the table shakes,” laughs Gissing.

But keeping costs low is wise in the current climate, and if Gissing is right about the e-tailer’s potential, it won’t be on shaky ground for long.