Andy Clarke: ‘Online rush will contribute to serious margin trouble across grocery’

More home-delivery capacity is not an answer to the grocery sector’s struggle to make a decent net margin in the face of sector overcapacity.

The issue has been highlighted by the obvious shortage of home-delivery capacity during the coronavirus lockdown. 

Not just for genuinely ‘need to shield’ groups, but for the large number of other customers who have become much more risk averse in the way they live their lives. 

Throughout the past six months, when the food industry has focused on keeping the shelves stocked and the aisles safe, virtually the only visible area of competitive activity has been around home delivery – and most of that has been about additional capacity. 

Tesco, as always, has led the way with its heavy investment in the extra people and facilities needed to double its home-delivery sales. 

Amazon’s launch of a (so far) limited but free delivery offer for Prime customers has added to the options available to consumers – stimulating Tesco to plan a free delivery offer for its Clubcard Plus customers – and Morrisons is trialling its own page on Amazon with a big range complementing its host’s basic offer.

“Throughout the past six months virtually the only visible area of competitive activity has been around home delivery – and most of that has been about additional capacity”

But the main event is the pending clash between Waitrose and Marks & Spencer, now that the latter has gone live with Ocado. 

M&S coughed up £750m in 2019 for a 50% share of Ocado’s UK home-delivery business and from September 1 replaced Waitrose in Ocado’s catalogue. 

The pre-launch of M&S’s 6,000-item online offer triggered a price war with Waitrose, which in turn has had to invest heavily in building its own managed home-delivery infrastructure. 

Responding to the M&S launch with heavy promotion of Waitrose.com, Waitrose is banking on a big gamble that existing Ocado users will switch to retain access to the Waitrose product offer. Let’s see.

The chief executive of Ocado has said in no uncertain terms that it won’t work, but Ocado famously took 15 years to make its first profit. Admittedly, it also took Amazon almost as long, until it gained the scale to strangle its competition across virtually the whole non-food market. 

The investors who pushed Ocado’s market valuation to a level that exceeds M&S, Morrisons and Sainsbury’s combined clearly think they will make some big money – one day.

The true cost

But today’s question is how long can the food industry go on putting all this money into online and home delivery? Can it get customers to pay the true cost of providing the service? 

That seems unlikely. Like ‘free’ banking or funding the NHS, when clever obfuscation marketing masks the true picture around who is really paying, introducing realistic charges becomes impossible. 

Food retailing is a complex business, with huge inventories of short-shelf-life products and low unit prices. Order picking is expensive and deliveries have to be timely and pre-arranged.

That explains why online has always been a seriously loss-making activity across the sector. All the big players have struggled to get customers to use online in ways that allow them to cover costs, let alone make a profit. 

This has meant getting them to accept rationing of pre-booked delivery slots, limited delivery charges and minimum spending hurdles. The current stampede into online is blowing away even those inadequate loss limiters.

Over the past six months, we’ve enjoyed the comfortable acceptance of a nobody-rock-the-boat consensus on gross margins across the sector. But we now face the distinct possibility of a sharp slowing economic environment and much more competitive conditions. 

“All the big players have struggled to get customers to use online in ways that allow them to cover costs, let alone make a profit”

The return of even normal promotional activity will make much of this online investment loss-making. Nobody talks numbers, but my guess is that the industry operating losses topped £500m on sales of approximately £12bn in 2019. Online sales growth in 2020 is expected to be 30% or more and direct costs are probably up by much the same percentage.

Absorbing this rising cost burden is going to be increasingly painful. A weak economy in 2021 seems highly likely, reflecting a big jump in unemployment, probable rising inflation and possible Brexit disruption. 

Furlough payments are being phased out and the chancellor is gearing up to introduce some severe belt-tightening measures in the near future. Recent borrowing numbers underline the fact that the government can’t go on pouring huge amounts of cash into short-term subsidies for much longer.

Hold on to your hats then for another round of serious net margin trouble across the sector in 2021. 

I seem to remember Dave Lewis telling us that Tesco’s margin wouldn’t go back from 3% to 6% in a hurry after the 2014 volume collapse. His Herculean efforts in the past five years produced a 2019 margin of 3.4%, with a return to something in the target 3.5% to 4% range pencilled in for 2020. 

With all the extra online costs to absorb, Tesco and everyone else will pretty soon be back to pushing the ball uphill. And as Delboy used to say, it’ll be déjà vu all over again.