Nick Bubb’s Verdict: Ocado and Waitrose - A doomed marriage?

The increasingly unhappy marriage of Ocado and Waitrose seems set to end in the divorce courts, but can the two sides patch up their differences?

Much has been written recently about the acrimonious state of the relationship between Ocado and Waitrose and much of the commentary has been sympathetic to Waitrose’s side of the affair.

But there are two sides to every story and food retailing analysts have just been given the chance to weigh up the arguments of the two protagonists, via yesterday’s Ocado interim results presentation and today’s breakfast business briefing by Waitrose (on the back of their customary Christmas range preview).

There is, of course, plenty of “history” to the so-called love-hate relationship between Ocado and Waitrose and it is fair to say that this was never exactly a marriage made in heaven.

Ocado’s entrepreneurial drive and online focus never sat very easily with the more conservative style of Waitrose’s management, but the initial supply agreement back in 2000 suited both sides: Ocado needed a quality grocery range to get started in Hatfield and Waitrose wanted to extend their customer reach by getting quickly involved in online grocery retailing.

But Waitrose soon wanted to do online themselves and it was the growth of Waitrose.com inside the M25 that helped to ratchet up the tension between the two companies.

Waitrose MD Mark Price has been famously quoted as saying that Ocado’s pursuit of a new supermarket partner (which culminated in the recent game-changing deal with Morrisons) amounted to a declaration of “Defcon 1” and Waitrose was clearly surprised by the news that Ocado was going to share its second warehouse in Dordon with its rival.

But it is possible to trace Ocado’s pursuit of such other avenues of growth back to the Waitrose decision to open a “dark” fulfilment store in Acton in October 2011 (because of the picking capacity constraints in many of its London stores).

In any nuclear arms race it gets hard to work out who is reacting to who, with an aggressive move by one side being met with retaliation by the other, but there are signs that Ocado and Waitrose are now taking a more pragmatic view of the relationship.

Both sides are clearly preparing for a life apart, after the first time the contract can be terminated by either party in 2017, but hopefully both sides will be rational. Conventional wisdom has it that Waitrose will walk in 2017 and that Ocado will be the victim, but there is, arguably, just as much a risk that Ocado will walk away, which might not be in Waitrose’s best interest.

When all is said and done, Ocado is Waitrose’s biggest customer, providing a significant (though unquantified) stream of income for the business through supplying their range to Ocado.

But the mix of Ocado’s business is changing fast, as they build up non-Waitrose supply sources, both in other food brands and own-label food. The total Ocado range is now 31,000 SKU’s and that will increase a lot further, towards 40,000 SKU’s as the non-food range develops (with pet products just the first specialty website).

Little more than 33% of Ocado’s current turnover comes from Waitrose own-label products and in the first half it is interesting that the business was broadly flat, as other products grew faster. Ocado claims that some 25% of their sales now come from products that customers can’t buy in a Waitrose supermarket.

There are clearly still restrictions in the supply agreement on how much Ocado can buy outside Waitrose, but Ocado is having some success in migrating its customers away from the perception that it is just a Waitrose supplier with another name.

It is a moot point why customers shop at Ocado rather than any other online grocery business, but the superior service in terms of stock availability and customer order delivery made possible by its centralised warehouse model is clearly a lot to do with it.

And these metrics continue to improve for Ocado, with order picking accuracy up to 99% in the first half and on-time delivery over 94%. Whether Ocado can ever make any real money out of all that is also a moot point, but it is their IP skills in technology and software that are attracting companies like Morrisons, as well as a string of overseas suitors to Ocado’s door.

Waitrose’s response is to throw down its own dot.com capacity as fast as it can, without crashing short-term profits.

But only about two-thirds of its current stores are big enough to be able to provide a dot.com picking and delivery service, so it is already planning a second “dark store” somewhere in South London next year.

Interestingly, however, by this time next year Ocado will probably be actively planning its third grocery online warehouse and “somewhere east of Bracknell” (Waitrose’s home town) would be a logical place to put it. And Ocado’s new warehouse is likely to open just before the two sides sit down to negotiate a new deal come 2017.

Both Waitrose and Ocado will have built up strong hands by the time it comes to negotiating a new supply agreement. Waitrose will no doubt be keen to increase the size of its supply fee from Ocado, but it is no longer a shareholder (the John Lewis Pension Fund sold out in February 2011, after Ocado’s IPO in 2010) and they may be nervous that if they push Ocado too far that M&S may step into their place.

On the other hand, Ocado will still be realistic about what damage they may suffer if they lose the Waitrose brand, however well they do over the next 4 years with Morrisons and with all their Overseas and non-food growth plans. Common sense may yet prevail as Ocado and Waitrose recognise that each side still has particular skills and strengths to keep their marriage going.