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Anonymous

Former CEO, Lidl UK 

Lidl: Hard Discounter Business Models

{audio:0:00:01} Marc, can you provide a short introduction to your background, please?

{audio:0:00:06} I lead grocery ecommerce fulfilment at The Partnering Group, a retail and CPG global consultancy helping, currently, mainly US grocers on their online fulfilment strategy and also to optimize the efficiency of their fulfilment. Prior to that, I had my own consultancy, focused mainly on European food retailers, helping them with online fulfilment strategy and execution. Prior to that, all the way back in 2013, I was a financial analyst for quite a long time – probably slightly too long – all around the world, with the previous 10 years focusing on Europe and the US.

{audio:0:00:50} How, exactly, have you been working with grocers moving online, over the last few years?

{audio:0:00:57} There are two things. Firstly, there is the strategy of how they want to do the physical picking of the orders, which is the most time-consuming and costly part. That mainly involves optimizing the manual processes and it’s a mixture of processes, technology and people management, to try to get them towards best-in-, which is UK levels of picking efficiency, per hour. In other words, around 130 to 140 units per hour, fully loaded; that’s all inclusive of all the preparation and the staging, not just the physical picking. Just as a benchmark, in the US, the average is around 40 UPH, so there is a lot to be done there.

{audio:0:01:40} Also looking at if, how and when to bring in automation. Looking at micro fulfilment solutions, both from existing providers, like Dematic, KNAPP or now with Takeoff, or the more next-generation systems, like that from Alert Innovation, which is working with Walmart, and Fabric and AutoStore. Of course, Ocado is a key part of that, so benchmarking against Ocado which, currently, has the most experience in doing automated fulfilment for grocery, both for itself and for its partner Morrisons and other partners. Looking at whether it makes sense to choose Ocado, as a third party, or to build their own CFC in-house or to test a micro fulfilment solution provider; that’s all part of it.

{audio:0:02:40} I have also consulted for a couple of those previously mentioned, automated MFC providers.

{audio:0:02:49} What are the decision-making criteria, for the grocers, when choosing between those solutions?

{audio:0:03:03} The first question is, is it worth us even looking at automation yet? Probably only the bigger ones think it’s actually worth running the test. You’ve got to have the resources and the people to take that sort of risk because it hasn’t been done. Micro fulfilment, for grocery, has not yet been proven, in terms of the fact that we don’t have the full numbers as to exactly how efficient it can be. Clearly, if you are running at 40 units per hour, like in the US, you are going to get a significant uplift, straightaway. But it’s still in the testing and optimization phase.

{audio:0:03:38} Then it’s looking at which solution. Are we going to go with the tried and tested ones, where we know the multi-shuttle systems hardware works, but we don’t know how that works when you scale it down to levels that we haven’t been to before, such as $30 million sales capacity a year? Previously, they had a minimum of $100 - 300 million. Are they going to manage that themselves, by just buying that hardware from the system provider? Are they going to bring in a systems integrator? Are they going to use Takeoff, which has put the software layer into the integration? Or are they going to look at the centralized fulfilment model, from Ocado? There are pros and cons to each.

{audio:0:04:32} Because it is a very unknown area, some of the decisions are not necessarily based on pure logic. Humans are not pure logical creatures. Sometimes, whoever is in charge argues, or very strongly feels, that this solution is the one they should go for. Maybe it’s more strategic, so there is a strategic element. Do we want to be very aggressive, to gain share, or do we want to just test and see? There is a whole bunch of criteria depending on the retailer, what their general strategy is, what their risk tolerance is and what their resources are.

{audio:0:05:10} What is your view of the Ocado OSP solution?

{audio:0:05:16} Ocado’s solution is an extremely good picking system. It can pick from a very broad range of 40,000 to 50,000 SKUs and does it very efficiently and is proven, in terms of the quality of service they provide to customers. It’s also end to end. It’s not just the picking, but it’s the front end and the routing software and people management. They do a fantastic job. If you look at the customer service metrics for both the Ocado brand and also Morrisons Online, they are far ahead of their UK store-based competitors, who are generally picking from stores. You get a better range; you’ve got a much better inventory control and better freshness. It provides a very good service.

{audio:0:06:06} But the question is then the cost. At what cost? Who is it suitable for? In my view, for a third party, it is really only suitable if your store base is relatively limited; if your existing share, in the markets where you are going to put your Ocado CFCs is very limited. That means that you will have a good chance, if you have a strong brand. For Marks & Spencer or Waitrose, it makes a lot of sense. Also, for Monoprix in France, it seems to make a lot of sense. They have a limited footprint, they have a very strong brand and, probably, there is a lot of demand, if only people could have access to their products, so they can get a lot of incremental share.

{audio:0:06:44} But I really feel it’s not the right solution at all for a major grocer who has significant share in their markets, where they are going to put the Ocado CFCs. The reason for that is, when you are building a dedicated fulfilment center, effectively, you are adding a double running cost center. Whatever sales that would have been fulfilled in your store are, basically, taken out of the store and allocated to that CFC, to cover the running costs. But it means you deleverage your store sales and hence your store profits. Let’s say you’ve taken 10% of sales away from the store and those online orders are now being fulfilled in Ocado, you’ve deleveraged that store’s sales by 10%. Given the fixed cost leverage you have in grocery, your EBIT, your operating profit is mechanically down between 30% and 40%.

{audio:0:07:39} In order to offset the cannibalization of your existing store-based sales and profits, you need a very, very high level of incremental share from the CFC. Additionally, you need the CFC to be at least as profitable as your stores, which is not yet fully proven on an EBIT basis. It’s a very, very aggressive strategy. I think it’s more aggressive and risky than a lot of people seem to understand because of the point about deleveraging existing stores. If it was all incremental, fine. But it’s not going to be. We’ve seen that, actually, it’s very difficult. Tesco, in the UK, went very aggressively to become the market leader, online. They used to have about 33% offline share and, in the early to mid-noughties, it went very hard to gain market leadership online and it did very well. They had a share of well north of 50%. But as your competitors react and they start fighting hard to either keep their high-spending, multi-channel customer or steal yours, that incrementality comes down, pretty fast. Now, Tesco online share is not that much higher than its offline share. Your natural customers tend to come back to you.

{audio:0:09:02} It’s very difficult to sustain a high level of market share. Initially, you get very excited as you get lots of incremental share and, obviously, retailers love gaining market share. But that tends not to be sustainable and the double running costs of that CFC are going to be offsetting any market share gains and also the fact that you’ve deleveraged your stores.

{audio:0:09:25} The other point is, a lot of what you gain in picking efficiency, you lose in delivery cost and time. It’s a centralized fulfilment operation but the cheapest and quickest way to deliver is, obviously, from your stores because you are as close to the customer as you can be. Once you take it away, you’ve got much longer delivery routes and higher costs, so a good portion of what you’ve gained in picking efficiency, you can lose in delivery costs. Also, it’s more difficult to do same day, if you think that is important.

{audio:0:09:56} Potentially, the only way it could work is if you have a grocer that has an existing store footprint that moves into a new region or new area, where it is incremental to the existing store base, or they don’t even have that store base in the first place?

{audio:0:10:15} Exactly. Often, when you are trying to move into a totally different market, your brand name is less well known. Obviously, you can’t differentiate on service as much as you would in an in-store environment, but you will probably have a broader range than most and you might stand some chance of getting decent share in that market. That’s the only way it can make sense to me.

{audio:0:10:46} But don’t all the partners or customers of Ocado today – Kroger, Casino – surely they understand the deleveraging aspect of their store base?

{audio:0:11:02} I’m not sure they fully do, to be honest. It’s actually quite a financial analyst type of thing to think about and you’ve really got to look at the ecomm side and the store side and bring it together. If the decisions are made by the head of ecommerce, they are generally motivated and even, I would guess, incentivized, mainly on the sales and optimizing their own P&L. I’m not sure if anyone has actually done the work of putting the two P&Ls together; what happens when you gain market share there but you lose from your stores?

{audio:0:11:45} You could call it strategic. You could say, we’re going on the front foot and I’m sure we can continue to optimize and maybe Ocado will be able to do micro fulfilment; although so far, they haven’t. They have not scaled it down yet, as far as I am aware, to the store level or the micro fulfilment level. Presumably, the idea is that the technology will evolve but I’m not sure if they’ve actually done that work.

{audio:0:12:09} When you talk about Casino, that’s Monoprix. That makes much more sense to me. Monoprix is a relatively small store format but you can’t really pick from the store. It’s got quite a differentiated range, with a lot of own brand and, actually, some non-food in there, in terms of clothing. Their store base is pretty concentrated in the Paris area and, as I said, you can’t pick from stores, anyway, so you’re going to need a fulfilment center to serve that area. It’s quite a dense area and it makes more sense if your market is particularly dense and you don’t have too many stores and that high a share of that particular market that you are aiming at. It makes more sense to me for the likes of Casino and Monoprix, but if you are just a standard, mainstream grocer, then it’s much more difficult.

{audio:0:13:12} As I said before, decisions are not just made on pure logic and other people might have different views. Maybe you’ve got your board or you’ve got someone arguing very strongly and you’ve got a very good salesman. No one will argue that Tim Steiner, CEO of Ocado, is not a good salesman. I’ve certainly heard him present at a lot of events and he’s very compelling. But, in the end, sometimes there are emotional decisions that are made. Is this decision going to make me look good? If I’m right about what I’m saying about the double running cost, you’re only going to see that cost in one, two or three years’ time, so it’s not an immediate impact.

{audio:0:13:49} How could we be wrong about that double running cost or the deleveraging? What could be the reason?

{audio:0:13:54} The only thing is if the level of incremental sales is just really, really high. It’s mechanical. In fact, the last piece of work I did, as an analyst, in 2013 – which was when 5% of UK grocery was online – was to work out what would happen if 15% to 20% of the market went online. That meant that pretty much all the picking would have to be taken out of stores, into fulfilment centers, with double running costs and I estimated the deleverage on stores. That was with zero incremental share because it’s a zero-sum game, overall. You’re not eating more because you’re buying online, excluding the shift from restaurants driven by Covid.

{audio:0:14:34} Mechanically, it said that if 15% to 20% went online, the sector profits would be down 40% to 50%, due to that deleverage effect. The only variable, really, in the model, is the level of incremental sales and the profitability you get from them. Those are the big unknowns. We don’t really know what the underlying profitability for a major retailer, with decent buying scale would be, with the Ocado model. The big question is incremental share. But I estimate you need at least three quarters incremental and sustain that level and that’s never been done. If you look at Ahold and Albert Heijn in Holland, they used to have a very high share and now that’s come right down, as well, similar to Tesco. Every time you’ve had a market leader really go aggressively, their competitors tend to react and that share tends to come down.

{audio:0:15:30} Aren’t Kroger moving their CFCs into new areas where they are not cannibalizing their existing estate?

{audio:0:15:39} They’re doing a mix. One of their first CFCs will be in Florida, where I don’t think they have any stores. Again, it’s a bet that online can make decent money, with a centralized model. But on the other hand, in other markets, such as Ohio, where they have significant share, it is going to be a very different model. Maybe they will get even higher share because their brand is known there but, for sure, they are going to be taking some share from their own stores. The overall P&L will look very different in those markets.

{audio:0:16:40} What about the history of Ocado and the relationship with Morrisons and how that evolved, over the years?

{audio:0:16:47} That’s actually quite interesting. It’s known that, when Morrisons did the deal with Ocado, they were way behind online and they weren’t particularly tech savvy, I think you could say. Desperation is the wrong word, but they needed to accelerate their online shift. They had been saying, we can’t make it profitable; Ken Morrison said it wasn’t profitable. But when they started to lose enough share to Tesco, they realized they would have to play this game. Pay to play; we’ve got to get in there. Ocado came along and so they signed with them.

{audio:0:17:20} But since they’ve signed, if you look, certainly what new management have done is a lot of rolling back where they could. One of the first moves of the new management was to actually reduce the extent of the partnership and then they declined to take up space the last time they were offered. They say they are using some of Ocado’s systems for in-store picking but, generally, they’ve been rolling back on their partnership with Ocado. They certainly haven’t been stepping up the pedal with them. Maybe that’s an indication for the future.

{audio:0:18:07} Is it just that it’s too costly to run the operations or no incremental sales for the costs?

{audio:0:18:12} If you look at their online market share, it’s obviously gone up from zero, but it’s not that far ahead of their offline share. I don’t know what the latest figures are but I did see, at one point, they were approaching their offline share. They’re now probably a little bit ahead because they do beat the others, as I said, on customer service. It seems to be that it’s not nearly incremental enough to justify the cost. I think their terms were particularly favorable to Ocado, at the time, so maybe the terms improved. Even then, I think it is indicative; by no means is it a clear success for them.

{audio:0:18:51} I think the new CEO changed the terms and I think they had some kind of wholesale deal with Amazon which seemed a bit weird given that there is some kind of exclusive contract with Ocado?

{audio:0:19:03} Yes; obviously they were looking for other means to sell online. Being a wholesaler to Amazon is probably lower risk, lower cost. That is the way I would have recommended if I’d been advising them. I would have also accelerated their manual picking efficiency with best-in-class systems and processes. It’s interesting that, if you look at the UK, Tesco and Sainsbury’s have pushed in-store picking as far as they can. I don’t know what the figures are but ninety something percent is in-store picking, in the UK, even though Tesco has five or six what they call dark stores. They haven’t built a new one for quite a long time, apart from the one they’ve done with Dematic, an automated MFC. Sainsbury’s really tried its utmost to not have to build a CFC, despite their very dense market share in the South East of the UK; they just did one semi-automated. In fact, their previous CEO, Justin King, was on record as saying, you really have to look at the economics of these things; it’s generally not worth it. It’s much better to sweat your existing assets, your stores, and pick from your stores, as far as possible. I think he got it.

{audio:0:20:26} Just looking at the real advantages of Ocado’s solution, clearly it has the broadest range, obviously a turnkey solution. But it does seem as if grocers are onboarding Ocado because of this great customer experience that they can offer, over other options in the market.

{audio:0:20:56} Yes, I think that’s fair. As you mentioned, it’s the full suite. You’ve got front end and fulfilment, all linked to the delivery. To some extent you don’t need to build your own front end capabilities and routing software so it takes a lot off your hands. Obviously, you are going to pay for that in the fees but what they do, they do extremely well, there’s no doubt about that.

{audio:0:21:29} Is the front end and the routing the real edge?

{audio:0:21:34} It is an advantage. If you’re confronted with a suite of solutions and you’re not too sure, then go with one company that is going to do everything; it’s just easier. Someone else is saying, but it really costs a lot and look at it when you put the two P&Ls together. It’s quite easy to say, forget all that. This is strategic; this makes sense; let’s just do it. I just wonder, to what extent, that’s the way some of these big decisions are made. You can look at all the data you want but, in the end, you’re just going to go with a gut feel.

{audio:0:22:12} Is it harder to replicate that front end, the routing and even the back end of delivery, or the picking, the automation?

{audio:0:22:21} I would say, the picking is still the tougher part, having been on the inside and having seen how micro fulfilment and the automation works. To optimize it is quite tricky, but they’re going to get there. In the picking, I think there is quite a lot of catching up going on. Over the next year or two, some of these competitors will be pretty much getting there, be it the new ones who have got made-to-measure 3D mobile robots or we’ll see how far these multi-shuttle systems can get, but they’re going to be decent. I think they’ve got an edge on the picking now but that’s going to narrow over the next year or two, as the others get hardened and optimized and proven.

{audio:0:23:12} In terms of the front end, on paper, it’s not all that difficult these days, but you do have to build the team and do it all yourself. It tends to be that the pure online grocers tend to have a better front end than the store-based ones. I think they still have an edge there. In theory, there’s no amazing technology there; it’s just people, process and optimizing the front end. I don’t think the difference is huge.

{audio:0:23:45} As for the routing and the last-mile delivery, there are loads of companies getting into that. It used to be very cutting edge, when Ocado first started rolling it out, but I think much less so now. I think that is where the motor is least developed.

{audio:0:24:02} Just looking at the economics, I think it is a 32% gross margin, for own retail, for Ocado; 12% delivery and 7% to 8% CFC cost. The delivery is typically the most expensive portion of ecommerce and you are saying that there is not necessarily an edge in the routing tech that Ocado’s turnkey solution has, over a solution that another grocer could integrate from other solutions?

{audio:0:24:34} No; I don’t think so anymore. You’ve got companies, like Bringg, that is specialized. Additionally, as we’ve got the gig economy, companies like Bringg literally bring in the gig economy and use is as effectively as they can. Interestingly, you mentioned about the 12% delivery figure. For the UK store-based grocers, it’s more like 8% and that reflects the fact that they are delivering from stores which are closer to the customer. There’s a roughly four percentage points difference there.

{audio:0:25:10} So Tesco and Sainsbury’s have that 400 basis points advantage in delivery?

{audio:0:25:16} That’s our estimate, yes. I would need to check the extent to which they actually quantify it explicitly, but we’ve done some work on that and that’s our estimate of around 8% of delivery for the likes of Tesco and Sainsbury’s, versus 12%. It makes sense, if you think about it.

{audio:1:02:07} Looking at the UK versus the US, and how Tesco’s gross profit margin is lower due to the mix online being higher in the UK, is there any reason why that would not happen in the US, because of the density and the size of the country? Is there any reason why we might not see grocery profits decline as much as we did in the UK?

{audio:1:02:34} The biggest factor is the presence of Instacart which has the biggest share; it’s over 50% of grocery, even though they direct to other stores. Instacart, effectively, subsidizes 5% or 6% of the cost which they are taking on board in their partnerships with retailers. Instacart is a great option if you want to have very quick extensive market access, with a very good front end; Instacart’s front end is very good. Again, that’s an example of the fact that if it is the core of what you do, you tend to do it better than those who have to do a lot of other stuff.

{audio:1:03:21} But the problem is, I don’t think the model is sustainable in the US. They can really only pick single order and it’s very difficult to do multi-order. You can never rival the picking efficiency. Right now, it doesn’t matter because most of the US grocers are not picking much better than single-order picking but as that changes very rapidly, Instacart’s efficiency is going to be left behind.

{audio:1:03:42} Why do the US grocers do that?

{audio:1:03:46} They only really started this game two or three years ago, when Amazon bought Whole Foods. Before that, there wasn’t much demand; it’s a different market. There also wasn’t much supply because no one had really gone with it aggressively. The UK has been doing it for 15 or 20 years longer. To pick efficiently in store, to go from that 40 to 130 UPH, is a mixture of processes and people management is an important part. It’s not an easy thing.

{audio:1:04:13} And it’s lower margin, that’s the funny thing. The UK is so much more efficient.

{audio:1:04:17} The problem is a rock and hard place. If you ignore online and say, I’m not going there because we can’t make a profit from it, your valuable customers are going to be nicked by someone else who is doing it. It’s a new pay to play; you’ve got to be in the game and you’ve got to do it at least as well as other people. But it is going to dilute your profits.

{audio:1:04:39} Just going back to your question, Instacart has provided a subsidy so that provides a cushion but I think Instacart is going to lose share. They charge far too much. What with all their fees, the service fees, the tip and the mark up, they are anything between 10% - 25% more expensive and people value low cost of service way ahead of speed. I think that subsidy is going to, effectively, become much less important as the retailers bring it in-house. That’s the main difference, this subsidy that they have had so far, by levering off Instacart.

{audio:1:05:15} Does the gig economy and all that really make the last mile more efficient? You’ve only got single cars versus well-routed vans and I’m not sure if you get a benefit from that. I don’t think the profit impact is going to be that different in the US. It may take slightly longer to show but when you’re jumping from low single digits to high single digits, you’ll see it next year, for sure.

{audio:1:05:37} In terms of the end game here do you think, going forward, it’s the grocers in the US starting to bring back some picking in-store, maybe testing with some micro fulfilment centers. Then those grocers that don’t have a presence in a certain region, can actually use the Ocado solution?

{audio:1:05:53} You’ve been listening very well. That’s a very exact summary of the way I think it’s going to go. I think that Ocado’s picking cost is actually around 3%. There’s the whole running of the warehouse but for delivery, they are more like 11.7% to 12%.

{audio:1:06:23} Is this the first-party retail or is this for the CFCs?

{audio:1:06:27} For their own CFCs. This is what it costs them, as a retailer. As of a year or two ago, Sainsbury’s in-store picking cost is actually the same as Ocado’s; 3%. This is because they are not taking the system cost into operation and they’ve got a lot of sunk costs in there; the store costs are already sunk. There is a lot of stuff being used for other things such as the shelves to hold product for customers. When you sweat the existing fixed costs and assets that you have and you are picking at 140 UPH, fully loaded, your picking costs are 3% and similar to Ocado.

{audio:1:07:43} Is that 3% of the store sales?

{audio:1:07:45} 3% of sales; that’s your labor costs for picking.

{audio:1:08:34} Can you compare the in-store picking efficiency of UK grocers versus Ocado’s?

{audio:1:08:43} Best-in-class UK operators – like Tesco and Sainsbury’s – are picking on a fully-loaded basis, including order preparation and the picking and staging, marshalling and getting ready for delivery or pick up and they are picking at towards 140 units per hour. Ocado’s original sheds were, I think, doing about 150 to 160 UPH and now the newest ones are doing north of 180 UPH. That also includes some in-bound that not’s the biggest part, so it’s not fully apples to apples, buy you’re not that far away, also remembering that, in percentage of sales wise, the incremental benefits of going from 140 to 180 are a lot less than when you are going from 40 to 60.

{audio:1:09:34} Sainsbury’s and Tesco reckon they are around 3% for picking costs, remembering that they are leveraging a lot of the fixed costs and assets in the store. The shelves they are picking from, the systems they are using, a lot is already sunk cost. I don’t think that 3% is that different from Ocado’s picking cost.

{audio:1:09:54} That’s why the grocers, such as Tesco and Sainsbury’s, typically pick in-store?

{audio:1:09:59} Exactly. There’s not much extra benefit so, as much as they can, they pick in-store. They’ve also, either explicitly or intuitively, understood the point about the fact that the moment you open a dedicated facility, you have to take sales away from an existing store base; it’s not going to all be incremental. That is going to undermine the P&L of your store base. I think they’ve understood that.

{audio:1:10:26} Why haven’t they tried a micro fulfilment solution?

{audio:1:10:29} Tesco is testing an MFC at West Bromwich, in its West Bromwich store. I think it is 15,000 to 20,000 square foot. Quite a few Tesco stores are over-spaced. They are testing at least one there, with Dematic. They had others on the cards; they had quite an extensive, double-digit roll out program.

{audio:1:10:56} They’re testing but, at the moment, just with one. I’m not sure if anyone else has any plans to test.

{audio:1:11:01} The picking is actually much more efficient than I expected in-store, but I guess you don’t have the range and availability you would in Ocado’s bigger CFCs?

{audio:1:11:10} Exactly. The service levels are less; your availability is not as good. Your range is the full store range which is enough.

{audio:1:11:17} The delivery must be lower, as well, for Sainsbury’s or Tesco picking in-store and delivering to customers?

{audio:1:11:23} Absolutely. It’s 3% to 4% lower than it is for Ocado. Last I heard, it was 11% or 12% of sales for Ocado, for delivery because these big CFCs are so much further from the customer. Delivering from the store, it’s around 8% for Tesco and Sainsbury’s.

{audio:1:11:41} So it must be 300 to 400 basis points difference in profitability, if you pick in-store, today, for those big grocers, versus using a solution like Ocado?

{audio:1:11:51} Probably not quite as much as that, remembering that, for Ocado, the cost of inbound, the cost of putting things on the shelf, for the retailer, is included in their figures. Also, the suppliers are delivering just to one big warehouse. But definitely, if you have stores and you can pick at that rate, UK grocers have proven that it doesn’t make sense for them.

{audio:1:12:19} It is interesting to compare the UK and the US because, clearly, Tesco and Sainsbury’s have figured out something, over the last 20 years, in how to run online and that, actually, getting smart in the store and picking properly in the store, protects your EBITDA, at least in the medium term?

{audio:1:12:39} That’s very well put. That’s why, to be honest, one of the main things we’re trying to do with US grocers is bring them up that curve as fast as possible. You get the biggest jump going from 40 to 60 UPH, where you get 400 basis points of labor cost saving; whereas 60 to 120 UPH, you only get another 400bps. There are a lot of easy, quick wins to be had. It requires a lot of focus and a lot of people resources; not that much money, as such. It’s the processes and making sure the people are doing the processes they are meant to be doing, that you think they’re doing. That requires very strong people management and integration with store operations. There’s quite a lot of touchy-feely management stuff that requires a lot of focus. It’s not as easy as, here are the tools, here is the technology; go do it. You’ve got to make sure that the items are all exactly on the shelf, where they are meant to be, at the right time, so effective use of the technology, as well. That is the way to go, clearly, for the medium term.

{audio:1:13:42} That should be a risk for Instacart?

{audio:1:13:44} Definitely. As I said, Instacart can’t begin to compete. The average Instacart shopper, doing a single order, even if they’re one of the 20% or so who can do two orders at the same time, can’t begin to compete on efficiency with a well-trained, well-equipped, fully-integrated store picker, who has the right processes, training and management. I think Instacart is going to become just a premium same-day operator. Same day is much more expensive and much more difficult but retailers can do it two or three times more efficiently themselves than Instacart stands a hope of doing it. Therefore, given that customers value low cost of service way over speed, all the surveys show, in the UK and the US, I think Instacart will become a premium niche service, for those who really want same day or even within the next two hours.

{audio:1:14:53} As you say, in the UK, a two-hour service hardly exists, apart from Amazon offering it for free, but that’s a real spanner in the works for everyone.

{audio:0:27:41} How do the grocers think about micro fulfilment?

{audio:0:27:45} All the major grocers I talk to are definitely intrigued, interested or actually testing. Most of the majors have at least talked to several different providers, be it Fabric or Dematic or AutoStore or Takeoff; probably Ocado, as well, for the bigger ones. They talk a lot and they’ve heard the pitches. The pitches tend to be very selling based so they may gloss over some of the challenges and the fact that few of the numbers they are talking about have been fully proven yet. But there is definitely strong interest.

{audio:0:28:37} What is the difference between Ocado’s micro fulfilment and Takeoff?

{audio:0:28:42} Ocado doesn’t really have micro fulfilment. What they call micro fulfilment is $300 million annual sales capacity. I think that translates to something like 60,000 orders a week. That is not micro fulfilment. That is still mega fulfilment. Maybe it’s micro compared to their one billion capacity facilities that they have in the UK. So far, I’m not aware of Ocado having announced anywhere what I would call micro fulfilment in annual sales capacity of £25 to 30 million of sales capacity. That is something that we are yet to see. For the micro fulfilment providers, the space is 10,000 to 15,000 square foot or 20,000 square foot at a maximum, including the manual fast picking area, in the back room.

{audio:0:29:47} Are these separate buildings or can they also be in the store?

{audio:0:29:51} Ideally, what they are doing is taking a bit of space away from the selling area that wasn’t really productive. Then, if they’ve got a particularly big storage area in the back, they can expand it or they can build a new one and extend it. It’s at the back of the store, using the storage space expanded, amended in some way. The key is the space efficiency and the MFCs are looking to put them in areas of 10,000 to 20,000 square foot, max.

{audio:0:30:29} Some people talk about micro fulfilment as, actually, a new, smaller facility.

{audio:0:30:36} Yes, that’s a standalone. A standalone with equipment capacity would be serving 10 to 15 other stores. Similarly, if you’re doing $30 million annual sales capacity, that’s about what one single store will sell, in the US. So assuming 10% of sales goes online, you are serving 10 other stores, from the store. The advantage of putting it in the store is that you are leveraging the fixed costs of operating that store, such as the rent or capital cost and all the other fixed costs. Whereas if you stand up a dedicated facility, then you’ve still got that problem of a double running cost center and you have to take sales away from the store, to allocate to that center, to offset its costs for some sort of profit unit, but then you’ve deleveraged the other 10 stores.

{audio:0:31:31} That’s why micro fulfilment is not really a silver bullet. It can help you improve the efficiency of your picking operations, but it doesn’t address the core, longer-term problem which is, for the market as a whole, online is not going to add extra sales again, once the natural sales have gone back to restaurants, post the pandemic. It makes it less bad; you’re not deleveraging as much as a big CFC, with $100 million or $300 million sales, but you’re still creating that problem, to some extent, depending on the level of incremental sales.

{audio:0:32:05} Ocado offers this smaller, almost standalone facility, that does $200 million in sales a year, roughly. That’s what they class as the micro today, versus Takeoffs or even Alert Innovation that has something that is in the store; there are very different solutions.

{audio:0:32:31} How does the supply chain work between the traditional CFC for Ocado and these new types of micro fulfilment centers, in the store?

{audio:0:32:43} Currently, it is very different. If you have a CFC, then the suppliers are just delivering straight to the CFC. You might get some cost benefits from that but then you have to take on the distribution to the other supply nodes and delivery points. For the MFCs, there are two ways you can do it. You can either just consider it part of the existing store or, more commonly, what they are doing is calling that a separate store, so the MFC has its own stock that comes in. Because, currently, the capacity of most of these systems is round about 15,000 to 18,000 SKUs max – so not the full range – and most of these grocers want to offer their full range, you do also have to bring in stock from the store, as well, either from the store floor, a fast-picking area in the back, or both. It’s a question of trying to optimize the manual picking efficiency with the automation and optimize what’s going in the automated system and we’ve done some work around that.

{audio:0:34:08} Because the Ocado system has much greater capacity to hold stock, you don’t have so much of that issue, of integrating the manual operations.

{audio:0:34:21} Again, Ocado is just a quicker solution to get to market, even for smaller facilities?

{audio:0:34:25} It’s not going to get to market quicker, because it takes 18 months to two years to build. These other ones can go in as quickly as three months. There is then a period of testing and optimization but they can get running pretty quickly. If your capacity is limited, your picking efficiency is going to be diluted by the amount that you have to bring in manually. But they are basically targeting 80% in the automated system and 20% of products from the store, so the dilution shouldn’t be that significant.

{audio:0:35:05} Let’s just say I’m a grocer in a region with $300 - 400 million in sales. I think that 10% is going to go online, therefore, $30 - 40 million of sales and I need to find a solution for my stores. How would I even begin choosing between building a smaller CFC with Ocado or carving out a portion of my stores for one of these true micro fulfilment centers, which cuts down the store and actually has some picking and fulfilment in the store?

Founder of Strategic Food Retail and Partner at The Partnering Group

Ocado & Online Grocery Economics

Comparison between US and UK picking efficiency and margin

The economics of Ocado’s solution and store deleveraging

Why micro-fulfilment could be a superior option versus Ocado

Cost comparison for grocers adopting Ocado OSP vs Micro-fulfillment or in-store picking

Why UK grocers do all their own picking in-house but US grocers do not

Challenges for Instacart as US grocers pick more in-store