Is Ocado really winning Covid-19?

Ocado shares have been the standout performers in the food retail sector over the past few years. Covid-19 and the channel shift to online should act as the growth catalyst par excellence, but actually the company is losing market share in online grocery. The reason for this contradiction is as follows. Investors perceive Ocado’s value not in its UK grocery business but in the technology solutions (CFC, Hive) it is licensing to retailers internationally. But arguably, the current limitations actually point to wider problems in the Ocado model.

The investment case into Ocado rests on the five theses:

1. The market has changed. Covid‐19 has resulted in years of growth in the online grocery market condensed into a matter of months. This likely permanent change means more demand for Ocado’s technology and expertise worldwide and on an ongoing basis.

2. All grocers will have to offer online capabilities, if not in house then at least in partnership with service providers such as Instacart, Uber or Deliveroo. (Whether this is universally true, actually needs to be seen).

3. There is a technology gap between Ocado and most bricks and mortar grocers, all the way from front end to last mile deliveries. For many retailers it will make more sense to buy in the expertise to save on development costs and time in house.

4. There are only a number of logistics companies with similar technology capabilities (as well as the micro fulfillment centre start ups). So the addressable market should be huge.

5. This means Ocado is likely to be prominent as a tech solutions provider in future. Moreover once the CFCs get embedded within the grocer’s operations, they are then very hard to get rid of, should circumstances change. There are very few other use cases for robot operated out of town sheds. This means there will be recurring services fee income for Ocado for years.

But there is also a different way of looking at Ocado’s proposition.

1) The model is inflexible due to its high set up costs and long lead times. In H1 sales at Ocado Retail rose 27% to £1.0bn (40% in May) with larger average order sizes. But, Ocado’s growth rate was less than Tesco’s and Sainsbury’s, with growth of 48% and 87% respectively. Bricks and mortar retailers scaled up delivery and click & collect capacity by adding thousands of in-store pickers and drivers.

This is a level of flexibilty Ocado simply cannot match (despite its Zoom offering). According to the company, Ocado could have grown sales at least fivefold, if it had been able to expand capacity. Instead, overwhelming demand meant it had to close the website to new shoppers and focus on serving existing customers. This meant, Ocado had more than 1m people on a waiting list. Whether these shoppers will in time (when Ocado is ready) convert or just use the competition is another matter.

2) Ocado’s CFC sheds require a lot of space and need to be located out of town. It is true that the store-pick model used by supermarkets has weaker profit margins compared with Ocado’s centralised warehouse model. But the hive model, impressive as it is, cannot serve the trend to 1 or 2 hour deliveries. Drive time from the Andover CFC to customer households in London can easily swallow up all the allocated time window, without picking, loading, hand over on the door step etc – not to speak of other deliveries on the route to increase drop density. Hence the big trend in online grocery towards urban micro fulfillment centres in central bricks and mortar store locations.

3) The Ocado model is very much about home delivery, missing out on the click & collect boom. While there are some work arounds available using a retail partner’s locations, the Ocado model is not readily suitable to click & collect, the rapidly growing fulfillment option beloved by retailers and shoppers alike. From a shoppers’ perspective click & collect is the most socially distant option, less touch-points are involved, and it is usually much cheaper than home delivery.

4) The return of bricks and mortar relevance for online grocery during Covid -19. Physical locations have proved essential for click and collect because it enabled retailers to offer additional capacity, as click & collect doesn’t require a driver and a van. Click & collect also eliminates last mile delivery costs. Apart from speedier delivery, bricks and mortar has also given grocers the option to rapidly scale up pick from store, from locations that didn’t support online grocery before.

5) New models could disrupt the current state of play. The other challenge in online grocery – apart from the micro fulfillment centre providers – comes from online grocery start ups such as Picnic, focussing on new customer journeys (app only) and new logistics models and the new model they pioneer – by radically reducing delivery time/window choice and operating a milk round principle based on AI and machine learning. While reducing delivery options these new start ups offer free deliveries and great reliability of actually delivering at the time when they promised.

Conclusion

Ocado will play a huge role in online grocery going forward, but the online grocery market will not all be about huge CFCs in out of town locations, just as it is not all about home delivery. To be fair, most retailers buying into the Ocado CFC model can probably serve the trend towards click & collect from their physical store estates with a a pick in store model (in addition to the Ocado shed).

Right now should be the time for Ocado to shine and having a waiting list of 1m customers just looks bad. Being incapable of scaling up rapidly and being inflexible are not just bugs but inherent features of the Ocado model. The weak spots of the Ocado robot operated sheds model, high set up costs, set up time, high space requirements and inability to serve rapid/rushed deliveries have been there all along.

In our view a better solution than Ocado’s Hive are Amazon’s robotics solutions or the micro fulfilment players, find out more here and here