The Washington Post "The staggering challenges of the online grocery business"
January 22, 2015
The online grocery delivery business seems to get more crowded--and more competitive--by the minute. Tech giants Google and Amazon.com are offering it in some major cities, and so are upstarts such as Instacart, Postmates and FreshDirect. These newcomers are battling with more established businesses such as Peapod, which has been delivering groceries for more than 20 years, and services from companies such as Wal-Mart that allow customers to place orders online and pick them up at a nearby store.
It's a business that everyone seems to want in on, even though new data show it's awfully hard to do profitably.
In some ways, the enthusiasm makes makes sense: According to a report from IBIS World, a market research firm, online grocery sales grew at an annual rate of 14.1 percent over the last five years and they are expected to grow at a rate of 9.6 percent between 2014 and 2018.
But look more closely at the report, and you see the major challenges these companies will face as they try to make these fledgling businesses viable. IBIS World estimates that the online grocery business collectively brought in $10.9 billion in sales in 2014. Profit, it estimates, was just $927.1 million, or 8.5 percent of total revenue. By 2018, the researchers project that profit margins will slip to 6.9 percent of sales. In part, that's because these operators will continue to contend with the high distribution costs associated with getting perishable items to customers.
The report also predicts that big players, particularly AmazonFresh, will play a role in compressing margins for the whole industry. Amazon has often sought to vanquish its competitors by undercutting them on price, and the report suggests that the company may use that tactic in the grocery business, dropping their prices as low as possible and, in doing so, pressuring their competitors to make similar price cuts. (Jeffrey P. Bezos, the chief executive of Amazon, owns The Washington Post.)
Even though it's a tough business model right now, report author and industry analyst Will McKitterick says companies of all stripes feel they can't afford not to take a chance on it.
"For larger companies, it’s definitely a process to build the infrastructure, develop the delivery networks," McKitterick said. "All of that takes a lot of time, and if they miss the boat now, then they’re going to be in a pretty bad position” later on if throngs of consumers take to online grocery shopping.
For all the speculation about how potentially disruptive these businesses are, IBIS World's report reveals that they so far have a very low penetration in the overall grocery market. Online grocery sales were only 1.9 percent of total grocery sales last year; by 2018, even given the rapid growth the researchers anticipate, online sales are still expected to equal only 2.9 percent of total grocery sales.
In the broader retail industry, online purchases now account for 7 percent of overall sales, which suggests that shoppers have been less willing to go digital with their grocery shopping routines than their other shopping routines. The report says that may have to do with shoppers' concern about quality and freshness of produce and meat, something that wouldn't be a factor in the purchase of apparel, electronics and other goods.
It may be that online grocery shopping hasn't been widely adopted yet in part because the services are only available in major cities, meaning that some shoppers that might want to take advantage of the service don't yet have the option. But experts say it's difficult to imagine a profitable scenario in which grocery delivery service is ever available outside of dense urban areas, meaning the customer base for these offerings is always going to be somewhat limited.
The extent of their challenge in luring customers is evident in the mix of products they're selling. For online grocers, some 30 percent of sales come from "non-food items" such as cleaning supplies and beauty products. At bricks-and-mortar grocery stores, the share of sales from non-food items is much lower, just 14 percent. This suggests that even when people are using online grocery services, they're not using them for the fresh products that make these grocers distinct from, say, a traditional retailer such as Target that could simply send you some paper towels or toothpaste via FedEx or UPS.
Despite these headwinds, McKitterick expects to see even more players try to succeed at online grocery retailing in the near future.
"I don’t know if it’s a 'do or die,' but it’s one of these opportunities that companies can’t skip out on," McKitterick said.