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The e-grocery explosion

August 3, 2015 03:50 PM
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U.S. consumers spent $591.6 billion buying groceries in 2014, according to the U.S. Commerce Department, making grocery the largest retail category in terms of dollar sales, after automobiles. And only a fraction of it was spent online. But, after years of slow growth in online grocery sales, that’s starting to change.

Sources estimate U.S. consumers spent about $18 to $24 billion buying groceries online last year, or between 3% and 4% of their total spend. That percentage may seem modest, and it is less than half of e-commerce’s penetration of total retail spending, but it’s a big jump from three years ago when e-grocery accounted for less than 1% of grocery sales, according to Kantar Retail. And there is more growth ahead: E-grocery sales will increase 21.1% annually through 2018, according to BI Intelligence research, compared to 3.1% for physical supermarkets. It’s a growth trajectory that ought to sound familiar to retail executives who have witnessed the rise of e-commerce over the last 20 years. 

“It will go faster than everyone else thinks,” says Chad Arnold, CEO of Door to Door Organics, a web-only e-retailer that deliveries organic foods to consumers in 55 cities. “Industry after industry has already seen this movie.” 

While U.S. consumers have been much slower to shift their grocery shopping duties to the web than other shopping tasks, it is now a market that is poised to go from a low simmer to full boil. 12% of U.S. consumers say they order groceries online for home delivery—such as by using Peapod.com or FreshDirect.com or AmazonFresh, which is now available in six markets including New York, Los Angeles and Philadelphia—and another 55% say they are willing to, according to The Future of Grocery report from The Nielsen Co.

Further, 9% say they are ordering groceries online and visiting the store to pick them up—a model many supermarket chains are implementing, including Wal-Mart Stores Inc. and Kroger Co., the No. 1 and No. 2 grocers in the United States by market share. Another 57% of consumers say they are willing to order their groceries online for pickup at the store. An estimate from Brick Meets Click, a grocery research and consultancy, forecasts online grocery spending in the United States will reach between 11% and 17% in most markets by 2023.

Several factors underlie the shift. Consumers who have grown up shopping online are now creating their own households and becoming the primary grocery shoppers. Many are never far from their smartphones, and those phones make online ordering easier. Plus, there simply are more ways to shop online for food and other household products.

For now, the market is segmented. The venture capital-funded startups are picking off convenience-oriented slices of the business, such as delivering meal-preparation kits or specialized products. Meanwhile, supermarket chains mostly are trying to leverage their stores, with programs such as buy online and pickup at curbside. A few companies—notably Peapod, Wal-Mart and Amazon—are delivering a full range of grocery products to consumers’ doorsteps, but only in some markets.

Consumers are segmenting, too, selecting the options they like best. While it’s natural to assume younger consumers would gravitate most quickly to online food shopping, it turns out that certain groups of older shoppers are finding that it’s easier to buy groceries online than travel to the store.

What hasn’t changed is that profit margins are razor-thin in grocery retailing, generally under 2%. That’s forcing every online grocery innovator to find ways to offer such superior convenience that the shopper will pay a premium.

Nick Taranto, co-founder and co-CEO of Plated.com, thinks he’s got profitability cornered. The 3-year-old e-retailer of gourmet meal kits sold by subscription already ships to consumers in the lower 48 states. Fueled by more than $56 million in venture funding—including $35 million raised last month—Plated.com’s revenue grew 400% last year to about $20 million while subscribers doubled.

Plated.com sells food online for home delivery, but its focused business model, Taranto says, means it can be more profitable than store-based grocers. It sells nine meal kit varieties each week, with each kit providing the ingredients necessary to prepare the meal; nothing more and nothing less. “We have predictable revenue and very limited inventory,” he says. “Every day we ship everything we have, which means our food waste is less than 2%. That translates into higher margins.” He says Plated.com will have profits a “magnitude higher” than the 1% to 2% category averages once Plated.com is scaled.

Another 3-year-old web-only food seller, NatureBox.com, takes a similarly targeted approach, selling only nutrition-focused snacks by subscription, five bags at a time for $19.95 a month, delivered. It too has attracted significant funding from investors, including $30 million from a funding round completed in May, for a total to date of $58.5 million.

Its snacks are not perishable, which means NatureBox.com doesn’t have to worry about refrigeration or maintaining a cold chain from warehouse to doorstep, and boxes are lightweight, which keeps shipping costs low, says co-founder Gautam Gupta. He argues it is easier to make money online if you sell specialized products, rather than attempting to sell every SKU under the sun. “Scaling a national supply chain that can deliver perishable products, that’s the biggest challenge because groceries are not a high-margin business,” he says. “When we think about our business, it’s a packaged good and the challenge is much more about driving innovations and creating these unique products consumers want.” 

Executives at Peapod LLC, the web-only grocer that’s been in the e-grocery game for 25 years now, knows how hard it is to deliver to the doorstep everything on supermarket shelves. “This is a brutal business operationally,” says co-founder and chief technology officer Thomas Parkinson. Peapod, which generated nearly $650 million in web sales last year, according to Internet Retailer estimates, is the biggest web grocer in the United States by sales. Its signature, bright green trucks currently deliver to consumers in 11 states and the District of Columbia. “It’s hard to create that infrastructure to handle the last mile and yield management,” he says. On the plus side, he says, the operational challenges of e-grocery have helped keep potential rivals largely at bay for years.

But with e-grocery reaching an inflection point—Parkinson points to mobile device adoption as the key change pushing the e-grocery’s sudden fast growth—Peapod is studying how others attack the problem. “We’re watching Instacart,” Parkinson says, although he’s skeptical that business model is sustainable or that consumers will like it long term.

Instacart is not a retailer per se, but a technology-based delivery company the delivers groceries purchased from local stores. It makes its money from the $3.99 fee consumers pay per order, and from a fee paid by the retailer, which is typically based on the number of orders Instacart fulfills from the store. “The math works where the retailer pays a portion to us for driving incremental sales,” says Nilam Ganenthiran, Instacart’s vice president of business development and strategy. Those incremental sales range from 3% to 8% of a store’s typical sales for high-volume stores, Ganenthiran says.

The 3-year-old San Francisco-based Instacart is backed by nearly $275 million in venture funding, operates in 16 major metro areas and works with 80-100 retail store brands. Ganenthiran says Instacart will be extending to more metro areas and moving deeper into the markets already served, such as expanding beyond Los Angeles into more of the San Fernando Valley.

But Instacart is about to have to manage more costs, and that’s in part what makes Parkinson and others skeptical of its long-term profit potential. The workers who shop at stores to fulfill Instacart orders and Instacart drivers have largely, until recently, worked as independent contract workers—meaning they weren’t officially on Instacart’s payroll and Instacart did not have to provide any benefits. In June, Instacart began offering some contractors status as part-time employees, which will raise Instacart’s costs. Instacart says the change will help improve the “quality and efficiency” of order picking and make for a better customer experience. And pressure is rising to move more workers to employee status, following a decision by the California Labor Commission that deemed an Uber car service contract worker should be classified as an employee. Several class action lawsuits are also pending regarding the contract worker model, although Instacart is not a company named in those suits.

“The 1099 model is not sustainable, but it’s made for a fun party for one-and-a-half years,” Parkinson says, referring to the tax form contract workers receive. He agrees with Instacart about the importance of pleasing the shopper, but says the comparison ends there. “They are a tech company. We are a grocer that uses technology in a clever way,” he says.

Peapod, a subsidiary of Dutch grocer Royal Ahold N.V., is also seeking to expand its customer base by offering alternative shopping and delivery options, such as through a partnership with Gatheredtable, a menu planning service. Gatheredtable users who are Peapod shoppers can quickly tap a recipe and have all needed ingredients appear in their Peapod cart. It also can automatically adjust for ingredients Peapod knows the consumer has purchased recently and is likely to already have on hand. The two companies split the revenue from sales.

Other recent Peapod updates expand the ways consumers get their orders. Consumers in some East Coast markets can elect to pickup their Peapod.com order at one of 210 Stop & Shop and Giant supermarket locations. Those orders are fulfilled by Peapod at a Peapod warehouse, but delivered to the stores, which Royal Ahold owns.

The curbside pickup model for e-grocery is one that several traditional grocers are trying. Grocery chains such as Kroger, Meijer, Hannaford, Wegmans, Hy-Vee and others have some version of online ordering with curbside pickup at the store at some locations.

Lowes Foods, with 77 locations, most in North Carolina, South Carolina and Virginia, offers online ordering with curbside pickup at 58 locations with its Lowes to Go option, and will build it into any new store locations, says Michael Moore, chief marketing officer. Consumers pay the same price for products they would pay in the store, plus a $4.95 fee. Lowes to Go began in 2001, but wasn’t widely available until recently, Moore says. The chain rolled the program out to more stores as it began a major remodeling of stores and a full rebranding in 2014.

Now, Moore says, it is focused on personalizing offers consumers see as part of its loyalty program. “We want to take the digital experience to a whole different place and deliver an omnichannel experience for our guests,” he says, adding the e-grocery option is valuable to consumers, and to the stores. The average order value of a Lowes to Go order is four times that of the average in-store basket, though shoppers buy online less frequently. A grocery retail executive who asked not to be named but who manages a large supermarket chain says e-grocery shoppers tend to place large orders about every two to three weeks, but then visit a store for fill-in trips two to three times a week. 

Mike Griswold, research vice president at Gartner Inc. covering the retail supply chain, believes the e-grocery business model with the greatest potential long term is curbside pickup at the store, more commonly referred to as “click and collect” overseas, where ordering groceries online is more common than in the United States. In Europe and elsewhere retailers often also operate pickup points in central, non-grocery locations as well, such as train stations or neighborhood cafés. “While home delivery will play a role, it’s going to be click and collect,” Griswold says. “I expect retailers to think long and hard about whether to invest in home delivery, but they should be jumping right in to [add online ordering] for pickup.”

Data from MyWebGrocer, an e-commerce platform provider for supermarkets whose clients include Harris Teeter and ShopRite, indicates consumers prefer the curbside pickup model over delivery. Among MyWebGrocer’s supermarket clients that offer curbside pickup and delivery, 68% of orders are placed for pickup. “Outside of some dense urban markets, it basically is easier for a consumer to say ‘I will drive by at 5:30,’ than to provide a window of 2-3 hours where they will be home,” says Rich Tarrant, founder and CEO. The grocery retail executive who asked not to be named says roughly 90% of the chain’s e-grocery orders are for curbside pickup, and 10% for delivery.

While the e-grocery business models vary, industry insiders largely agree on the forces propelling e-grocery’s development. Consumers are busy, they want convenience and they increasingly shop online, more and more often from a smartphone. Nearly half of all Peapod.com orders take place on a mobile device, with 48% of mobile orders originating from iPhones, the e-retailer says.

All those trends are most pronounced among younger consumers, and they are most inclined to shop for groceries on the web. Surveyed globally, consumers age 15-20 and 21-34 are the most avid online grocery shoppers, according to Nielsen data, with 28% of the younger group and 30% of the older group already ordering groceries online for home delivery, and 14% and 17% ordering online for pickup at the store.

To bricks-and-mortar grocers not investing in online grocery sales because they say their customers are not interested, Griswold says they could be right about their core middle-aged shopper today. A spokeswoman for Publix, which operates more than 1,100 supermarkets in the Southeastern United States, says that after two tests of e-grocery models generated disappointing results, it is not pursuing another test now, although it remains open to the idea. “We found that customers still want to engage and come to their Publix, and it is still the customer engagement that you can’t account for in [e-grocery programs],” she says. At the moment, Publix shoppers can pre-order online from the deli and bakery departments and have their orders ready for pickup when they do their other shopping in the store. A “significant amount” of customers use that program so there isn’t a wait at the store, the spokeswoman says.

But the next generation, Griswold says, will not be as patient or willing to spend time grocery shopping. “The group that is 25 or 26 years old, that group has 30 years of shopping ahead of them, and everything they do is online,” he says. “To them the idea of wading through a supermarket for an hour is not acceptable.”

Executives at Plated.com are banking on that preference. “One of our hypotheses with Plated is that spend is going to shift online massively over the next decade, and there will be dozens of new brands that emerge as consumers grow more comfortable with buying food online,” Taranto says. “There will be traditional food retailers that are forced to figure out how they leverage the Internet. And if a retailer does not have an e-commerce strategy, they are not going to be around in 10 years.”

Merchants say their e-grocery customers do tend to be younger, but they aren’t writing off older shoppers either. Ganenthiran, at Instacart, says its largest customer group in terms of volume and spend are dual-income couples with young kids, followed by young, urban singles. But its third group by sales and volume is older consumers who find it hard to travel to stores and to navigate supermarket aisles. Some middle-aged customers are also ordering groceries for delivery to their parents.

In other words, the growing graying population may well help drive e-grocery, too. The retail executive that asked for anonymity says that chain’s e-grocery customer demographics skew similarly, with busy families being the most frequent users and temporarily or permanently disabled and the elderly making up the second-largest group. That retailer is seeking to identify mobility-challenged customers who don’t use the e-grocery service and expose them to it.  

One thing is for certain: Food sales are flowing to the web. The category’s low margins means scale is critical. And that suggests the ultimate winners will be the food retailers that use the web most effectively to make life easier for the largest number of grocery shoppers.

allison@verticalwebmedia.com
@AEnrightIR

 

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