Online Grocers and Operations Systems: What Scale for Profitability?

| About: Koninklijke Ahold (ADRNY)
This article is now exclusive for PRO subscribers.

The Wall Street Journal had an interesting article a few days ago about Ocado, a British e-grocer (“Automation Powers U.K. Grocer“).

The article discusses the operations system developed by the firm:

Most online grocers fulfill Web orders by gathering goods from the shelf of a local supermarket and then loading them in a truck for delivery. But Ocado has developed a highly automated, centralized operation that dispatches products to 65% of British postal codes from a single warehouse.

The operation is spread across 23 acres of floor space on an old airfield. Ocado has built a complex, automated system that gathers items using its own algorithm-driven system. Baskets travel along a 10-mile maze of conveyor belts, stopping at bagging stations where workers follow a computer’s directions, loading products and shipping off 90,000 orders a week with close to 99.9% accuracy.

You cannot discuss highly automated e-grocers (and in particular, billion dollar investments in these) without mentioning Webvan, a San Francisco-based online grocery start-up that raised 1 Billion Dollars during the Internet hey days and went bust in 2001.

So what’s different this time?

On Monday, Ocado’s Chief Financial Officer Andrew Bracey attributed the improved performance to operational efficiency. “We have better availability, we have a longer range, we have fresher produce, and we’re able to deliver in a one-hour window,” he said.”

I have to admit that I am not impressed. While I do enjoy looking at huge automated logistics systems (…who doesn’t…), I just don’t see the difference between this and Webvan. But I have to admit that I don’t have all the information. As part of the operations strategy course we analyze a case on Peapod – another egrocer that in 2001 was bought by AHold (AHONY.PK) , a Dutch supermarket chain. I cannot the analysis of the case, but let me say that the next statement is pretty crucial:

The Hatfield warehouse is the brainchild of Chief Executive Tim Steiner, who believed that superior technology would help Ocado “cost dominate” in a sector known for low margins.

Clearly, this is still a low margin business. Clearly there is a huge investment in automation here. What we don’t know – what scale is needed to make it a really profitable business that can do well in the long run. In particular, such a high accuracy level and very short window of delivery entail very high capacity, which goes beyond the automated system. Are we sure that customers are willing to pay enough to offset these additional costs? (Did I mention Webvan).