We were struck by a comment from Morrisons CEO Dalton Philips at the group’s meeting for analysts following its interim results. In response to a question, Mr Philips basically stated that the challenge of online is making the channel profitable without penalising the lot of the in-store shopper.
In-store shoppers naturally originate across all income bands, potentially subsidising the distribution costs of online shoppers, whom we suspect tend to be among the most affluent.
The economics of this assertion are not too difficult to ascertain. Justin King, CEO of Sainsbury’s, has spoken of an online grocery order understandably being someway larger than the average in-store purchase - by three to four times - but for fulfilment costs to come in at about £20 per home-delivered order. Assuming Sainsbury’s costs are a reasonable ‘proxy’ for the trade, then a quarter of the true cost of the online order has been paid for by the customer, at best the balance seemingly absorbed by other customers and shareholders alike.
“Online grocery without charging for distribution is not sustainable”
If the subject of that absorption is the in-store shopper, then one has to ask is that fair, particularly given that more online shoppers will come from higher-income echelons? No doubt the supermarkets will say that this is not the case and it is margins that are affected by online and so shareholders that ‘pay’.
While this is so, one then has to ask is it sustainable if online is to inexorably gain market share? Perhaps this is the key point in this debate. Online grocery without proper charging for distribution is not a sustainable model.
For evidence of this, just look at Ocado and its paltry returns on a reasonably substantial sales base - returns that are more likely than not to go down than up, in our view.
This distribution challenge is also a key reason why the supermarkets, led by Tesco, are so hot on click & collect, because it materially reduces the cost of overall online delivery - a deep flaw in Ocado’s competitiveness at this stage. Click & collect may be Morrisons’ best first step into online grocery, but in the long run, the service cost of home delivery will need to be better covered if this growing channel is not going to deplete returns and penalise the poor.
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