Ocado vs Tesco is not a fair fight

There was a mixed response to the recent news that Ocado had overtaken UK’s leading grocer Tesco, albeit briefly, as UK’s most valuable grocery company. In the 20 years since its launch, Ocado has been the subject of much debate and skepticism about its business model and many grocery industry stalwarts did not show any enthusiasm for on-line grocery operations. A former Tesco chief executive once described the firm as a "charity" because of the losses it had racked up in its early years, and Morrison's did not even have an online grocery offering until their relationship with Ocado started in 2014.

There are good reasons to be cautious about online grocery businesses given the complexities that need to be addressed when compared with other online product categories. These include the size and range of the items bought, the differing product temperatures from ambient to frozen, limited shelf-lives and the awkwardness of handling fresh products. Given these challenges, it is not surprising that most grocery retailers chose to fulfill customer orders by using their staff to pick items in store and deliver using local routes. The advantages of this approach are a lower investment risk, quicker implementation and flexibility in scaling up or down according to demand.

Ocado has always believed that this approach is flawed and have spent the last 20 years trying to prove it. Their view is that it is inefficient to move stock into retail outlets and then use store staff to pick and pack prior to deploying local delivery services. Ocado has been on a mission to automate the value chain, removing inefficient human processes and thereby improve the margin achieved for online purchases. Most grocery retailers work on a bottom-line margin of 2-3%, so improving margin for online sales by 1-2% is highly significant – this is what Ocado aims to deliver through its high-tech approach. So, comparing Ocado’s valuation against that for Tesco does not make a lot a sense. It’s apples and pears!

Ocado’s valuation

Whether you believe that Ocado’s valuation is overstated depends on whether you see Ocado as a technology company that does some online grocery retailing or a grocery company that is heavily reliant on advanced technology. Ocado is clear that it is the former, and its growth plans are based on providing proprietary technology and IP to international grocers. UK consumers are advanced users of online retail, and Ocado aims to take them to the next stage by utilising advanced technology and information by developing proprietary robotics and AI.

The rapid increase in the penetration of online grocery shopping, from 8% to 13% of the total market, as a result of the UK Coronavirus lockdown in March has also boosted Ocado’s share price. Its stock market valuation has largely been driven by how investors view its technology, which provides retailers with the infrastructure and software to build their online service and compete with giants such as Amazon.

This is not just a technology jamboree as Ocado has a clear focus on how technology advances will help deliver excellent customer experiences. The focus on customer experience has seen high-tech tools developed to make the ordering process easier and more accurate by, for example, personalising and customising search results by individual grocery buying behaviors.

Ocado can also consider attributes such as seasonality, stock availability and shelf life in refining the information presented to the customer. In its own online grocery business, now in conjunction with M&S, Ocado recognises that the only face-to-face contact customers have with Ocado is through their delivery drivers. They aim to make this part of the operation as customer friendly as possible, with highly accurate order fulfilment and delivery time slot achievement rates which will result in industry-leading customer experience. Ocado believes that controlling the ‘final mile’ is the only way to put its stamp on this key interaction with their customers.

Ocado's increasing share price has been buoyed by their success in striking a number of big technology-based deals with overseas grocery businesses, including Kroger in USA, Casino in France, Sobeys in Canada, ICA Group in Sweden and Coles in Australia.

A shift in shopping habits

UK’s traditional grocers like Tesco, Sainsbury’s, Waitrose and Morrisons are not standing still and have seen significant increases in online grocery purchases since the pandemic hit. Tesco has experienced exceptional online growth and has recently announced it is adding 16,000 permanent jobs, in addition to the 4,000 already created since March. These include 10,000 staff to pick customer orders, 3,000 delivery drivers, as well as a variety of other roles in stores and distribution centres.

This rapid expansion of their capabilities has enabled Tesco to increase their capacity by 69% to be able to handle 1.5 million online orders a week. Impressively, Tesco has scaled up their online business to twice the size of Ocado’s own retail operation in only five weeks. The question that should be asked of Tesco is how profitable and sustainable is this additional revenue? Or are increased revenues matched by increased costs and squeezed margins?

The most recent development in the grocery market is the acquisition of ASDA by Moshin and Zuber Issa. They recognise that the UK grocery market needs transformation and are considering changing ASDA stores to include mini distribution centres for online shopping. Other grocers are considering how to make best use of their properties and we can expect to see more initiatives to support their customers online activities.

Co-authored by Andrew Bryan, Executive Fellow and Programme Director of MSc Strategic Marketing Leadership.