business news in context, analysis with attitude

Content Guy's Note: The goal of "The Innovation Conversation" is to explore some facet of the fast-changing, technology-driven retail landscape and how it affects businesses and consumers. It is, we think, fertile territory ... and one that Tom Furphy - a former Amazon executive, the originator of Amazon Fresh, and currently CEO and Managing Director of Consumer Equity Partners (CEP), a venture capital and venture development firm in Seattle, WA, that works with many top retailers and manufacturers - is uniquely positioned to address.

This week, we focus on the clicking clock facing retailers, and why retailers cannot afford to be complacent or take their time in addressing the need to innovate.

And now, the Conversation continues…

KC: Well, there have been a number of interesting developments sine our last Innovation Conversation, so let’s get to it.  When Kroger invested in Ocado to the tune of $250 million we did a brief “Innovation Chat,” and you said that it was an opportunity for Kroger, though not a move that addressed a glaring weakness.

I’ve talked to other retailers who said that they’re not wildly concerned, since it will take some time for Kroger to integrate Ocado’s technology into its own operations to any meaningful extent … though it seems to me that they have to be careful not to be too complacent.  After all, while this may not be revolutionary all by itself, the whole may be larger than the sum of the parts, especially if Kroger can use robotics not just as a way of driving down labor costs, but also in the end to be more responsive to what customers need and want.  Anything that makes retailers more responsive is a good thing is the bottom line for me, but they can’t take forever.

Tom Furphy:
Any Grocery retailer trying to develop a broad e-commerce offering faces cost-to-serve challenges. For the most part, picking off store shelves is not sustainable economically in today’s model. By the time the product gets to the store shelf, it has incurred most of its costs except for front-end handling and the bag. We all know traditional industry net profit margins are in the low single digits, so that leaves very little room to cover the incremental cost of picking, packing and delivering the product.

This means that any retailer trying to win in e-commerce must be willing to rethink their model. This ultimately goes all the way back through the manufacturer to production, packaging, trade terms and distribution. But that’s a topic for a different time. However, retailers can solely control the model from the time it lands on their warehouse receiving dock through to conveying the product to the customer. So, it is critical that they focus here.

An e-commerce model consists of two main components – demand generation and fulfillment. Demand generation encompasses things such as the website, digital marketing, apps, IoT, auto-replenishment, etc. These are the innovative ways that shoppers can put products into their basket and direct them toward the home. Fulfillment covers all of the elements of the model required to get the products into customers’ hands. These include click & collect, local delivery, parcel delivery, on-demand delivery, etc.

The jury is still out on which service configurations will best serve customers. Amazon has made it clear that they are innovating aggressively in this area with their efforts in merging Fresh and Prime Now and other experiments they will take on within the Whole Foods platform. Likewise, everyone else in the space will need to invest, test and learn as they go.

While Kroger’s deal with Ocado doesn’t address a glaring weakness in Kroger’s model, it does address an important challenge in the overall service model. Getting products into totes to either be delivered to homes or picked up by customers is expensive. And as we said, doing that out of stores is a very difficult proposition. Ocado’s automated facilities dramatically lower the cost of getting products into totes quickly. How that ultimately fits into the service model will be up to Kroger to test and configure. But having an exclusive deal, effectively their own lab for experimentation, puts them in a very good place competitively to figure it out and better serve their customers.

I don’t think that other retailers have the luxury of sitting back and taking their time. The space is developing quickly and the most innovative and agile companies stand the best chance to win. Sure, it will take Kroger a while to get the first facilities online. And before, during and after that, Kroger will continue to perfect their model in many ways. Any competitive capabilities other retailers develop will take some time, too. As you say, Kevin, “compete” is a verb. This is not a time to be watching from the sidelines.

KC: We’d hardly finished covering the Kroger-Ocado deal when Kroger then decided to acquire Home Chef, the nation’s third largest meal kit business, for another $250 million (though that number could go to $700 million if Home Chef meets certain benchmarks).  Albertsons already owns Plated, and then Blue Apron’s stock price actually started to go up, which it hadn’t for quite some time.

I’ve been fascinated with the degree to which companies are looking for some entry into the meal kit business - Amazon is doing its own, Walmart is doing its own, Costco is selling Blue Apron kits, and last week I noticed that a relatively small, regional player named Roche Bros. is doing its own meal kits.  But I also wonder if this flurry of activity points to what strikes me as being a likely scenario - that we’re going to see a lot of acquisitions or mergers or alliances in the coming months, as retailers of all sizes realize that they can’t stand pat with the cards they’re holding, and that the clock is ticking.

The idea of a well-executed meal kit program makes sense for many households. Whether foodies trying to expand their repertoire or busy moms trying to get a solid meal on the table within time constraints or any other life situation that makes putting a meal on the table challenging, meal kits can certainly serve a purpose. However, most of these models have struggled to thrive on their own.

The common challenges with standalone models has been around cost-to-serve and customer subscription breakage. Product, production and distribution costs can be challenging in any food service environment. When you add the complexities of this business, including those of quality assurance, packaging and fulfillment, it requires a high degree of precision to be successful. Also, in subscription models, it’s important to continue to provide compelling value and good service to keep customers. That really raises the bar.

Grocery retailers are particularly well positioned to play in this market. Simply from an engagement and distribution standpoint, they have large customer bases with tremendous foot traffic and web traffic. They can put these kits in front of shoppers on line and in the store. And they can also get them into customers’ hands effectively, without all the traditional parcel packaging and delivery costs. And they don’t necessarily need to require a subscription.

Further, many Grocery retailers have advanced culinary capabilities and can take some of the production and quality burden off these models. Integrating production into existing central facilities and/or stores can lower costs and drive quality. As shoppers make meal time decisions, either in real time or in advance, having fresh ingredients, meal kits and prepared meal options to choose from is the best customer experience. I think customers will grow to expect this range of solutions from their favorite stores.

I think the recent flurry of partnership and acquisition activity indicates that we’re seeing retailers starting to embrace the ecosystem approach to the market. There are certain core capabilities that are important to retailers, which they should develop or acquire. And there are other capabilities that can be partnered with and woven into the service offering. Regardless, it’s up to the retailer to own their customer experience, deliver great value and make sure their customers give them emotional credit for solving their needs.

The Innovation Conversation will continue…

KC's View: