Back in 2017, the world of retail was changing rapidly.
Each year, increasing numbers of consumers were making purchases online, preferring to do their shopping via e-commerce rather than visiting bricks-and-mortar stores. Nowhere in Europe was this more true than in the United Kingdom. In 2017, online sales represented more than 17% of retail sales, making the British the leading adopters of e-commerce.
This embrace of e-commerce extended to the grocery segment, but the online grocery channel presented challenges that other online retail segments did not. Grocery margins were much thinner and so did not allow much room to add services such as home delivery and still remain profitable. Similarly, the need to respect the chilled or frozen chains added cost and complexity to the delivery logistics and equipment. There was also the question of consumer preferences, as many shoppers were still reluctant to try online grocery delivery because they preferred to physically see and choose their own items.
With this heightened sensitivity to price, grocery chains had to find a profitable positioning for their online grocery offering through operational efficiencies, and these issues led some analysts to be bearish on grocery home delivery.
The UK grocery landscape
While there e-commerce giants such as Amazon were making moves in the space in 2017, the UK already had a high level of retail supply chain sophistication, with major chains like Tesco, Sainsbury’s and Asda competing not just in bricks-and-mortar, but also online.
The largest retailer in the UK was Tesco, with 28% of the total grocery market in 2017, and this dominance extended to online, where it was the channel leader with 39% market share.
Far down the list of UK grocers, with just 1.3% of the total UK grocery market, was Ocado. But Ocado was very different from the top retailers like Tesco or Asda. It did not have any stores, it only sold groceries online. Furthermore, the way that it went about competing in the online grocery space was completely different.
The evolution of Tesco.com and Ocado
Tesco set up Tesco.com in 2006. Initially, the company fulfilled orders through its network of grocery stores. Employees travelled along the aisles, picking products with shopping carts, much like a consumer. This approach was simple, did not require any capital investment and allowed Tesco to scale up quickly and enter the online grocery market.
In 2009 Tesco complemented this network by opening up “dark stores,” similar to regular grocery stores, but they were dedicated to online orders and not open to the public. Over time these dark stores evolved into “dotcom centers,” or small distribution centers equipped with automation to assist in order preparation. Over time, the company experimented with delivery fees and models for online shopping, including membership packages and click-and-collect models.
Online vs brick and mortar
In contrast, Ocado was a UK-only grocer with no stores. It offered home delivery of online grocery orders, so while Ocado claimed only about 1% of the total UK grocery market in 2015, it was the largest purely online player competing in the space and claimed over 13% of the online market. By 2017, Ocado was also catching up in terms of product variety, with a steadily growing count of 50,000 SKUs vs Tesco’s 60,000SKUs.
Ocado serviced its delivery market through a hub-and-spoke distribution model. Orders were picked at three customer fulfilment centres (CFCs). About a third of the orders were shipped to local customers directly from the CFCs, while orders for outlying areas were shipped in full trucks to one of 17 spokes across England and delivered by vans from that point. In 2017, Ocado covered only 70% of the UK market.
As the CFCs were dedicated to customer delivery, Ocado invested heavily in automation, in terms of both software and equipment. The automated systems in the CFCs, as well as the software packages that drove the supply chain – from customer interaction through to last-mile delivery – were developed in-house by Ocado. In fact, Ocado generated revenues by leveraging its technology to provide online fulfilment solutions for other retailers, including Morrisons in the UK, Groupe Casino in France and Sobeys, Canada’s second largest supermarket group.
As with Tesco, the pricing model was complex. Orders had to be for a minimum of£40,with delivery charges ranging from£2.99 to£6.99;delivery for orders over £75 could be free. Similarly, for an annual fee of over £100, deliveries were free. Deliveries were generally next-day, but it could take two days for customers served from a spoke.
Two fundamentally different approaches
Ocado and Tesco approach the challenge of online grocery delivery from very different angles. Tesco is looking to leverage its existing store network as a ship-from-store fulfilment model. Its substantial store network is, in effect, its distribution network.
Ocado does not have any stores and has chosen to invest substantially in state-of-the-art distribution that leverages Industry 4.0 and supply chain digitalization(SCD) to the fullest through a ship-from-warehouse model.
Each model has its advantages and disadvantages. The first theme is that Ocado’s model is less expensive overall. Picking using Industry 4.0 technologies is faster than the pick-to-cart manual methods Tesco employs. And crucially, there is an entire link in the chain that Ocado manages to eliminate. It does not have to pick, pack and ship products to stores, unload them and place them on shelves. Eliminating this step provides labour savings and also leads to less damage, less residence time in the chain for a given product, and so a fresher supply chain overall with less waste.
But Tesco’s approach offers faster delivery to customers. This is directly because there are hundreds of Tesco stores acting as distribution centres, and these stores are invariably closer to customers ordering online. Ocado is obliged to compensate for the much higher transportation costs of trying to service all of England from a handful of DCs by using overnight hubs. These hubs serve as way stations to receive full trucks of consolidated orders picked at Ocado DCs. It ships the individual orders to customers the next morning, as much as 24 hours later than Tesco.
So, which model is better?
From a supply chain perspective, this is very much up for debate, and the nature of the market matters a great deal. Overall, Ocado would seem to have a lower cost structure, while Tesco would seem to offer better perceived service.
We would argue that the supply chain configuration is such an integral part of the business strategy that the proper framing of the question is to ask which company is “better.” One way to consider “better,” then, is to think about the shareholders. Even here there is no consensus, with some prominent investment banks considering Ocado’s ship-from-warehouse model a competitive advantage, while others argues the exact opposite.
We would argue that wrestling with the question of which model is better is not the proper lens through which to look at online grocery in the context of supply chain digitalization. Instead, we should look at how British consumers view the performance of the different online grocery companies.
Research from Which? shows Ocado is clearly the preferred online grocer in the UK, with a significantly higher customer score than Tesco, the largest player.
Why is Ocado the winner?
In particular, Ocado scores highest on its website experience. This does not appear to be an accident. The company has fostered a digital culture whereby the website, and the intelligence that drives it, are positioned as a competitive advantage. Because Ocado is an online-only retailer, it can focus its resources, attention and value proposition around the omnichannel experience in a way that a traditional retailer likely cannot.
Ocado’s innate digital savvy has allowed it to drive Industry 4.0 and SCD innovations, deploy them at scale and create a new business model working with other partners. It offers proof beyond the promise that it is possible for companies to fully embrace digitalization, bring supply chain into the essential fabric of the company’s strategy and show a path for others to follow.
Ralf Seifert is Professor of Operations Management at IMD Business School and co-author of new book, The Digital Supply Chain Challenge (2nd edition), with Supply Chain Management Professor at ESCP in Paris and Founding Partner at Innovobot, Richard Markoff.