Ocado’s eventful start to 2019…

Ocado, the UK’s and the world’s leading online-only grocery retailer, has had an eventful start to 2019. First there was the fire at its automated customer fulfilment centre in Andover, something we covered in detail in last month’s Analyst Comment.

Then in late February 2019, as the deadline for extending its supply deal with Waitrose loomed in March, Ocado and M&S they were to partner in a joint-venture that would see M&S replace Waitrose as supplier and the retailer invest £750 million in the Ocado retail business.

Below we highlight the terms of the deal, what it means for Waitrose and ultimately what it means for the pair and the online grocery market moving forward.

The deal

Following significant rumours in the press, on the 27th of February 2019 Ocado and M&S announced they were to partner.

The terms and magnitude of the deal was perhaps a bit of a shock. Rather than simply replacing Waitrose as a supplier, Ocado was to split its business into two, retail and Solutions, with M&S paying £750 million to enter into a 50/50 joint venture on the retail side of Ocado’s business.

The deal itself will not close until Ocado’s third quarter 2019 (June to August), subject to shareholder approval, although it will not be until September 2020 that M&S products are made available via Ocado, the date at which the current supply deal with Waitrose is due to end.

Where does it leave Waitrose?

Ocado and Waitrose have had a 19-year relationship, which has seen the John Lewis Partnership move from investor and partner to simply supplier. In 2010 the two signed a new 10-year supply deal, hence why M&S products will not be seen on Ocado’s site until 2020, worth around £15 million to Waitrose annually.

On both Waitrose and Ocado’s part there seems to have been a willingness for the partnership to end. For Waitrose it has invested heavily in e-commerce in the last few years, which has been rewarded by strong growth in its online grocery business. Indeed as highlighted by Mintel’s Online Grocery – UK, March 2019 Report, Waitrose was one of the few players to grow its market share in 2018, from 3.7% to 3.9%.

This is a share still significantly lower than Ocado’s 13.1% but Waitrose quickly responded by saying that it was planning a second fulfilment centre to support its growing volumes and there is particular potential to expand and grow its penetration within the M25, still Ocado’s heartland, and capitalise on any customers who are not happy with the switch to M&S. If it achieves this then this will more than offset the £15 million lost from the supply deal ending.

What it means for M&S and Ocado

Ocado as a business has had a busy few years, with the Solutions side of the operation securing its first international deal in June 2017, following it over the next year with four more deals across Europe, ICA and Groupe Casino, and North America, Sobeys and Kroger.

This deal essentially separates the two sides of the Ocado business, retail and Solutions, into two – with Ocado retaining full control of the Solutions arm and 50% of the new retail joint venture. Solutions will license its technology to the new retail arm, and will continue to be free to sign further deals across the globe.

In a retail sense Ocado could hardly have wished for a better partner than M&S to replace Waitrose. As highlighted by research from Mintel’s Supermarkets – UK, November 2018, both Waitrose and M&S over-index in terms of high earners, as does Ocado, and therefore its new partner is certainly complementary to its current position. M&S’ current customer base does skew older than either Waitrose or Ocado, although as Morrisons has shown since its move into the online market, the addition of an online grocery service can help to bring younger customers into the business.

One of the key attractions for Ocado must have been M&S’ broader geographic coverage in terms of stores. Ocado developed in-store picking technology back in 2017, as part of the Morrisons deal, and Ocado can now bring this tech to M&S, potentially expanding its coverage to a near-national scale and past its limitations based on the number of CFCs it operates.

For M&S the move to online has been long overdue. There have been small-scale trials but with Ocado it has found the perfect partner to go national, and indeed through the joint venture has acquired 50% of a retail business that is still growing strongly. As we touched upon above the M&S positioning lends itself well to the core online shopping demographics, although there may be room for range development to ensure M&S has the full-basket offering required to adequately cover the loss of Waitrose and to tap into larger basket demand that currently characterises the online grocery market.

What it means for the sector

In terms of what it means for the online grocery sector, there is unlikely to be a massive shift in the short term. Ocado may lose or gain some shoppers, to the potential benefit of Waitrose, but ultimately, with Waitrose operating its own service, the reasons for shopping with Ocado were far broader than simply the presence of Waitrose products.

However, one area that could be transformative, if done correctly, could be the potential for M&S and Ocado to use Ocado’s new same-day Zoom scheme to truly tap into the demand for meal-for-tonight-based online grocery delivery.

As we discuss in Mintel’s Online Grocery Retailing – UK, March 2019 Report, the online grocery market has recorded slowing growth in the past three years, with the total number of users (45% as of December 2018) plateauing over this period. There is a sense that the market and services need to evolve to better capitalise on the smaller frequent basket demand that has become a key aspect of grocery shoppers behaviour in the past decade. There are some services, including Waitrose’s recently launched Waitrose Rapid, which are aiming to tap into this – but most as small scale trials.

M&S is very strong in the convenience and meal-for-tonight area, and when this is combined with the in-store picking technology and the new Zoom service it could create an attractive service for shoppers, although we will have to see if Ocado can find a way to scale this to national city-based levels. Whether this is the step change the sector more broadly needs to drive growth is questionable, but the two combined would create a very appealing proposition for consumers, particularly current online grocery shoppers.

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