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's topic: How e-commerce dealt with the holidays, the challenge to bricks-and-mortar stores, and the advantage of no-limits thinking.

And now, the Conversation continues...

KC: I was talking to a friend of mine who was exhibiting at NRF last week, and one of the things that he told me was that someone from Forbes magazine came to his booth and asked why online grocery isn't working.  That’s an amazing question to me.  Forget about Amazon for a minute … it seems to me that it was way too premature and way too inaccurate to reach that conclusion.  If you look at companies like Kroger and Hy-Vee and Harris Teeter and Roche Bros. and Ahold Delhaize-owned Peapod - just to name a few - there seems to be clear evidence that to varying degrees, e-grocery is working.  It may not be taking off as fast as books and movies, but it also is a lot more complicated, with a lot more barriers to acceptance.  Are you as astounded as I am by the fact that there seems to be a perception that e-grocery is not working?

Tom Furphy:
I guess I’m not really that astounded. When we think of e-grocery, we think about the replacement for the traditional grocery store trip. The full basket of goods that transitions into a delivered or click-and-collect order. The fact is, the e-grocery market under that definition measures only a couple percentage points of the market. Given that the model has been around for almost twenty years, I think it’s fair to perceive that it’s not working.

KC: Well, so much for my point of view.

Stay with me here. While it is hard to deem it a premature assessment after two decades, I think we actually will look back and agree that calling it unsuccessful at this time is premature. Since inception, the model has faced significant headwinds. At first, Webvan overinvested in infrastructure before broadband could deliver a good shopping experience. The lack of volume and delivery density couldn’t generate the profits that were needed to sustain the model.

Since then, players like Simon Delivers,, Peapod and FreshDirect all came along. While there are differences between the models, they’ve all seem some level of success. Certainly not enough to bring the market to a tipping point, but they’ve demonstrated enough traction with enough shoppers to prove that the model is desirable. Now, today, you add AmazonFresh, Kroger’s ClickList, Hy-Vee’s Aisles Online and others, and you have further proof of customer desire.

Part of the undertow inhibiting growth has been that traditional retailers are running parallel businesses. They still must maintain their traditional stores while layering in e-commerce. That becomes very difficult to do profitably. Pulling some volume away from the store, then adding the costs of e-commerce, barely pencils out. But it’s the right thing to do in order to be ready for what’s coming next.

Sweeping format changes in the grocery business have always taken time. The evolution from the corner store to the supermarket then to the alternative formats of today have taken decades each. Considering what is coming in the next few years, I think we’ll look back and view this shift into e-commerce as fairly swift.

KC: Okay, I feel better. I agree with you about headwinds. In fact, I think that one of the reasons that e-grocery has a perception problem is that companies like Instacart are running into problems.  You and I both felt the same way about Instacart, I think - that it was not a sustainable business model, that ownership was in a race to see if it could sell the thing before it collapsed, and that retailers were making a mistake by trusting Instacart to be a delivery mechanism when it was serving the same role for other retailers in the same market - it just seemed not nearly differentiated enough, and now Instacart seems to be cutting labor costs, which isn't going to make its drivers happy, and they’re the ones representing retailers to consumers.  What’s your sense of Instacart’s current situation, and what retailers need to be thinking about?

I notice you are almost referring to Instacart in the past tense. It’s like you’ve already written them off.

KC: Am I being overly pessimistic?

While I do have serious doubts about the model, I think the company still has a good chance to reach a successful outcome. The changes in their compensation model make me think that they are honing the unit economics in preparation for a sale. They’ve demonstrated a reasonable level of consumer acceptance. From what I’ve seen, shoppers that regularly use the service love it. If they can prove that the economics work, then they will in a position to be acquired.

Ultimately, I don’t see how the current third-party, store-pick, model can be sustainable. By the time products get to the store shelf they are fully burdened with costs. The only cost left is the front-end scan, which costs barely pennies per item. So layering in the cost of picking, tendering and delivering to that adds a good amount of cost. Sure, customers are paying a delivery fee to cover that cost. But if that cost is $10 per order to break even, how much can they ultimately charge for the convenience, and how much market is available to them? I think the jury is still out on that.

To make a new model work would require changes in the physical supply chain and underlying financials all the back through to the source of the product to reconfigure product flows and balance the costs and margins throughout. Over time the industry may get there, but it’s a significant change of some very entrenched practices.

I understand that Instacart has been a cost-effective way for grocers to get to market quickly in e-commerce. But I have to think that the grocers that are going to win into the future will be the ones that can deliver their own branded experience to their shoppers. If they stop short of that and rely on Instacart or other third-party services, these retailers are merely expensive warehouses that can, and will, be replaced over time.

KC: If you had to guess, will there be a tipping point that will accelerate the growth and acceptance of e-grocery?  And what do you think it will be?

I do. The innovations have already been developed inside Amazon, and their rollout into the market will force the industry over the tipping point. Frankly, I think the tipping point has occurred, but our big lumbering industry hasn’t fully felt it and is taking a long time to respond and tip.

The innovations that Amazon has brought to market across the range of shopping automation and efficient delivery will continue to allow them to gobble up market share. They are a shopping utility that has already claimed the volume almost 1,000 traditional supermarkets, growing substantially every year. When we see companies across our industry reporting softness, particularly in center store, that’s where a big chunk of the volume is going. Given how the Amazon flywheel works, this impact stands to deepen significantly in the coming few years. This will force a tipping point in how people shop and, in turn, how retailers need to serve them.

In reaction you’ll see the big players successfully offering e-commerce in most US markets. That will help soften the blow, but at the cost of lower profitability. To me the big tipping point will come when new types of shopping, like automated replenishment, completely transform the traditional center store and provide the basis for profitable e-commerce. When this happens, when the center store becomes an automated service for shoppers, then stores can be reconfigured over time, the perimeter can expand and become even more important, and the industry will experience a renaissance.

The Conversation will continue...

KC's View: