Kroger Co.'s plan to build Ocado Group PLC warehouses could be a leap forward for grocery delivery in the U.S. — if the pair successfully negotiates yawning disparities between the U.S. and U.K. markets, according to industry analysts.
The partnership between the second-largest grocer in the U.S. and the British grocer aims to provide new capacity dedicated solely to filling customer grocery orders made online. For the companies, the hope is that the partnership will capture share in the nascent U.S. online grocery market, much as Ocado did in Great Britain starting in the early 2000s.
Unlike Kroger, which operates about 2,800 supermarkets around the U.S., Ocado operates no physical stores. Instead, the company, based north of London in the town of Hatfield, commands about 1.2% of the U.K. grocery market using a network of automated warehouses, according to data from Kantar Worldpanel.
To replicate that success in the U.S., the duo will have to overcome multiple challenges ranging from serving a patchwork of small-to-midsize cities to drumming up enough business to pay for distribution centers that cost significantly more than those Kroger has erected in the past, analysts told S&P Global Market Intelligence.
Analysts agree that the deal, announced May 17, is ambitious: Provided both companies honor the terms, Kroger will build 20 warehouses over the next three years, with Ocado providing robots, conveyors and other components of an automated infrastructure that it has deployed in the U.K.
The project represents the largest yet for Ocado, which operates four order fulfillment centers and a series of intermediate facilities, which the company calls "spokes," in the U.K.
But with Amazon.com Inc. continuing to expand delivery options at its Whole Foods Market Inc. and U.S. consumers open to buying more of their food online, Kroger may have decided a major move was necessary.
"The three-year period suggests a real sense of urgency in moving forward," said Bill Bishop, chief architect and co-founder of Brick Meets Click, a Barrington, Ill.-based consultancy focused on the food and grocery industries.
The expansion is so rapid, Bishop said, that Kroger could end up increasing its online-focused warehouse space faster than consumers convert to having their groceries delivered. Brick Meets Click estimates that online grocery transactions could account for more than 8% of all grocery sales in the U.S. by 2022, up from less than 5% in 2017.
"There's a risk that this could expand the capacity significantly faster than demand," Bishop said in an interview.
Little grocer, big country
Other challenges could come from the United States' large size and sparsely distributed population relative to the U.K. Since its founding in 2000, Ocado has built its network of warehouses in Southern England, with three of its four distribution centers near either London or Birmingham.
Kroger, meanwhile, has indicated that its deal with Ocado could include serving smaller cities, such as Lexington, Ky. The grocer has not yet disclosed where any of the warehouses it plans to build with Ocado will be located.
Serving smaller cities, or ones where residents are spread out over a larger area, such as Scottsdale, Ariz., could require Kroger and Ocado to build smaller distribution centers, said Neil Saunders, a managing director and retail analyst at GlobalData Retail, a research and consulting firm.
"You're going to have some intermediate point" between the main distribution centers and either the customers' homes or Kroger-owned stores, he said in an interview. Ocado's order fulfillment centers in the U.K. have helped make the company successful, he said, because of their proximity to densely populated urban areas.
On their own, Ocado's warehouses could be best suited to the Northeastern U.S., where high population density in cities including Boston, New York City and Philadelphia would maximize the sales that Kroger could process through a distribution center, said Marc Wulfraat, founder and president of MWPVL International, a consulting firm that focuses on supply chains and logistics. Locating a distribution center in the region would also expand Kroger's footprint in an area where it has not competed historically, he said.
Kroger's offerings through Ocado will also have to find a way to coexist with Clicklist, a service that the company offered in around 1,000 stores as of the end of its 2017 fiscal year. Through the service, customers can order their groceries online and pick them up at a Kroger store.
Speaking at an industry conference May 17, Kroger Executive Vice President and CFO J. Michael Schlotman said the company could also use the warehouses it builds with Ocado to process Clicklist orders.
That could be an appealing option, Brick Meets Click's Bishop said, if Kroger's business with Instacart and other delivery services that fill customer orders directly from stores continues to grow, crowding out customers who still prefer to shop in-store. "You need to get that out of there to avoid gridlock," he said.
Instacart, which uses personal shoppers to select items for customers at brick-and-mortar grocers, has worked with Kroger since November 2017. The delivery startup has been expanding its footprint across the U.S. in recent years, including in the wake of Amazon's August 2017 purchase of Whole Foods.
"Unprecedented" spending on distribution
Ocado's U.K. warehouses use robots to fill most customer orders, with human workers typically involved in the delivery process only after machines have placed all the items that customers have ordered into a basket. The result is a warehouse that can process more orders than a typical e-commerce-focused warehouse in the U.S., Wulfraat said.
The warehouses will also likely cost more to build than a typical U.S. grocery distribution center, he said.
In a September 2013 presentation, Ocado told investors that it planned to spend about £231 million, or $368.1 million at the time, to construct its warehouse near Birmingham. That made the warehouse more expensive than its non-robotic American cousins, which generally cost up to $140 million, according to Wulfraat.
"That type of money for a distribution center is unprecedented," he said in an interview, adding that Kroger could be anticipating sales for each distribution center to total up to $400 million annually.
Those costs are higher than alternatives Kroger could have pursued, Wulfraat said, such as opening a network of traditional supermarkets just for filling customer orders — known in the industry as "dark stores."
But Kroger has made a big bet on adding technology to its warehouses before. Starting in 2004, the grocer used technology from German logistics company Witron to automate its warehouses, decreasing the time it took to compile and package shipments destined for its stores.
"Kroger's no stranger to automation," Wulfraat said. "They have that propensity to absorb the risk from anything that's new."
Neither Kroger nor Ocado responded to requests for comment from S&P Global Market Intelligence.
