Groceries are by far the biggest category in the retail industry but have been slower than most other categories to migrate online. In the latest Nordea On Your Mind report, ‘E-commerce and Corona‘, Johan Trocmé (JT), Director of Nordea Thematics, talks to Johan Lagercrantz (JL), CEO of online grocery retailer MatHem, about the changes triggered by the Covid-19 pandemic and the outlook going forward.
Lagercrantz explains why he expects to see an increase in online grocery shopping even after the pandemic that will take the category to a whole new level of online penetration.
JT: What do you see as the main challenges for groceries to overcome as the industry catches up with the rest of the retail industry in online penetration?
JL: It is a very good question that many have reflected over, as it is an area that has fallen behind other categories, and there is no simple answer. There are some different drivers in groceries compared to other e-commerce segments, and fulfilment is much more complex. For instance, buying a book online at a lower price than in a bookstore, and getting it delivered to your door in 1-2 days, is quite straightforward. It is a clear customer logic and a simple product to handle from a logistical perspective. There is a completely different complexity with food, which gives little room for any price advantages from buying it online, as the product is complex and expensive.
We have had to drive the development of e-commerce for food based on other parameters, where convenience is an important factor. Convenience is essentially the reason why consumers buy food online today. At the same time, it is not a driver in all customer segments, as offline grocery shopping is a deeply rooted habit. The weekly shopping is typically done on Sunday or Monday, and we have our routines for how to shop. Buying a book or a sweater does not include the same routines as a part of the life puzzle. We must consider other parameters to challenge these routines and habits.
Recent experience has shown that once customers shop for groceries online, they are positively surprised and realise that it is a great service which they want to continue to use. I think we will see an increase in online grocery shopping after the pandemic that will take this category to a new level of online penetration. However, it should be mentioned that one factor which has held back the development of e-commerce for groceries is high gross margins for incumbent food retailers in the Nordics. The market is dominated by a few major players who have had little immediate incentive to drive sales from physical stores to online. These players are satisfied with their physical store networks as long as they generate attractive profits. It is hard for a new entrant like MatHem to challenge the establishment, owing to the big capital expenditure needed to do this.
As a smaller player on the market, we do not have the same purchasing power to be able to compete on price. An incumbent can have a 3-4% EBITDA margin centrally and another 4-5% EBITDA margin in the store chain. Why would they try to push their revenues online if the business generates a profitability of 10% today? Compare that to a minor, niche bookseller who can become competitive without the same type of barriers. As long as the dominant players are in that position, they will not drive major change. Instead, players like MatHem need to be the driving force. That is the kind of challenger we want to be. Today, 3-4% of Swedish food retail is online, which is extremely low, compared with over 50% in categories like books and media.
Grocery picking is complex, with four different temperature zones, and hence expensive.
JT: Why is fulfilment complex in online food retail, and how do you address this?
JL: It is expensive to put the orders together. And in addition, it is expensive to distribute refrigerated deliveries. The activities such as picking, storing and receiving need to be performed in different temperature zones, where we have four different zones: room temperature, cool for fruit and greens, refrigerated and frozen. Picking and storing activities need to be made in various zones, and thereafter consolidation is needed. Additionally, this may require cross-docking with products from our partners, which makes the handling even more complex.
Our facilities are not fully designed for these types of activities from the beginning, and it requires a lot of working hours to pick these orders. Staff costs are high in Sweden, of course for good reasons. This means we need to make major investments in automation to reduce the required number of working hours per sold product. We are investigating different automation solutions in order to increase the efficiency. This area is super interesting and offers great opportunities as it is quite new. There is no online grocery retail player that we can use as a template. In the food industry, there is continuous innovation, and change happens fast. We make big investments in our customer fulfilment centres in order to be more efficient and reduce the cost per order.
JT: Out of curiosity, do you develop your fulfilment capabilities yourself or do you use external partners?
JL: We have not bought any complete solution but opted to develop the concept ourself. However, we have suppliers who support us with equipment and good ideas, allowing us to put together a full solution. There are different approaches, but we believe in ours, and our owners are good references as they have worked with other companies with similar solutions. Therefore, we are confident that this is a suitable way forward for MatHem. The complexity is the uniqueness of each order, meaning if we pick ten thousand orders, no order will be the same. Consequently, it is even more important to find efficient solutions to increase the profitability.
Nordic population density is sufficient to allow similar penetration for online food retail as in the leading countries.
JT: Are there structural differences between the Nordic region and the rest of the world which help or hinder the potential for online groceries sales? Do you think the Nordic region will not be able to reach as high penetration for online groceries sales as in countries like the UK and Korea?
JL: Not really. There are plenty of areas with high population density in the Nordic region with good business opportunities for online grocery retail. In Sweden, for instance, we are already present in areas such as the Stockholm region, the west coast area around Gothenburg, and in Skåne. Today, we reach 55% of Swedish households. I think that Sweden has a high enough population density in order to achieve the same online groceries penetration rates as in the most prominent countries.
The competitive landscape can of course differ among countries. Norway does not have the same amount of large department stores, and thus does not need the same wide assortment of products. This means that online grocery sales can be conducted with a lower number of unique products, which creates potential for higher efficiency. In Sweden, the customers are used to a broad product offering, which creates another level of complexity compared to Norway. I would say there are some differences, but of minor character.
JT: Our equity research analyst estimates that the online penetration for food retail can reach approximately 15% in the Nordic market in ten years. What do you think?
JL: We have not made any internal analysis regarding this and usually think your analysis is reasonable. By comparing to other markets, such as the UK or South Korea which have high numbers compared to Sweden, I believe that the number is realistic.
JT: How has the COVID-19 pandemic affected your business in 2020? Do you expect any changes in consumer behaviour to be permanent?
JL: Using South Korea as an example, in 2014-15, it was hit by the MERS pandemic, which was more severe locally at that time compared with COVID-19 in Europe now. The online sales of groceries had an extreme upswing in 2015 and continued to increase in the following years. It became a snowball effect and not just a temporary increase that later declined. Instead, it continued to grow. This is what we expect also in the Swedish market.
During the COVID-19 pandemic in 2020, MatHem has prioritised basic functionality and the ability to deliver, which has been sorely needed.
JL: Year 2020 has been an extremely challenging year where MatHem has focused on even being able to provide the services to all our customers. There have been periods when we feel that we have provided societal benefits by providing risk groups and sick individuals with food. They have been dependent on the service MatHem offers. We have focused on fundamental functionality to secure our ability to deliver.
The focus has not been to evaluate how many different brands of sausages we have in our assortment, or if the delivery time slot could be narrowed to 30, 45 or 60 minutes. Instead, the question has been if we can provide the delivery at all. In order to increase capacity and ensure safety, we have scaled down the service offering, removing services such as returns and recycling of bottles, bags or used carbon dioxide cartridges. This is to make sure that people do not need to be exposed to unnecessary contacts. Our priority has been to deliver on core capacity and functionality. Risk groups, such as individuals over 70, have received longer delivery slots and hence been able to get deliveries even though we are fully booked. We have tried to create various solutions in order to support the risk groups as much as possible.
The growth surge in 2020 has led to a greater need to invest in more automation and efficiency to cope.
JL: This increase over the past year is a change in the markets that otherwise might have taken 2-3 years. It means that several development projects such as new warehouses, automation and efficiency projects are needed now. As demand has increased at a much faster pace, we need these solutions earlier than expected. Moreover, we have lost time, when we actively could have focused on developing our daily business. Now it is vital for MatHem to ensure that we have the resources to work with this in the long term, focus on efficiency and not only on day-to-day business. It has previously been a challenge to understand how to prioritise between short- and long term.
JT: What do you need to continue expanding and growing? What are the bottlenecks? Is it investments in facilities, machinery and systems, personnel or IT?
JL: The greatest bottleneck is the logistics facilities. It takes time to modify existing facilities and build new ones. We must also configure and install automation systems, which have long lead times. Around 600-700 new staff members have been hired during the past year, which also requires time and resources. From an efficiency perspective, it is challenging, as it take times for new employees to get into full work speed.
The availability of delivery vehicles has been a challenge, as we found out when trying to order refrigerating trucks from Italy and Germany last year, when production was temporarily shut down. For some areas, it is easy to find temporary solutions, while it is more difficult with the logistics and automation solutions.
JT: How do you see the future roles for incumbent store-based food retailers and the new online players? Advantages and disadvantages for each? What will be needed to be competitive and viable in tomorrow’s groceries marketplace?
JL: In ten years, I think the competitive landscape will have changed and more players will have entered the market compared with today. In comparison to other European countries, Sweden is unique, as we only have about four major players that dominate the market today. Generally, I think it is good if the number of players in the market increases. It will benefit the end customer who gets more choices.
MatHem will be at the forefront in terms of e-commerce. The other players will also succeed with mixed models, where some will probably continue to focus on physical stores. Everyone will find their own niche. Of course, our ambition is to grow and take market shares, which means that someone else would need to lose share. However, the biggest players today have too large a share of the market in order for it to be healthy for the end customer. There is no doubt that online grocery retail will continue to grow and take shares from the physical retail. We are well positioned to pursue those opportunities.
The biggest advantage of incumbents is purchasing power from size, but they face challenges in how to choose between optimising their offline or their online businesses.
JL: The incumbents enjoy great benefits in purchasing power owing to their size. But their physical distribution networks are not beneficial for what tomorrow’s marketplace will look like, and I am not envious of needing to manage that. A disadvantage for these traditional players is the conflict in deciding whether to optimise the store-based offering or the online offering. It is always a trade-off and it creates friction internally. I also believe that it is challenging for incumbents to change and adapt at the same pace at which change happens. The organisational structure can be an obstacle, where there often is a built-in inertia. I would therefore say that their largest benefit is the purchasing power.
JT: Is there a sustainability challenge for online food retail? Are emissions from home deliveries an issue? If we decide to get everything delivered at home instead of physical shopping, will the emissions increase not be a problem? What is your view on this?
JL: I would say it is the opposite. Our data show that it is more efficient that one vehicle from MatHem delivers food to 30-40 families, instead of all of these families doing the grocery shopping themselves. In addition, Mathem strives to provide a wide assortment, allowing the customer to do several errands at the same time. Synergies can thus be achieved, and one does not need to travel to different areas. We also work on how to further reduce emissions and use fossil-free fuel or electric vehicles. There is still much to improve in those areas. In e-commerce, we purchase from the supplier who delivers to our warehouse, from where it is ultimately distributed to the end customer. In offline retail, the supplier delivers to the central warehouse, which delivers to the physical stores from where end customers pick up goods and bring them home themselves. That is an additional transportation step, which creates emissions. With shorter lead times and fewer storage hubs, we can drive better sustainably from the product side.
There are of course other aspects as well. Online is a sustainable way to shop, as it supports the customer in making smart choices. It is easy to compare the products, easy to get access to information and the customer can make smart choices, both personally and for the environment. That is also an interesting aspect, regarding what power we can give the customers and support them in the sustainability journey. It is a strong focus for us: both how we can support customers, how we act and what requirements we should put on our suppliers. For instance, we put requirements on package solutions, and it is important for us to take responsibility, partly since our owners expect that, but also because our customers want to see this development. We do what we can, and as an example, we will have Stockholm’s largest solar panel park on the roof of our new warehouse opening in 2022, that supplies 50% of the electricity it needs.
One critical area of focus for us now is data. We are investigating AI and machine learning to optimise processes and to customise customer experiences in apps and on the web. This offers the potential for better margins, improved customer experiences and also better sustainability. If we can optimise the distribution routes for our trucks and inform customers so they are able to choose sustainable delivery time slots, we do not need to drive the same distances as now. It will become a greener alternative. I believe this area will be a crucial factor for determining who succeeds and who does not succeed in this industry.
If you are a corporate client and want to access the full Nordea On Your Mind report, please contact Viktor Sonebäck.
And don’t miss the latest podcast episode of Nordea On Your Mind, in which Adam Schatz, CEO of BHG Group, discusses whether changes in consumer behaviour due to the pandemic will be permanent, and how online and brick-and-mortar retailers need to respond, with hosts Johan Trocmé and Viktor Sonebäck from Nordea Thematics.
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