Food is the biggest retail category, accounting for nearly half of retail sales. While the segment has lagged in online penetration, the Covid-19 pandemic has been a major catalyst for change, helping to double the share of online food retail sales from 2% to 4% in a single year. Nordea Equity Research analyst Daniel Ovin explains why the online shift should continue and how far it could go.
Social distancing during the Covid-19 pandemic has sent grocery shoppers online, a trend surveys suggest will continue. What’s more, new warehouse automation technologies, combined with higher density deliveries, are helping to make the category more profitable.
Daniel Ovin (DO), e-commerce and digital business analyst in Nordea Equity Research, expects online grocery penetration to continue to climb in the Nordics in the coming years, but online retailers need to be able to offer home deliveries without fees and with competitive prices to remain competitive. He explains why in this interview with Johan Trocmé (JT) from the Nordea On Your Mind, ‘E-commerce and Corona‘.
JT: Why is the online share for food retail so much lower than for other retail categories?
DO: Food is the largest retail category, but it is also the retail category with the lowest online penetration. The reason for this is that groceries are the most difficult product to offer profitably online – an average food basket contains around 40-50 items, each with a relatively low average selling price and needing to be picked individually, then bundled for home delivery, keeping some items frozen, others chilled and some ambient.
JT: Countries like South Korea, China and the UK have a significantly higher online share of food retail than the rest of the world. What have been the key drivers for this, and are any of them applicable for the Nordic region?
DO: There are some common factors for countries where the food online penetration is higher. They tend to have a relatively high population density, a high tech savviness in the population in general, and a high online penetration also for other categories. In general, countries with a high online grocery penetration are also countries with a relatively high disposable income (for China, in areas where online food retail penetration is high). Sweden meets most of these criteria except for a high population density. By only focusing on three metropolitan areas in Sweden (Stockholm, Göteborg, Skåne), however, we believe that an online food retailer could serve 75-80% of the Swedish food retail market.
The share of consumers aged 45+ who buy food online trebled to 30% last year.
JT: How has the COVID-19 pandemic affected Nordic food retail so far? Do you expect effects to revert, or be permanent?
DO: COVID-19 has accelerated the online shift for most retail categories and for food retail in particular. In 2020, food has been the fastest growing of all categories online in Sweden, up by around 90% y/y. The main driver has been that consumers over 45 years have stepped into the category online, as well as that consumers already ordering food online increased their share of wallet in the online channel. For those over 45, we estimate that more than 30% will have purchased food online during 2020 versus less than 10% previously. According to surveys in Sweden and abroad, consumers buying groceries online for the first time during 2020 were very pleased and say they will continue to shop for groceries online. According to Sweden’s biggest food retailer ICA, as much as 40% of households surveyed which were new to online grocery shopping with ICA during 2020 even said that they will make online their primary grocery purchasing channel going forward. So I believe that more than half of the increase in online grocery sales we saw during 2020 will stay and form the base to grow from during 2021.
JT: How will the different players be affected by online migration? Incumbent store-based food retailers versus new online players? What will be needed to be viable and competitive in ten years?
DO: The opportunity in the online grocery channel has grown significantly during 2020 and retailers without an attractive online offering will see their overall market share decline. Incumbent food retailers such as ICA and Axfood have upped their game significantly in the online channel and we believe they will continue to regain some of the lost share in the online channel. We believe that incumbent food retailers with a sizable store network are likely to see margin pressure from sales going online, however. This does not have so much to do with the negative mix effects from online having a lower margin, but is more to do with the store base facing deteriorating operating leverage when sales go online and the brick and mortar stores still being stuck with high fixed costs in terms of rent and personnel. We have seen this effect in many other categories when sales have moved online, such as clothing and apparel. For all players, a higher grocery online penetration will increase density in deliveries and make it easier to earn a positive EBIT margin in the online channel, however. In order to be competitive ten years from now, we believe that online grocery retailers need to be able to offer home deliveries without fees and with competitive prices. In the UK, online players are also competing on offering attractive and tight delivery windows. To be able to offer this, we believe online grocery retailers will need to operate highly automated warehouses and also build a decent local scale with a relatively high density in deliveries.
New warehouse automation solutions paired with higher delivery density could raise online food retail margins by several percentage points.
JT: What innovations are we seeing in picking and delivery? Could this boost online penetration for food retail, and how could it affect profitability for the retailers?
DO: In the last few years, automation for picking groceries has developed quickly. UK-based Ocado has been the pioneer in this area and started to develop automated warehouses for picking groceries fifteen years ago as there were no automation companies that could offer this kind of automation. In the last few years, however, automation companies such as Swisslog and Dematic have developed highly automated warehouses intended to pick groceries, and the demand for this technology has grown in several countries. We believe that these automated warehouses in combination with a higher density in deliveries could lift the EBIT margin by several percentage points and allow several online operators to reach profitability.
Sweden and Denmark could see online penetration of food retail of 15% in ten years, with Norway and Finland likely a bit lower owing to lower population density.
Daniel Ovin, e-commerce and digital business analyst in Nordea Equity Research
JT: How high could the Nordic online share for food retail be in the long term? Are there any major differences in potential between the four Nordic countries?
DO: The Nordic countries had a similar online grocery penetration before the COVID-19 pandemic of around 1-2%, where Sweden and Denmark were around 2% and Norway and Finland around 1%, we estimate. The pandemic is likely to have driven growth in online groceries in a similar way in all Nordic countries during 2020. Longer term, we believe that Sweden and Denmark are likely to reach around 15% penetration in ten years’ time, with the figure a bit lower in Norway and Finland.
In Sweden, we have pure play online operators such as Mathem and Mat.se that are driving growth and forcing incumbents to invest heavily in their online business so as not to lose overall market share. In Denmark, there are several incumbents that are investing in the online channel, and a relatively high population density should allow for a relatively high online penetration. In Norway, the population density is lower, with only one larger metropolitan area around Oslo, so we believe the overall online penetration in Norway will be below 15% in ten years’ time despite pure play online operator Kolonial driving growth. For Finland, there is no pure play online operator driving growth and the overall population density is also lower, so we believe Finland will also end up with an online penetration below 15% ten years from now.
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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