03 July 2010

I Just Don't Get Ocado Business Model?

I Just Don't Get Ocado Business Model?

I am fascinated by Ocado and its upcoming flotation.  Why you might ask?  Well, it is because Steenbergs is having a go at becoming an online retailer, but obviously on a micro, mini scale compared to Ocado.  But also, I just don't understand their business model at all, because to me they are a courier business pretending to be a retailer.  And a courier with one big customer, who can also compete against them.

I will try and explain what I mean. 

The first thing we decided when we started was to outsource transport as it's a commodity business with few barriers to entry and adds no value to your brand/business.  Obviously, bad delivery service can be a problem (and occasionally is for us), but I am glad we do not have to worry about routing vans, filling empty vans on their return journeys and optimising routing.  If we were involved in delivering chilled or frozen products we might need to consider it, but we have also steered away from those for the moment, while there are third party distributors who provide frozen deliveries and might (I suppose) do chilled if the volumes were right.

By ignoring transport and just seeking to get that cost down, we were able to focus on the core parts of retailing which are buying and merchandising.  The buying process allows you to build an image of how you look to the customer and the world out there, and (perhaps even more importantly) work on your retail margins by working on your volumes and (if you are Tesco or Sainsbury or Waitrose) your suppliers to squeeze out better margins. 

Secondly, you can work on your merchandising, including developing your own branding, so for example 98% of chilled sales on the high street come from own label and 40% of Sainsbury's sales are own label, while the discounters have an even higher percentage.  And for Steenbergs, our own original core of Steenbergs Organic spices, herbs and teas remains what brings people into our site.

But Ocado does not do this side of retailing, outsourcing much of it to Waitrose and then agreeing to limits on how much non-Waitrose it can buy in.  So it misses out most of what real retailing is about.

Further, there is no obvious exit strategy for Ocado shareholders, as John Lewis is sitting there as a poison pill.  If you take over Ocado, Waitrose can walk and would probably want to walk (assuming that the buyer is another retailer) and you would have the headache of needing to rebuild your supply chain.  Similarly, John Lewis is never going to pay big bucks to take the whole business in house.  Then on top of this Waitrose has its own online shop and has been allowed to compete directly for customers within the M25 region, leaving Ocado with the whole of the rest of the UK to cover.

So what is Ocado?  I think it is a glorified courier business that is masquerading as a real retailer, and one that has a single major customer, which is not fully tied into supplying Ocado.  Plus if you want to buy Waitrose products, you can still go and visit a Waitrose anywhere in the UK and even buy online then collect in store. 

Although it pains me to say so, the Tesco model is much, much better.  Here, Tesco Direct complements its supermarkets with deliveries in any catchment coming out of the local store.  As a result, local store managers and workers can see Tesco Direct as boosting local business and widening their retail catchment, i.e. Boroughbridge and Ripon do not have Tescos but you can still get deliveries from Tesco Direct which will come from stores in Thirsk or York or Leeds.  Whereas Ocado actually do the opposite as it competes against your local Waitrose, as the distribution chain is separate, so why would the store manager of Waitrose in Harrogate or Hexham want you to go to Ocado?  They wouldn't would they, so they are not going to genuinely promote competition that would effectively reduce your annual John Lewis bonus.  Note that Warren Buffet has increased his shareholding in Tesco in the last few months - what does that mean?

In fact, if you put HG4 5GZ into the Waitrose web site it tells you can shop online and pick up from store (in Harrogate) for groceries and home direct kit, while it says the delivery service is not available in our area.  There is no linkage or push to Ocado, which cannot deliver to us but Tesco, Asda and Sainsbury do.  If you are in London, say Moray Road, it does push you to Waitrose stores first and then Ocado for now, but from next year Waitrose can deliver direct within the M25; is the float being done now before any cannabilisation in sales from Waitrose next year?

Of course, Ocado will get away with it and it will eventually make a small profit, but (in my opionion) it's investing money in the wrong part of retailing, i.e. distribution rather than buying, supply chain and merchandising.  It's a southern phenomenon that shareholders and investment bankers in the south will see day in day out in vans parping around London looking busy, but it isn't really out here in the styx; it just doesn't really exist in the heart of England and Scotland where much of the nitty-gritty profits of retailing are being made.

Steenbergs already makes a real cash profit and its retail site is growing strongly year on year, but we are doing that by using internally generated cash to build the business; it will take longer, much longer to make us any money, but it does seem a more solid way to try and make money out of retailing.