During the height of the Covid-19 pandemic, shoppers worldwide switched to online shopping faster than ever before. But achieving profitability in online grocery remains a challenge for retailers and consumer packaged goods companies alike. Marc-André Kamel, who leads Bain's Global Retail practice, discusses the growth of online grocery and how retailers and CPGs can use their unique tools to collaborate and succeed together in the future of online retail.
Online Grocery: A Joint Challenge for Retailers and CPG Suppliers
While online grocery has continued to surge, grocers and consumer packaged-goods groups must work together to fix the dilutive economics of the channel.
Read a transcript of the video below:
MARC-ANDRE KAMEL: What an extraordinary 18 months it has been for the world and for our industries. One of the major impacts of the pandemic on the business side has been to create a step change in the adoption of online grocery. All around the world, shoppers switched to online shopping at a greater speed than we've ever seen before.
In the UK, online penetration doubled compared to pre-pandemic levels, reaching 16% at the peak. In the US, we saw online share across the country well above the 10% mark, indicating that in urban centers, like New York or San Francisco, it was certainly much higher. Even in Korea, where the online share was already high at 15%, we saw it soar to 27% in grocery.
So will this new normal be the basis for future growth? As always at Bain, to answer this question, we turned to the consumer, and we spotted deep consumer behavior changes from our global shopper survey that we've been conducting throughout the pandemic.
We noticed first that throughout the pandemic, grocery shoppers increasingly considered themselves as regular online grocery shoppers. In the UK, for instance, there were only 28% of all consumers in May 2020. One year later, the number is now 63%.
Our latest data from May 2021 shows that online grocery shoppers are highly satisfied with the experience. Eighty-three percent of all shoppers are satisfied or very satisfied in China, 78% in the UK, and 68% in the US. In Australia, consumers are giving online grocery shopping a higher NPS (33%) than shopping in store (28%).
High satisfaction and high NPS is an indication that the behavior is likely to stick. With these fundamental shopper-driven trends in mind, at Bain, we've modeled our projections, and we believe that by 2025, online grocery will settle at significantly higher levels than expected before the pandemic. Pre-Covid, Korea, for instance, was projected to reach 25% penetration by 2025, and we now believe that it will far exceed this and hit 35% to 40% in the next few years.
The same reasoning applies to the UK, where we project online grocery to reach 17% of the total market by 2025 vs. pre-Covid expectations of 10% only. And in the US, the online grocery is projected to reach 13% in 2025 vs. pre-Covid expectations of 8% only. The accelerated growth of online has thrown grocers into a frantic search for capacity.
But while capacity is important, we believe it's not the No. 1 problem; profitability is. In truth, very few retailers have complete transparency on their economics on a fully allocated basis. But we know that online grocery is unprofitable for most payers. And it is very diluted for all.
When online grocery was a small percentage of the overall market -- say, 1% to 2%, for instance, in the pre-pandemic Germany -- nobody cared. And online profitability could be looked at on a marginal basis. But the dilutive economies can no longer be overlooked as online grocery is becoming a more meaningful share of the overall market.
So it's a prisoner's dilemma. You really have to pay online. But how do you do this with minimal profit dilution? Firstly, grocers must recognize there are huge variations in the efficiency of different picking and packing models and in the last-mile options they operate. The choices they make will have a profound impact on their economics as they already are operating on thin margins in in-store sales, roughly 2% to 4%, and online just adds to their costs.
Let's start with picking, in fact. Most grocers are using manual picking options. These are the simplest to set up and to scale with limited investment. But they're generally operated at a loss. The most efficient model is automated picking, which can operate roughly at breakeven.
There are two approaches there: either large and centralized warehouses outside of city centers, where baskets are still shipped to pickup points; or micro-fulfillment centers, which are smaller and located nearer to the end consumer. The challenge with automated fulfillment centers is that they require significant capital investment. It's in the range of $100 million to $300 million for receives.
Then you have the last mile, meaning getting the goods to the consumer. Regardless of whether a grocer chooses manual picking or the most efficient automated solution, in today's world, they will be loss-making on that basket after the deliveries between minus 15% margin and minus 2% at best. Of course, if they choose click-and-collect rather than delivery, economics would be better. But click-and-collect does not work in all catchment areas. And it has its own costs, too.
And it's not only about costs. The revenue side of the equation is important, too. In most models, we observe the current customer fee is not sufficient to cover these costs. And even if grocers optimize the right mix of models plus increase the charges to the customer, they are still going to be, at best, breakeven, which is why they need to fundamentally think about generating new revenue streams and assessing the value of the service.
Getting to grips with growing profitably online is not just a retailer problem; it is also CPG problem. Retailers and CPGs share a lot in terms of what they're trying to solve for, the disintermediation threats they're fighting, and the possible winning solutions.
For years, CPGs were somewhat reluctant to actively accelerate their digital commerce efforts. The challenge remains small, the barriers to entry high, and the cost to operate even higher. Without sufficient consumer demand, there was no incentive to shift away from a high-margin in-store business.
Covid changed all of that. With shoppers flocking to Amazon, to grocery dotcoms, to Instacart, or other online players, CPGs had no choice but to watch as their sales rapidly shifted to online platforms. And as they did so, many players were impressed by their own growth in online, with a sense of having accomplished what they never thought feasible.
The reality, though, if you look at the average online penetration by category, is that leading CPGs continue to have significant headroom for growth online. In fact, the gap in online penetration for some players will have even widened as high as 8 percentage points for a sample of leading CPGs in their respective categories.
CPGs cannot let that gap remain. The online channel will be critically important for the brands going forward. It is destined to approach 15% to 20% of total sales globally in the coming years -- and even more. But it's not just where you sell; it's becoming the place that you build the brand and connect with the consumer.
The traditional marketing brand funnel of building awareness through media advertising, which leads to brand consideration in the eye, and then converting this to purchase, is collapsing. In the digital arena, consumers are discovering brands and buying them at the same point of interaction. Additionally, online is where CPGs can have access to first-party data and where they can easily and cost efficiently test and learn as they innovate and develop their offer.
And as smaller, nimbler competitors continue to grow their digital-first presence, CPGs have no choice but to invest in this space. One of the greatest challenges CPGs face is the lack of transparency for tracking online sales internally by brand and category as well as externally in the market. Online sales are notoriously difficult to accurately measure. But this lack of transparency also applies to profitability of the different online sales channels.
Remember, we said grocers struggle to know the real profitability. Well, CPGs are in a similar boat. At Bain, we've modeled the P&Ls of large CPGs for a variety of online channels or vendors. And our analysis shows that in many channels, online transactions are heavily profit dilutive for CPGs vs. in-store sales.
For example, in the food and beverage category, the D2C channel is actually loss making, with margins of minus-5% to minus-10% for the same reasons that grocers lose money -- it's expensive to pick, to pack, and to deliver goods. Online vendors, such as Amazon or Instacart, which, at the outset, seemed to offer a refreshing alternative to the intense negotiations with incumbent grocers -- well, they also have disappointing margins, anything from roughly breakeven to 9%.
The only online channel where CPGs have a chance of being as profitable as store-based sales is the dotcom of incumbent grocers, with margins of around 18% for average CPGs in the food and beverage category. So for most CPGs, the most profitable channel seems to be the incumbent grocer, either in store or via the grocer dotcom.
This is a critical insight, as it creates an imperative for CPGs to work closely with grocers to find a way to collectively make the economics work. In such a fast-moving environment, we know that both incumbent grocers and CPGs can deliver specific profitability improvements if they approach the problem on a standalone basis.
On the grocery side first, retailers can reduce the cost of picking and delivery by being more tactical with their existing network nodes to serve the online business. They can also improve basket profitability by encouraging bigger baskets, by reducing the online SKU assortment to enable faster picking from smaller centers and focus on products with higher inventory turn, by applying markups on prices, by offering a delivery subscription package, therefore locking in the share of volume.
And fundamentally, incumbent grocers need to convince shoppers of the value of the service as their disruptive peers, the third-party pickers or the food delivery players, are finding ways to charge for their service and cover their costs. On the CPG side, brands can work on the product, on the packaging, on the supply chain, to make them efficient for online logistics and improve the unit economics.
They can also rethink their business model to target higher retention or repeat purchases with the example of subscription models, which rebalance the lifetime value of the shopper against the customer acquisition costs. Each of these actions will improve profitability. But where I really believe there is greater potential is to achieve profitable growth.
If grocers and CPG brands were to collaborate and align their interests, the combination of their unique assets would enable them to both grow faster and profitably online and outcompete their disrupters. Both could get a tremendous amount of value by partnering to take out system costs out of the factory to shelf supply chain.
In addition, grocers are sitting on a goldmine of shopper data, which is of enormous value to CPG brands and to themselves. If grocers worked with CPG brands to analyze previously untapped data pools, they could, together, get a deeper understanding on the shopper journey from research to repurchase.
To do that, grocers will need to shift from selling physical real estate and shelf space to selling shopper access and data, which is better suited to the digital world. CPG brands could help unlock value for the grocers and for themselves through richer marketing and activation opportunities, leveraging the grocer dotcom websites and data and insights to conduct faster and more cost-efficient test and learn for higher conversion, bigger baskets, et cetera -- or shifting from mass marketing to precision marketing and testing new levers to drive repurchase.
There is tremendous value creation potential here. However, today most grocers' technology platforms lack the sophistication to unlock value for CPG brands. They have limited data analytics capabilities to collect test-and-learn trial data or make personalized recommendations. The challenge is really how to get started.
Both parties will need to invest time and resources to create assets that maximize value creation. And the first step is to identify the unique strengths and value that the other party can bring. Beyond the urgent need today to fix the economic challenge of growing online, grocers and CPGs need to partner to anticipate the inevitable next waves of disruption.
The future of online retail is constantly evolving. We will never really arrive at the end state. Technologies that are nascent or costly today will continue to evolve and will become more affordable. Consumer expectations will continue to increase, fueled by new experiments, such as on-demand delivery, which is receiving enormous levels of venture capital.
Grocers and CPGs must align their interests and accept that they cannot win without the other party. This is a profound shift in mindset for both. We at Bain are convinced that they will seize this fantastic opportunity to innovate together and to keep the many disrupters at bay. And the surge in online grocery will turn from an existential threat into a source of continued value creation.