- The pandemic has turbocharged adoption of online grocery by shoppers, and we forecast that 35%–45% of the spending surge will survive the easing of lockdown measures in 2020.
- Between 2020 and 2025, online grocery penetration could as much as double in select markets. All markets we analyzed have seen a two- to five-year acceleration in penetration that could massively dilute retailer profits without action to improve the poor economics of the channel.
- Grocers can defend themselves against this threat by optimizing their omnichannel network, diversifying revenue streams and removing unsustainable channel subsidies.
For more than two decades, food shopping has been slowly migrating online. Now Covid-19 has radically accelerated this digital transition in the space of a few months. Around the world, shoppers are breaking with lifelong habits by ordering groceries through the Internet instead of visiting a supermarket, while earlier converts to the web are heaping their virtual baskets with extra items.
This unexpected surge poses a threat to the industry, even though mainstream e-commerce adoption has been on the horizon for so long. For the vast majority of grocers, home delivery and curbside pickup are structurally less profitable than in-store transactions—and in many cases, each order comes at a loss. When an in-store transaction migrates online, it erodes or destroys what was already only a slim profit. Do that a few hundred thousand times a day and you’re in trouble.
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Before the pandemic, many retailers hoped that consumers’ unhurried embrace of online grocery would give them a few years to develop a business model that wasn’t so dilutive. Now they need to find a much more rapid fix for the broken economics of the channel—and at the same time ramp up their e-commerce capacity to meet the surging demand.
The stakes are high. Those that choose not to expand online will avoid short-term earnings erosion, but their resulting lack of digital infrastructure could leave them uncompetitive in the long term. Grocers that scale up through a third party to meet demand will be similarly vulnerable if the partnership ends and leaves them without e-commerce operations. Yet according to our modeling, a grocer that ramps up its own online arm without structural reform could see its overall profitability fall by 50–80 basis points over the next five years depending on the rate of online growth. And those that raise fees to cover the cost of the service they provide could face a backlash if the public misconstrues their actions as profiteering.
In spite of these pitfalls, we think it is possible to ramp up online grocery for the post-Covid age without destroying the bottom line. Executive teams can find their way to breakeven and beyond by heeding three calls to action: Optimize your omnichannel network, diversify revenue streams and remove unsustainable channel subsidies. It won’t be an easy transformation, given the operational challenges exacerbated by the pandemic, but it’s one that can’t be put off any longer.
How much of the surging demand will stick?
Covid-19 has turbocharged grocery e-commerce internationally, and the increase in penetration is even more striking when you consider that in-store sales spiked at the same time. In the US, the online channel accounted for 5.1% of sales at the end of 2019, before the pandemic emerged. At the peak of the crisis, penetration had risen to 6.6% (see Figure 1). UK penetration peaked at 12.4%, up from 8.1% pre-Covid. In France, it jumped from 6% to 10.2%. In Italy, even more of an online grocery laggard than the US, penetration more than doubled to 4.3%. In Germany, which has been wedded to in-store shopping, online grocery went from 1.5% to 2.9%. In Asia, meanwhile, penetration has also been growing, albeit from a much higher base in countries such as South Korea and China.
Uptake had been low, so adding a percentage point or three to the penetration rate is a big deal
It’s worth bearing in mind that many shoppers were unable to find an online grocer with the capacity to process their order during the lockdown demand surges—so the figures most likely understate the public willingness to embrace web-based ordering around the world. For instance, when Bain & Company surveyed 7,500 shoppers in Western Europe in May, we found that a fifth of those who had wanted to buy groceries online in the previous four weeks had been unable to do so.
How much extra spending will stick? In the short term, that depends on several factors, such as customer experience, whether a grocer excels at selling fresh produce online (if not, many newbies will go back to brick-and-mortar), its ability to scale up capacity in order to fulfill orders reliably and quickly amid the continuing stampede, and how quickly politicians lift distancing measures that deter in-store shopping. In 2020, our best estimate is that online grocery will hang on to 35% of the Covid-related spending surge in Italy, 40% in the US and France, and 45% in the UK and Germany.
That would be a major advance for online grocery. In the US, Germany, France, the UK and Italy, for instance, we estimate that there are going to be about 350 million more online grocery orders in 2020 than there were in 2019, swelling the channel’s sales by about $36 billion year over year. Strategically, it’s like someone pressing the fast-forward button on the industry by several years. During the pandemic, online grocery penetration in the UK, France and Germany peaked at levels we hadn’t expected until well after 2025. In Italy and the US, the comparable acceleration was as if 2024 and 2023 had come early.
To recalibrate our medium-term forecasts for the coronavirus age, we modeled three scenarios (see Figure 2). The first is the most favorable for online grocery demand but the worst for humanity; it assumes that Covid-19 restrictions end quickly—only to be reinstated after six months or so because of a fresh wave of infections. In this “second wave spike” scenario, a vaccine wouldn’t be ready until mid-2021 after 18 months of development, further encouraging shoppers to rush to home delivery or curbside pickup, while grocers scale up fast enough to keep up with the next surge in demand, better serving both new and existing customers than in the first wave.
Our middle scenario—the “faster shift online”—anticipates a slower but more stable exit from restrictions, arrival of a vaccine within 12–14 months, grocers keeping up with most of the increased demand and a better customer experience than in the early stages of the pandemic (but still with room for improvement). The lower-growth scenario (“rapid return to traditional grocery”) anticipates a more modest acceleration of demand thanks to best-case management of the virus (a rapid removal of restrictions, no second wave of infections and a vaccine within 12 months), a patchier customer experience and a struggle on the part of some grocers to keep up with demand.
If the “second wave spike” scenario prevails (and we sincerely hope it doesn’t), online grocery penetration could over the next five years soar to almost 14% in the UK, 13% in France, 11% in the US, more than 8% in Italy and 4% in Germany. That’s about one-and-a-half times the pre-Covid forecast in these countries—or even more. Yet even in the lower-growth scenarios, online grocery penetration is poised for a forecast-busting advance between now and 2025. Grocers are indeed running out of time to make e-commerce pay its way.
Three ways to fix online channel economics
When they moved online, most traditional grocers cut-and-pasted their in-store value proposition to the web, layering new capabilities and costs on top of their existing operational infrastructure. The in-store value proposition tends to generate an operating margin of 2%–4%. Yet replicating that online adds the hefty costs of picking orders on behalf of customers and providing home delivery or click and collect services—without removing significant store costs. Although these online services improve customers’ lives (to the extent of being a lifeline for many during lockdown), few grocers charge enough to cover their cost, if they charge at all. Even fewer have fully exploited the new revenue-raising opportunities created by the sector’s digital migration, such as selling online advertising space or monetizing customer insights.
Consequently, traditional grocers that do their own online order picking from their physical store network (and provide delivery without any customer fees) are typically suffering a negative operating margin of about –15%, or –11% if they pick from a “dark” store that’s not open to the public. If a third party (such as Instacart in the US) does the picking from a regular store, the margin is likely to be about –5%. The bleeding is less severe for click-and-collect services, because they avoid the “last mile” logistics challenge that bedevils delivery services. The margin is likely to be about –5% for a grocer that does its own picking from a regular store without charging a fee. Click-and-collect orders picked from a dark store or by a third party should break even.
The broken economics of the channel have barely evolved over more than 20 years, but they don’t have to take decades to fix. By taking short- and medium-term action, executive teams can neutralize the dilutive threat posed by today’s online boom. We find it helpful to group these actions into three areas: optimizing the omnichannel network, diversifying revenue streams and removing unsustainable channel subsidies. Not all the actions will be appropriate for every retailer: Grocers need to select those that match their value proposition and refine their approach through experimentation. In all three areas, companies should also consider partnering or buying in expertise through M&A as a way of accelerating progress.
Optimize the omnichannel network
The acceleration of e-commerce during the pandemic is likely to force almost all retailers to rethink their physical store network. Because they remained open during lockdown, grocers have been able to move quicker than other retailers in this regard, finding fresh ways to knit online and offline retail into a more seamless omnichannel whole. For instance, Whole Foods and Kroger were among the grocers converting traditional stores into “dark stores” tailored to satisfying increased demand for home delivery or pickup.
Grocers should continue to find substantial opportunities to stem their online losses during this omnichannel overhaul. Consider a grocer at the least mature end of the online grocery scale, one that manually picks its own orders from its own stores. We calculate that its operating margins could be boosted by between 2 and 12 percentage points through an optimization push that involves tweaking current methods of manual picking and delivery, moving to more automated fulfillment methods to serve the densest areas of high demand and changing some outlets to dark stores or automated fulfillment centers.
Automation is likely to yield the biggest optimization gains (see Figure 3), both at centralized fulfillment centers (CFCs), such as those operated by Ocado in the UK, and micro-fulfillment centers (MFCs), which offer similar robotic picking from a much smaller site, potentially within an existing store or dark store. MFC technology is nascent, but its relative portability and the rapidity with which it can be deployed is attractive: One European grocer rolled out a pilot facility in about three months rather than the two years that a CFC would have required. However, such technologies require meaningful capital expenditure, which grocers will need to allocate by making trade-offs against other investment opportunities.
Automated fulfillment requires heavy capital expenditure but can transform online grocery profitability, especially when customers are charged fees, too
Diversify revenue streams
Now that online orders are beginning to generate a more substantial chunk of sales, grocers need to think more about the specific characteristics of the online channel as they manage their vendor relationships: How can they build new models of digital retailing that create mutual, long-term benefits for both grocer and vendor? These models are already starting to evolve in some corners of the industry, highlighting opportunities for grocers to diversify their revenue streams online.
Vendors can be encouraged to fund brand activation initiatives that leverage the possibilities created by this virtual setting (without confusing or annoying shoppers in the process). Those initiatives might include selling banner ads on your website or app and allowing branded manufacturers to drop a sample into a customer’s basket for a fee. Grocers can auction prominent space in category pages and in search results for a particular product, while also charging a fee for vendor-branded pages and services such as a “shop the recipe” feature. They can sell consumer packaged goods companies insights from their data (such as basket mix and size, as well as the frequency and substitutability of purchases, or effectiveness of various activation tactics).
With an individual vendor, it might make sense to separate elements of the online negotiations from the talks covering the physical store estate. A new approach to negotiating cost of goods sold, listing fees and promotions for the online channel could help stimulate demand and unlock incremental growth and profit for both retailers and suppliers, thus contributing to covering the costs of the heavy software and analytics investments needed to realize the online channel’s full potential. Overall, we estimate that diversifying revenue streams while maintaining traditional trade terms could add up to six percentage points to a grocer’s online operating margin, without causing online channel economics to deteriorate for vendors.
Remove unsustainable channel subsidies
The grocery executives we meet tend to doubt their ability to raise the price of online grocery. It’s true that, when you’ve been charging too little for a valuable service for two decades, there’s no easy fix—and Covid-19 has increased the risk of backlash. The pandemic has not only damaged purchasing power, it has also given online deliveries and click-and-collect the aura of an essential social service, a utility almost.
Without minimizing the challenges and sensitivities, we think that pricing can be part of a broader reset of online grocery economics. Consider the boom in home deliveries of hot food during lockdown: Unlike many grocers, the likes of Uber Eats don’t deliver for free, and customers are happy to pay for the convenience the service brings. By the same token, Instacart is growing while charging delivery fees starting at $3.99 plus a 5% service fee—on top of item markups.
If a grocer is today fully subsidizing its value-added online services (either delivery or pickup) without any additional customer charges, we think there is room to improve margins by 15–20 percentage points. The combined measures that could achieve this include increasing the minimum basket sizes, charging a delivery fee if one is not in place already, introducing a picking fee for click-and-collect, operating a monthly or yearly membership scheme, varying delivery fees according to time-slot popularity and tilting the mix of purchases more toward private label products and other higher-margin items. In practice, the available levers, and thus the achievable savings, will be limited by the grocer’s starting point, its value proposition and the expectations of local consumers, but they can still help it break even at the very least.
Executive teams must manage the risk to their brand of even modest charges, of course. They’ll need to dazzle online customers in the key fresh produce category and avoid disappointing them with out-of-stocks and random substitutions. They’ll have to factor in the delivery needs of vulnerable customers long after lockdown eases. They might need to give customers choices over what they are willing to pay for (dynamic pricing that varies with urgency or time of day can help with this). Yet as they feel their way toward a viable long-term charging model, grocers can draw on the localized nature of their industry, which gives them room to test and refine new fee structures with a small pool of customers before a riskier large-scale launch.
Twenty years on, a chance to banish the ghost of Webvan
Next year marks a significant date in the history of online grocery: the 20th anniversary of the collapse of Webvan, the California-based grocery delivery service that badly misjudged the economics of what was then an entirely new sales channel and in July 2001 became a symbol of the US dot-com bust.
Over the coming months, online grocers around the world have an opportunity to banish the ghost of Webvan by tackling the financial weaknesses that still permeate the channel it helped to pioneer. Executive teams can draw on a range of actions spanning their value proposition, their revenue model and their operations.
Postponing this already long-delayed e-commerce overhaul isn’t an option, however. Many of the consumers who tried online grocery for the first time out of necessity during the pandemic will stick with it out of preference in calmer times. Those companies that can find a way to offer them a differentiated service and manage to be profitable are likely to thrive in the post-Covid world.
The global Covid-19 pandemic has extracted a terrible human toll and spurred sweeping changes in the world economy. Across industries, executives have begun reassessing their strategies and repositioning their companies to thrive now and in the world beyond coronavirus.