From Farm to Phone: A Paradigm Shift in Grocery

In the blink of an eye, millennials, moms, and grandparents alike have abandoned the decades-old practice of wandering dusty grocery aisles for the convenient and novel use of online grocery. While Instacart, Amazon Fresh, and others have been offering an alternative to brick and mortar grocery for years, it is the global pandemic that has classified them as essential businesses and more than ever afforded them a clear competitive advantage.

But these past couple months have seen not only drastic changes in consumer behavior, but also fundamental shifts in the business models adopted by grocers worldwide. These shifts are not temporary -- indeed, they are here to stay, corona-catalyzed and permanent. 

Fulfillment innovation can drive efficiency and cost savings  

For the consumer, online grocery generally starts and ends the same way: They place their order on an app or website, and hours later it shows up at their door. But the ways those orders are being fulfilled run the gamut.

The most widely known approach comes from Instacart, which relies on hundreds of thousands of human shoppers fulfilling customers’ online grocery orders by shopping side-by-side with regular brick and mortar customers. The model clearly works for Instacart, which is valued at nearly $14 billion after its latest raise. 

However, this model is far from ideal. Even pre-COVID, shoppers were known to crowd out regular customers, not to mention introduce high delivery costs and the element of human error to the fulfillment process. 

One obvious solution has become the central fulfillment center, or CFC. CFCs are large, standalone warehouses -- often serving distinct geographies -- that can supply both brick and mortar stores and online grocery deliveries. As order volumes rise and consumers demand faster and faster delivery times, innovation has already been infused into the CFC model.

Some grocers, notably Kroger, believe that introducing robotic automation into CFCs via solutions such as Ocado can create economies of scale for fulfillment. These CFCs deploy fulfillment robots, controlled by air-traffic control tech, that run along a grid system and move goods via categorized crates. Kroger is continuing its investment in the model, recently announcing 3 new Ocado-automated CFCs in the West, Pacific Northwest, and Great Lakes regions of the United States. The smallest location is over 150K square feet. 

While Kroger remains uniquely attached to the CFC model, Safeway, Albertsons, Walmart, and many others, prefer the micro-fulfillment center (MFC). MFCs, typically far smaller in size (think ~10K square feet), are automated warehouses carved out of the back of existing stores that drive faster fulfillment times in a smaller geographic area, allowing chain stores to use their numerous geographic locations to act as effective fulfillment/delivery hubs for e-grocery coverage.

Source: Takeoff Technologies / Prof. Timothy Laseter (Darden School of Business)

MFCs are all the rage in bricks & mortar right now and the market for them is expected to quadruple in the next 2 years ($26B to $113B). MFCs are a low-cost fulfillment and delivery front, avoiding both the labor costs of crowdsourced shopping and the shipping costs of distant central fulfillment centers. Thus, when compared to other types of fulfillment (traditional, crowdsourced, CFCs), MFCs have markedly lower overall costs. MFC providers claim to be the only gross margin positive option for e-grocery. 

The vast, 1,000-robot Ocado CFC (source) vs. the compact, integrated Takeoff MFC (source) 

Thus, it comes at no surprise that a host of MFC providers have sprung up, with each striking major grocer partnerships -- Takeoff Technologies with Albertsons, Alert Innovation with Walmart, Dematic with Amazon, and more. While MFCs average around $5 million to build out (Takeoff’s is $4 million), CFCs are 10x the cost (Ocado’s is $55 million). Thus, MFCs are quicker to set up and reach profitability in less than ¼ of the time than their CFC counterparts (Jefferies Group). 

All about darkstores

Of course, MFCs still require a somewhat costly transformation of existing brick & mortar space particularly as grocers are forced to adapt at lightning speeds to changes in consumer demand. Now, enter the darkstore - which will increasingly become a core link in e-grocery supply chains.

Darkstores are exactly what they sound like -- local stores that are closed to regular shoppers, instead using their space and inventory to exclusively serve online grocery orders. While early darkstores have simply used existing brick & mortar square footage -- Whole Foods converting its Manhattan Bryant Park location to focus on Amazon Prime grocery deliveries -- future darkstores are not limited to existing locations or even grocery. Darkstore is one such company that capitalizes on under-utilized real estate throughout malls, storage facilities, and urban areas, using the spaces as third-party fulfillment centers to the likes of Nike and Tuft & Needle. Particularly in a post-pandemic world where real estate vacancies will be unfortunately commonplace, opportunities abound for darkstores to put the real estate to good use. 

Darkstores allow the ugly strip malls of the 90’s to be refashioned as logistics hubs for speedy delivery. Getir, which recently raised $25 million from Sequoia’s Michael Moritz, converts underutilized real estate throughout Istanbul and other core cities to enable an average fulfillment time of 10 minutes. Samokat has adopted a similar strategy in Russia, promising over 3,000 SKUs and an under 45 minute delivery time fulfilled via their urban darkstores. Domestic players should look to the model of these international pioneers as a key to unlocking low-cost e-commerce fulfillment. 

The most profitable option

For traditional brick and mortar grocers, e-grocery can be a meaningful revenue driver. In February 2020, Dr. Robert Kulick (NERA Economic Consulting) conducted a study examining the impact of Instacart on top-line growth for various grocers. He concluded that Instacart’s entry into metropolitan areas increased the overall industry revenue of retail grocers, estimating an incremental increase in 2019 of over $300 million for cities in California and over $150 million for cities in New York. An Incisiv/AT&T study echoed similar findings of top-line growth, additionally confirming that most of this growth is “net-new” and any cannibalization of brick and mortar sales is minimal. 

However, examining the margins tells a slightly less rosy story. The same AT&T study revealed that while online grocery has increased topline numbers, both overall profit margins and profit per order have shrunk, except, that is, for grocers shipping from distribution centers. Thus, it is clear that the adoption of automated fulfillment centers, ideally micro-fulfillment centers (MFCs), is the most profitable path forward for brick and mortar grocers hoping to expand into online.

The digital transition has vastly improved customer experience

The sudden influx of online grocery customers has given rise to “digital-only” grocery brands, and a host of customer engagement strategies previously unavailable to brick and mortar-only  grocers.

The rise of digital-only, ethnic-focused grocers such as Weee! (East Asian) and Subziwalla (South Asian) have quickly become the darlings of customers who have long frequented a variety of ethnic brick and mortar stores. These platforms have been quick to expand their product offerings, partner with local restaurants, and meet customer demand even in the unpredictable world. Weee! raised an almost $50 million Series B in March 2020 to fuel its hyper-growth and geographic expansion.

The mass shift to online grocery will also unlock vast amounts of untapped customer data that can enable hyper-personalization. Platforms such as Constructor, using natural language processing to deliver personalized e-commerce search results and analytics/insights to grocers, can be leveraged to introduce an unlimited number of new products or product combinations to customers that would be impossible in the rigid environment of store shelves and aisles (Disclosure: I am an Investor in Constructor).

This pandemic has created new opportunities for grocery consumers, retailers, and technology providers alike, opening up an evolving, exciting landscape for all to shape. 

Why grocery technology matters

Grocery margins will always be razor thin, and the difference between a profitable and unprofitable grocer is often just cents on the dollar. Thus, as the adoption of e-grocery becomes more commonplace, retailers must not only optimize their fulfillment operations (i.e. MFCs), but also the logistics of delivery to a customer’s doorstep to ensure speed and quality (i.e. darkstores). 

Players are rapidly differentiating themselves in this competitive landscape by investing in capex to enable near instant delivery. Leveraging automation (MFCs) or real estate (darkstores) are great starts to improving margins and the customer experience, but grocers still have a long way to go before they can fully embrace e-grocery and bid adieu to brick and mortar. 

This article originally appeared in Techcrunch on July 20th, 2020 and was co-authored by Signia's Kevin Wu