More than 20 years ago, a startup called Webvan raised more than $800 Million with the promise to revolutionize grocery delivery at the height of the Dot-Com Bubble. We all know how that story ended (spoiler: it went bust). Now, here we are in 2021 and eGrocery is in the spotlight. Is the business model ready for primetime?
Over the last several years, we have seen many players entering the eGrocery market. The vast majority of those aspiring to lead the charge are either incumbent grocers adapting their model or disruptive eCommerce players using their technological infrastructure to lower costs and modernized apps to acquire new customers.
“For 2020, online grocery’s percentage of the $1.04 trillion grocery market is pegged at 10.2%, or about $106 billion … By 2025, online grocery’s dollar share stands to climb to $250.26 billion of the estimated $1.16 trillion overall grocery market.”
Supermarket News
Pureplay ‘eGrocers,’ or those who are 100% online with no physical outlets, are having their moment in the sun thanks to the acceleration of the eGrocery shift brought on by the pandemic. Similar to the ‘Challenger Banks’ in the Fintech world, these eGrocers are trying to disrupt the core model of grocery itself by removing the storefront.
That’s about as far as the similarities go, however, as delivering mangoes versus moving money are two vastly different business models.
So while traction and growth are one thing, as we have seen with the Food Delivery Apps (who continue to lose $Billions years after year), profitability is another. That’s why we are going to dig into the business model of eGrocers and better understand the mechanics behind the business model innovation.
How does the Grocery Delivery Business Model work?
At its core, grocery is a low-margin/high-volume business.
Grocery retailing is fundamentally a low margin business. Depending on the format or how developed the market is, EBITDA margins generally range from 4 to 8% and EBIT runs between 2 and 5% of net sales.
Foley Retail Consulting
Pureplay eGrocers don’t necessarily fare much better on a margin basis (depending on which company you analyze and where) generally, as the lease/storefront costs get redistributed into other areas of the business (technology, distribution costs).
The main point is that ‘going digital’ with the business model doesn’t suddenly make grocery a higher-margin business.
Profitability of the model will depend what mix of products an eGrocer decides to sell (based on margins), how they merchandise those goods, what discount models are applied (ie. via subscription or reward points) and several other factors. What consumers buy will also shift significantly from a bricks (physical retail) versus clicks (eCommerce) model.
With a different mix of goods, changing consumers preferences for delivery vs. in-store pickup, and rapid supply-chain innovation, it is a lot of work just to decipher who is doing what in the eGrocery space.
Now that the pandemic has rapidly accelerated consumer demand , we are starting to see the rise of the disruptors emerge in the eGrocery space. More than 20 years on from WebVan debacle, the question is whether or not consumer demand is the missing ingredient combined with a dash of Business Model Innovation?
What is the Business Model Innovation in Grocery Delivery?
As we have seen above, there are many different players in the space who are pushing the limits of innovation to try and become one of the dominant players in the new grocery industry. Recently, we have seen big deals to illustrate how hot this market is becoming, for example:
“On-demand grocery delivery platform Instacart has raised a $265 million … pushes the company’s valuation to $39 billion.”
TechCrunch
We also have seen smaller examples of innovative new companies localizing the supply-chain and re-inventing the distribution through so called ‘dark store’ model where companies hold goods in ‘micro-warehouses’ and ship directly to the consumer.
Examples of smaller deals in the space show how this Business Model Innovation is changing the way the whole grocery model works by cutting out the middleman:
- ”Flink, the Berlin-based grocery delivery startup that operates its own ‘dark stores’, raises $52M“
- Mexican online grocer Jüsto raises $65M “It claims to be the first supermarket in Mexico with no physical store.”
The so-called ‘dark store‘ is similar to what we are seeing in many different industries (ghost kitchens, co-living, etc.) where real-estate is being repurposed to suit these new industrial models. In this case, the dark store enables a new model for on-demand grocery delivery of fresh foods by increasing productivity and repurposing space.
“This will provide major gains in your productivity but that’s balanced against the cap-ex associated with bringing that on,” he said. “The nice part is that cap-ex continues to get more and more attractive as we see more come online.”
Winsight Grocery
In a hyper-growth market like eGrocery right now. this model makes sense; however, the volume will need to continue accelerating into the future for the dark-store model alone to pay off.
That’s why the “disruptors” – who don’t have the burden of legacy IT system or customer relationships – can also work at the supply-chain level to localize distribution, like we are seeing with Mexican-based Jüsto.
The startup only sells items from local suppliers, with whom it prides itself on developing fair trade agreements (“Jüsto” means fair in Spanish). It also uses artificial intelligence to forecast demand and to try to reduce food waste at its micro-fulfillment centers. The company’s approach results in “competitive prices, lower transaction costs, and improved convenience to consumers by eliminating intermediaries in the supply chain,” according to the company.
TechCrunch
The business model innovation here, on the Cost Structure side of the Canvas, can be summarized as follows:
- cut out the middlemen
- use technology to lower logistical costs
- leverage data-science to better match supply & demand
- remove physical infrastructure costs associated with retail
Increased fill rates on orders (ie. less waste) and arrival of fresher products are among two of the consumer benefits of this model.
As we mentioned in the section above, none of these points change the fact that grocery is a low-margin business. The question is whether or not all of these factors working in unison can shift the business model enough to make it profitable for upstart companies to deliver fresh groceries, on-demand and turn a profit.
When you look at the mechanics of the Food Delivery business model, one can be forgiven for being skeptical that the eGrocer model will work long-term for the disruptors. Nonetheless, the business model innovation is notable and worth considering against the models used by incumbents and their partners/acquisitions to preserve their own market share.
Grocery Delivery – Competition
This dark-store/micro-warehouse model is new in this space. Most of the eGrocery competition (Instacart, Shipt, and other global high-flyers) source their grocery/retail products from 3rd party Grocers and Partners, rather than creating their own inventory and fulfilling orders Direct-to-Consumer from their own spaces.
Enter the concept of a “dark store,” a converted supermarket or former supermarket space converted into an e-commerce warehouse. These stores offer no retail—no cash registers or merchandising—but can meet online demand more efficiently than picked stores.
Winsight Grocery
Many of the pureplay business models in the eGrocery space are similar to Food Delivery Apps in terms of structure and pricing. There are:
- delivery/origination Flat Fees for each order that is placed (tiered Delivery Fees + others like ‘Heavy Fee’ if necessary)
- Service Fees typically based on the % of the order
- some type of Membership offering that allows you discounts on the fees based on usage
- Tipping is also becoming a common practice on many of the eGrocery apps, which creates another cost for consumers.
In fact, on the margin, shopping with eGrocers is typically more expensive (on average) for consumers than retail in-store shopping.
In a sense this makes sense, as the service offers convenience and a new experience; however, will consumers sustain their purchasing on these new eGrocers in the middle of a large-scale economic contraction if their bills are consistently higher? We shall see.
Yet shoppers exhibited less price sensitivity as product availability took precedence.
Supermarket News
The following is an example from Instacart’s delivery pricing, where Service Fees generally range from 5 – 10% on the order.
Delivery Fee
Instacart delivery starts at $3.99 for same-day orders over $35. Fees vary for one-hour deliveries, club store deliveries, and deliveries under $35.
Instacart
If you sign up for Instacart Express (starting at $99 for the year or $9.99 if you do it by the month) you’ll get free delivery for orders that are more than $35.
The Kitchn
We can see from our analysis of Uber (Eats) and other Food Delivery Apps, that the pricing structure is very similar for services like Instacart, Shipt and other similar eGrocer models who send ‘personal shoppers’ in to buy from local and national grocery/retail chains on behalf of consumers.
This is why many Food Delivery businesses are expanding their services rapidly into the grocery market.
On the merchant side of the eGrocery model, services like Instacart charge an average Commission as a % markup on the in-store price (average of 15%, but potentially much higher or lower depending on the situation). The way that fee is calculated and how it is determined for specific partner stores vs. other local stores is the subject of much debate.
What we do know is that the net effect for Grocers is margin erosion.
Margin erosion: Instacart charges a five to eight percent platform fee to retailers. Some choose to pass this on as a markup; others absorb it and lose margin.
Retail Wire
On the incumbent side, many mainstream grocers are bundling the eGrocery model into their core model in order to ensure they don’t lose market share to upstart eGrocers. That doesn’t necessarily mean they prefer to have customers shop online only, as we have shown in the analysis above. Their business model is built on volume, but because of their physical presence they run huge costs to maintain high-quality physical spaces and can use those spaces to build strong customer relationships in ways that pureplay eGrocers can’t.
Some examples are a hybrid, like the Whole Foods/Amazon model (Amazon bought Whole Foods in 2017), where they derive elements from each to create new services for their core customers.
BMi – Key Components of the Canvas
These new players (dark-store model) in eGrocery cut out the middlemen by sourcing locally, sell groceries direct to the consumer (and thus no markup from in-app vs. in-store pricing), and hold inventory in their own dark stores/micro-warehouses.
Value Proposition
What unique value does a Grocery Delivery company’s product or service create for customers?
On-demand, fresh, and local grocery service. Lower waste, potential to create better profits for local-market suppliers (compared to other models).
Customer Segments
What group(s) of customers is a Grocery Delivery company targeting with its product or service?
The space is still very young and consumers are experimenting, but generally we would expect mid/high income consumers in large urban areas (as many services are not available in rural markets). As the market expands in the next few years, we will see more defined customer segments emerge.
…. project that online grocery will account for 21.5% of total grocery sales by 2025 – an estimated $250 billion- which is a more than 60% increase over pre-pandemic estimates.
Mercatus
Customer Relationships
How does an eGrocery company plan to build and maintain relationships with the customers it is serving?
Similar to pureplay eCommerce providers, the relationship with consumers is purely digital. In many ways, this is where traditional/hybrid grocers still maintain an advantage.
Customer Channels
What channels does an eGrocery company use to acquire, retain and continuously develop its customers?
Most of the customer engagement is in-app or via online channels (social media, customer support, etc).
Revenue Streams
How is a Grocery Delivery company pulling all of the above elements together to create a revenue stream(s) and generate cashflow?
- dark-store eGrocers charge Delivery Fees, like their competitors
- whether they charge Service Fees is still unclear, as this space is still new and they hold their own grocery inventory
- we assume they make the majority of their revenue on Gross Margin from selling groceries much like a traditional grocer; this is the main difference between these new models and services like Instacart
The above 5 Building Blocks represent the right side of the canvas and contribute to the Revenue side of the business model.
Key Resources
What assets and knowledge does a Grocery Delivery company possess that allow it to deliver its value to customers in ways that other companies can’t?
This model uses technology in many different ways: but fundamentally, they own the relationship with the consumer and they own their own inventory, so the knowledge they build around these assets via data science, etc. will be key in the future.
Key Activities
What activities does a Grocery Delivery company engage in that allow it to execute its strategy and either establish a presence in the market or gain market share?
Right now they are the new/innovative upstarts who are expanding their warehouses rapidly in order to try and meet rapid demand. They are raising large amounts of capital (in some cases debt) to expand, and so their goal is to maintain momentum while impressing new customers with the quality of the service.
Key Partnerships:
What strategic and cooperative partnerships does a Grocery Delivery company form to increase the scalability and efficiency of the business?
This will be an interesting space to watch in the future. The model is so new, but if some of these new eGrocers build strong relationships with local suppliers, this would be an opportunity to forge alliances that will help them take on the Grocery Giants.
Cost Structure:
What are the key costs associated with running a Grocery business and how can key partnerships/resources be leveraged to reduce the cost structure?
Depending on the model, most of the cost base is absorbed either in physical space and the logistics of running that space. New players are investing heavily in technology/innovation in order to try and preserve another 1% in margin. In such a low-margin industry, even a 1 or 2% cost savings in the long-term can make the difference between winning and losing in the massive grocery space.
The remaining 4 Building Blocks come together to form the left side of the canvas, and contribute to the Cost Structure of the business model.
Business Model Analytics
With very little data publicly available, it is necessary to draw some assumptions here. The likely problems they face will probably be similar – although not exactly the same – to the Food Delivery Apps: losing money on a per order basis, lack of loyalty (consumers using multiple apps), and a requirement to constantly compete on margin (race to the bottom) because of how competitive the space is becoming.
One interesting stat is the MAUs (Monthly Active Users) in the US market are ordering 2.8X per month per average on eGrocery services. This helps paint a picture of frequency of use.
In the US market, AOV (Average Order Value) was $95 as of September 2020, up 32% YoY (year over year).
If frequency of ordering and AOV continue to trend up, this bodes well for leaders in the space.
In the Food Delivery space, we have seen ‘promiscuous’ customers using multiple different Food Delivery Apps. A lack of customer loyalty would create big problems long term for eGrocers, so we will need to maintain a close eye on how app usage plays out over time in relation to customer loyalty.
Overall, this is a new and exciting space with lots of competition and a lot of business model innovation, as seen by the new ‘dark-store operators’ and their industry partners. Let’s see consumers respond in key markets to these new offerings, and how traditional retail operators innovate their own models in order to defend their market share.
What is Business Model Innovation?
Innovation using the Business Model as the main mechanism, rather than product or technological innovation. Reinventing a business model – or creating a new one – is a matter of remixing the core components of a business model and developing new value propositions, revenue streams, and cost structures.
Top 3 – Learn More
Strategy & Grocery – Thrive Market + Memberships