State of Digital Grocery: Growth at the Cost of Profitability

This is a summary of the key findings of the report. The full report can be downloaded here.

Digital is the Primary Driver of Growth

Historically, growth in grocery retailing is glacial. On average, sales growth is 2.7% year over year. In fact, in the last three decades, sales have grown more than 5% (y-o-y) only once (2011). In 2020, sales more than tripled average annual growth to 9.5%! The main driver of this growth was the rise in digital sales, which were up more than 5x over 2019.

As has been well documented, digital’s unexpected growth came by way of a global pandemic that effectively shut down the world. People still needed groceries and other essentials, but with lockdowns and ‘shelter in place’ orders, the only way to shop was online. This drove digital adoption by new shoppers, increased online basket sizes and forced grocery retailers to rapidly adopt and scale new capabilities (e.g third-party partnerships, curbside delivery, etc.).

This growth, however, has come at the cost of profitability. With digital projected to rise to 20% of overall sales by 2025, grocers will need to focus their attention on improving their digital execution.

Execution Challenges

Profitability of Digital Orders is Way Below Average

The surge in online orders (volumes and average basket size) has failed to translate into profits for most grocery retailers, especially those below a billion dollars in revenue. It's no surprise that 86% of grocery retailers are dissatisfied with the profitability of their online business. The average gross margin for digital orders was just 9% in 2020, and many grocers lost money on their online orders.

This is unsustainable to a grocer's business model. If the current sales and profitability trends continue, grocery retailers will lose $14 million in gross margin for every billion dollars of sales in 2025.

Grocery retailers need to sharpen their focus on their operational levers (e.g picking efficiency, labor utilization), technology platform (e.g inventory visibility, optimization) and partner relationships to plug this profit leak.

Third-Party Platforms Have Driven Growth…

Third-party platforms have provided an easy growth opportunity for grocery retailers, and 46% of all online sales came through third-party platforms in 2020. It's critical for grocery retailers to understand this importance for two reasons.

First, in less than a year, third-party platforms transacted almost as much business as grocers did on their own. In addition, these platforms are growing at a much faster rate than the direct to commerce business of grocery retailers.

Second, grocery retailers are so reliant on these platforms that over 2/3 (66%) believe they can't scale their online business without them. Smaller retailers (less than $1 billion) have a greater dependence on these platforms, and only 1 in 4 believe they can scale their digital business without them. However, this dependence is increasingly viewed as a business risk as grocery retailers try to chart a path to online profitability.

But Grocers Struggle With Third-Party Platforms

There is growing discomfort with third-party platforms for a variety of reasons. 81% of grocery retailers believe that they will become their direct competitors in the future. 84% of grocery retailers believe they will lose touch with their customer base as third-party platforms become the front-end commerce brand and, in effect, disintermediate them from their shoppers.

While the risk is evident, third-party platforms are here to stay. Larger retailers (more than $1 billion) are focused on reducing their dependence on third-party platforms and project that by 2025 only 20% of their online orders will be delivered through third-party platforms.

However, smaller retailers will need to develop strategies to work with third-party platforms more efficiently in order to improve margins.

Digital Operations are Inefficient

Prior to 2020, digital operations of grocery retailers were very immature compared to other retail segments. A 5x surge in demand and the addition of new fulfillment methods (e.g., curbside) in 2020 has pushed them to their breaking point.

Fortunately, this growth exposed inefficiencies in execution that lie at the core of improving profitability -knowing where the product is (inventory visibility), picking it efficiently (order picking efficiency), and sending it cheaply (last-mile delivery).

Amongst these, order picking efficiency is top of mind as 92% of grocery retailers are dissatisfied with their order picking efficiency. Over the next 24 months, we will see grocery retailers experiment with capabilities like micro-fulfillment centers, automated picking solutions, and labor models to bring down the fulfillment costs.

Grocers Must Upgrade Their Technology to Stay Competitive

Grocers have a significant technology gap to overcome as they try to reduce their dependence on third-party platforms and improve their operational efficiencies. They also need to upgrade their technology platforms at a much faster pace (1 in 3 large grocery retailers rate it as a top 3 business challenge) than before.

While grocery retailers believe that new technologies like Robotics and autonomous vehicles will have a disruptive impact on their business, their investment focus is on technologies that can drive a clear, established business outcome (e.g., inventory visibility, mobile picking). The only 'new' technology that will gain traction over the next 24 months is micro-fulfillment. Grocery retailers expect 3.6% of all their online orders to be fulfilled from micro fulfillment centers by 2025.

Growth Without Profits is Unsustainable

Grocery retailing is difficult. It's a complex business with low growth and meager margins. The rapid digital growth of 2020 may have been tremendous for revenue (+9.5%), but retailers lost margin on online orders (-70%) and became a degree removed from their shoppers.

There is no going back to pre-pandemic shopping patterns. The shopper journey and expectations have been fundamentally altered, and digital will be 20%+ of overall sales by 2025. If the trend lines continue, grocery retailers will lose $14 million in margin for every $1 Bn of revenue. It's no surprise the #1 challenge facing grocery retailers is the profitability of their online business.

The path to profitability is clear, if not easy.

Grocery retailers need to improve their operational efficiencies by fundamentally re-imagining their processes (e.g., labor utilization, picking, delivery) and the underlying technologies (e.g., micro-fulfillment) supporting them. They also need to take control of their digital commerce and digital experience. It is the best hedge against being disintermediated by third-party platforms. Owning the brand experience and getting access to shopper data is the main revenue lever needed to improve basket economics.

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