Kroger will soon confirm micro-fulfillment partner for grocery delivery challenge
Since 2017, when Kroger launched Restock, the grocer has quadrupled its digital sales, introduced new revenue streams and partnerships with a wide range of companies, and implemented efficiency steps like automation and SKU rationalization that have shaved around $1 billion off its balance sheet annually.
In an investor update Tuesday morning — held in place of the company's regular investor day, which has shifted to next spring — Kroger CEO Rodney McMullen said the company's three-year Restock strategy focused on cost savings, digital growth and alternative profit streams has positioned it well during the pandemic and will drive further growth in the future.
“We would expect Ocado to be an important partner in micro-fulfillment. And obviously one of the keys is getting the economics to work, and a lot of the models that are out there today really don’t have the right level of SKU offerings, and they’re incredibly expensive to operate.”
The strategy resulted in a digital footprint that was able to capitalize on the massive consumer shift to online buying earlier this year, with its pickup program in particular drawing in droves of new shoppers. Waiving the $5 fee for that program helped bring in customers, McMullen said, while the company’s personalized offers and other promotions, which didn’t pull back at any point during the pandemic, helped secure loyalty and build larger baskets.
Although Kroger's comparable store sales have lagged fellow national competitor Albertsons in recent quarters, it's still achieving sales growth well above average and is currently seeing comps in the low double digits for the third quarter.
“We're having the strongest market share growth that we've had in 10 years,” he said, noting that Kroger stores are now No. 1 and 2 in market share in 90% of operating markets.
McMullen, along with Chief Financial Officer Gary Millerchip, reaffirmed Kroger’s guidance for fiscal 2020, which includes comps below 13% and earnings per share between $3.20 and $3.30. They also noted they expect sales in 2021 to perform better than the company expected due mainly to structural shifts in shopping and eating habits centered on at-home consumption.
The executives reiterated their vision for a future where the company is "indifferent" to which channel consumers shop, but analysts on the call pressed for more information on how the company will close the margin gap between digital and in-store.
Noting digital profitability is one of the most frequent topics investors raise, Millerchip said Kroger’s incremental margin rate for digital sales is positive — currently in the "mid single digits" — but lower due to labor costs than the in-store rate, which is typically over 15%. The grocer has improved that metric for digital this year by introducing various productivity measures. Without noting specifics, he said the company’s pickup-only store in Cincinnati, which opened in March and remains dark, serves as a learning lab for the company.
“By applying learnings from this facility, we have achieved meaningful reduction in the cost to fulfill a digital order,” he said. “And we are in the process of implementing additional improvements and technology enhancements that will further reduce costs and improve digital profitability.”
Kroger is owning more of the customer experience and offloading operational assets where necessary. In response to a question about the company’s relationship with Instacart, Millerchip said Kroger currently sees more orders coming through its own websites than through Instacart’s marketplace. He said he also has high hopes for its ship-to-home marketplace, which aims to boost customer baskets without requiring additional infrastructure costs for the company.
Millerchip said Kroger’s digital media business, which offers advertising services to more than 1,000 CPGs, is driving profitability and is anticipated to grow more than 100% this year. That revenue has helped offset the waived pickup fee, he said, and Kroger expects its digital media arm to continue to grow in tandem with online shopping.
“Our ability to close the loop and match media exposure to an actual purchase allows us to help our partners improve their return on ad spend,” Millerchip said.
Closing the gap between digital and in-store margin, however, will require Kroger’s tie-up with Ocado to drive long-term efficiencies, as well as demand. Industry observers have expressed skepticism over this initiative, noting that even with the tailwind of the pandemic, overcoming the cost of building and operating 20 large-scale automated warehouses will be steep. Ocado’s legacy next-day service, meanwhile, may not be able to keep up with the growing lineup of same-day delivery options from the likes of Target, Walmart and Amazon.
Asked about this by BMO Capital Markets' Kelly Bania, McMullen, as he has in the past, stressed the “flexibility” of the Ocado partnership and Kroger’s own e-commerce properties, noting that the grocer will rely on store, micro-fulfillment centers (MFCs), small warehouse and large warehouse assets.
“While Kroger has not yet formally introduced MFCs, these will be both automated and non-automated.”
“We would expect Ocado to be an important partner in [micro-fulfillment],” he said. “And obviously one of the keys is getting the economics to work, and a lot of the models that are out there today really don't have the right level of SKU offerings, and they're incredibly expensive to operate.”
“Ocado has piloted Zoom, a same-day delivery service in London powered by micro-fulfillment, while other MFC operators have linked up with U.S. retailers like H-E-B, Ahold Delhaize, Albertsons and Meijer.”
In a note to investors following the call, analysts with R5 Capital noted the drag on profitability that the Ocado partnership entails, while also noting Kroger’s ability to capitalize on demand during the pandemic.
“Through its partnership with Ocado, the company is making a big bet that the centralized fulfillment model will work well in the U.S.,” the note read. “In our view, there are some pluses to what Kroger is doing if consumer expectations are not wedded to short lead time delivery and pick up solutions. Regardless, opening the centers is likely to be a drag on profitability.”
