The online grocer has had detractors ever since launch, but boss Tim Steiner is still confident he’s seen the future of retail.

Ocado remains at the centre of one of the great debates in retail – how much money can be made from online grocery generally and, in particular, from the Hatfield-based pure-play’s model?

Ocado has divided opinion ever since it launched in 2000. On one side of the fence stands chief executive Tim Steiner with an army of cash-rich, time‑poor families as customers who love the convenience and range Ocado offers.

On the other side lie those such as Sainsbury’s boss Justin King who, despite running an £800m online operation, remains sceptical about the likely size of the online grocery market in 10 years’ time.

Steiner came out fighting last week as Ocado reported a modest pre-tax profit, tearing into his rivals. He is sure the trend to online shopping will continue and tells Retail Week: “What is clear is that in every category outside grocery we have seen a channel shift to the internet. That has meant a very vicious cycle of decline for store operators – we have seen people failing and closing stores.

And he is confident that the Ocado model has advantages over his food competitors. He argues that the £100 average online basket spend at rival Tesco comes at a cost of £15 to £20 to the retailer which, combined with a decline in sales densities at its larger stores, is having a big impact.

“They are cannibalising sales,” Steiner argues. “They are just moving shoppers from stores to online and that makes it easier for us to acquire those customers. We would be delighted if Tesco, Asda and Morrisons brought all their customers online – we would be a £16.5bn retailer.”

A slowdown in Ocado’s sales growth to 12% in the first half, against Sainsbury’s reported 20% online growth in its first quarter, was not well received by the City.

However, Steiner believes that Ocado is still gaining market share. He says: “The important thing to remember is that Sainsbury’s sales per sq ft is shrinking. The only person who claims to be growing faster is Sainsbury’s, but they have not put out audited numbers.” Steiner then accused Sainsbury’s of “bragging”.

But Sainsbury’s hit back. A spokeswoman says: “We were surprised by these comments, as our online grocery delivery numbers are all verified by external auditors. Then again it hasn’t been easy for Ocado lately, so they’re in a tough spot.”

Steiner, a fiercely proud entrepreneur ranked 23 in this year’s Retail Week Power List, defends Ocado to the hilt and, whichever side of the debate retailers and industry observers take, its model remains a key talking point.

In numbers

£14.9m EBITDA (up 4.5%)

£71.3m Net debt

£181,000 Pre-tax profit

122,000 Average orders per week

(24 weeks to May 13)

Supermarket to hypermarket

Ocado is entering a significant 12 months, opening a new warehouse and moving, in Steiner’s words, “from supermarket to hypermarket”.

Its expansion strategy into general merchandise became clearer last week when Ocado said it would spend £5m on fitting out a non-food warehouse as a prelude to launching a host of dedicated non-food sites in categories such as pets, baby, health and beauty and home and garden starting in the first half of Next year.

The retailer poached Simon Belsham from Tesco last year to head its non-food operation and hopes to offer the depth of range expected in specialist stores. Ocado has already increased its range of non-food products by 2,000 lines this year and that will rise by about 5,000 products by the end of the year.

Oriel Securities analyst Jonathan Pritchard says: “Ocado’s branch into non-food is, in part, a response to the fact that basket sizes are getting smaller in the grocery market – it’s well established that frequency of shop is up and size is down. It’s sensible to try to preserve basket size. Branching into specialist websites is a perfectly good idea, but it takes a long time to establish a brand in non-food that’s naturally associated with food.”

Capacity concerns

Meanwhile, the opening of Ocado’s second customer fulfilment centre in Warwickshire in the first quarter of 2013 will present its biggest challenge and opportunity yet.

Ocado has complained of capacity constraints at its Hatfield base – resulting in a profit warning last December – and a trip around the giant mechanised warehouse reveals every inch of space is used. But the question is, will Ocado gain the new customers that the extra capacity demands?

The perception that Ocado is a Southeast-only business has already been partly dispelled with the opening of several new ‘spokes’ – small distribution centres as opposed to the Hatfield hub – which have extended its reach across the UK, including into Scotland. Therefore, a concerted marketing drive may achieve the requisite custom for the new centre.

And Ocado remains at the forefront of the market in terms of technology. A team of 300 IT experts beaver away at Hatfield using all sorts of technology including gaming software to work out the optimum route for baskets and how to create operational efficiencies.

The grocer has relaunched its home page in the past three weeks to improve navigation. Steiner said some smaller product categories, which are now easier to find, have achieved a 40% to 50% sales uplift since the revamp.

Brand loyalty

But Tesco and Waitrose aim to muscle in on one of Ocado’s key USPs – delivery loyalty. Ocado allows customers to book a certain weekly slot, receive a text to within 10 minutes of delivery time and, importantly, rewards customers who invest in its Delivery Pass with reduced fees.

Last month, however, Tesco introduced unlimited deliveries for a one-off £10 charge while Waitrose offers free delivery on purchases more than £50. It is clear that attempts are being made to take the shine off Ocado’s offer.

But the elephant in the room in discussions over Ocado’s future is its partnership with Waitrose.

Originally set up as a distributor of the upmarket grocer’s product, Ocado has subsequently worked to establish its own label. That is to “fill the gaps”when its partner has too high a price point, Steiner says, but many industry observers have always believed that without the Waitrose connection, Ocado’s appeal would be much diminished and they are concerned that Waitrose is developing its own online business.

Analysts point to Waitrose’s break-clause in its Ocado contract in 2017 as a cause for concern. Ocado has also been open in building up its own profile and that of its product, despite claiming the Waitrose partnership is strong.

Aside from the debate over Ocado’s model, the etailer cannot ignore the wider market conditions.

The grocer has long offered deals on customers’ first spend, and the frequency of its marketing has stepped up markedly while Tesco, Asda and Morrisons have all been tempting shoppers with blanket money-off coupons.

Steiner says: “Nobody is getting the sales that they wanted to do 12 months ago. The market has shrunk. It has become more aggressive in terms of couponing.”

Logistic uncertainties

There are other concerns. Steiner said last week that the third quarter is hard to forecast following logistical problems caused by the Jubilee celebrations in London. He said: “There is uncertainty as to the effect of the forthcoming Olympic Games.” 

Unlike its rivals, Ocado has no store network to fall back on. If the Olympics plays havoc with deliveries to its crucial Greater London core customer base, some industry observers fear a profit warning could be on the cards. If that happened, a low share price may encourage predators to take another look at Ocado and potentially pick the business up for a bargain price. The very fact that Ocado is talked about as an acquisition target shows that, whatever its critics may say, value can be seen in its infrastructure as well as its business.

There may be some tough months ahead as one-off events such as the Olympics take a toll, but Steiner is confident in the Ocado model. Despite the critics, he remains convinced that he has seen the future of retail – and it works.

Is Ocado on the right track?

Andrew Wade

Andrew Wade

YES: Andrew Wade, analyst, joint house broker Numis

“There is a channel shift towards online retail and Ocado is well-positioned. It has the best service, biggest range, more delivery slots and importantly the best technology. It is leading the way in range and freshness as it has fewer days in the supply chain by not picking from stores. The accuracy rate is a lot higher than Tesco.

“The biggest moment in life is having kids and Ocado is perfectly positioned to take advantage of that change.

“New parents plan out meals and that doesn’t change for 15 to 20 years while they grow. Family size is the biggest driver of Ocado’s spending, rather than income.

“An acquisition [of Ocado] would make sense for someone looking to branch into food. Amazon appears most likely as it’s independent from the grocery market and it allows it to use an existing brand.

“Ocado would lose customers if Morrisons acquired it. Ocado is synonymous with online grocery. The question is can it ratchet up demand as capacity increases?”

Philip Dorgan

Philip Dorgan

NO: Philip Dorgan, analyst, Panmure Gordon

“Ocado is losing market share online and the competitive environment is likely to get tougher. Asda published its first quarter sales numbers recently and we estimate that online food grew by more than 20%. Sainsbury’s online food business is growing at 20%; Tesco’s at about 12% and Waitrose.com increased sales by 46% in its recent weekly figures.

“Ocado is losing market share. Why is this? We think that it is because its competitors have sharpened up their act; delivery windows are narrowing, product quality is improving and substitutions are decreasing, or getting better. We don’t expect that these trends will reverse. With click-and-collect being rolled out by Tesco, others will surely follow. This popular shopping method cannot be replicated by Ocado. We therefore believe that Ocado will continue to struggle to make money.

“We don’t buy the bull argument, which is centred around the removal of capacity constraints and the lack of incremental cost increases thereafter. We don’t think that Ocado is special.”