The Supply Chain Matters blog features an updated commentary focused on U.S. grocery and food retailer Kroger, and this retailer’s efforts to transform itself into various forms of online and in-store digital experiences.

This retailer is arguably one of the largest U.S. grocery retailers with over $120 billion in annual sales. The firm’s business model has been anchored on garnering more intimacy with customers and at the same time, providing a broader assortment of privately branded food products that provide consumer value at lower cost. By some accounts, private branded food products  have been outpacing national brands by upwards of 40 percent. They also provide significant higher margins for retailers.  Ocado  robots

In a May 2018 blog, we initially highlighted the chain’s bold strategic investment in United Kingdom based robotics technology provider Ocado. Kroger invested upwards of $247 million, equating to a 6 percent stake in the U.K. firm, in order to license and deploy Ocado’s unique robotics-based automated warehouse technology to process online orders. The announcement was timely in that throughout 2019, the growth of online retail has been more closely linked to consumer desires to order groceries online. Amazon’s acquisition and now assimilation of natural foods chain Whole Foods coupled with Walmart and Target’s aggressive investing in online grocery have collectively added to the new competitive industry landscape.

In November, Kroger announced plans for its latest Ocado automated warehouse. The facility will serve customers in Wisconsin, Northern Illinois and Northwest Indiana.

 

Financial Performance

This week, the grocery retailer reported third quarter 2019 financial results which from our lens, provide a perspective on the many different financial, merchandising and technology business factors that need to be balanced in today’s retail industry.

While modern technology is deployed and introduced over multiple quarters, external competitive dynamics and internal business needs crimp performance. The challenge is in balancing forces while finding means in accelerating the moves toward end-state transformational needs. Some food retailers have elected to fulfil online orders directly in-store vs. an automated warehouse. Kroeger

Headlines of the latest quarterly financial performance included healthy same-store sales growth, but profitability hampered by ongoing investments, among other business factors. The retailer reported its fifth consecutive quarterly profit decline in spite of a 2.5 percent increase in same-store sales, excluding fuel sales. The retailer’s branded sales were up 3.4 percent year-over-year. Gross margin was reported as 22.1 percent of sales in the quarter.

Digital based sales reportedly increased 21 percent in the quarter, reflecting a slower pace from the year earlier period.

In addition to the deployment of 20 Ocado automated warehouses over a three-year period, the retailer launched its “Restock Koger” initiative, an additional bold effort to renovate existing stores while wringing out excess costs. This initiative is parallel with an initiative to achieve $1 billion in overall cost savings per year starting in 2018. Thus far, the retailer remains on-track to deliver such initiatives. Operating expenses were reduced by 15 basis points during the quarter, and primarily attributed to the Restock Kroger program.

What apparently has bogged down profitability growth have been write-downs of certain other business investments such as a $238 million write-down of a Lucky’s Market natural grocer investment that occurred three years ago. Other challenges related to the retailer’s pharmacy business also contributed to drive additional write-downs.

Strategic Perspectives

In the latest briefing to investors and equity analysts, CEO William McMullen commented on the continued strategic moves to digital:

Digitally engaged customers not only drive growth through our digital modalities, they also help drive brick-and-mortar sales growth as well and share of wallet. So seamless is a both, not an either/or.

That statement is insightful, one that some industry players continue to struggle with, namely that digital and physical in-store experiences or any retail brand need to reside under a common umbrella of systems and business process capabilities.

McMullen went on to note:

We continue to invest in digital platforms as this is where the customers are increasingly going to meet many of their needs. Providing our customers with the ability to have anything, anytime, anywhere from Kroger sets us apart from a large segment of our competitors and will drive loyalty as well as our long-term growth and margin expansion.

To reinforce the above, the financial performance release indicates that the retailer has now expanded to over online 1900 pick-up and over 2300 delivery locations covering 96 percent of Kroger households.

Regarding margin outlook, McMullen noted:

What’s so exciting about Ocado is their model to deliver to the customer is significantly less costly than our existing model and any of the other models we’ve examined as well. Not only will these facilities accelerate our ability to provide customers with a seamless experience, they will also help us to do it in a much more cost-effective way. We know Ocado’s value is not just its current capabilities but also how quickly the company is able to innovate to serve a rapidly developing online consumer market.”

With such statements, it might occur to readers as it did to this Editor, why the extended transition toward online digital?

By our lens, the challenge seems twofold.

First, Ocado’s technology related to robotics and facility layout apparently takes considerable time to deploy, which raises the question of whether 20 automated warehouses over three years is realistic, perhaps too aggressive. CEO McMullen hinted to analysts that the company has acquired added learning, and so has Ocado, the latter now coming up with smaller footprint micro warehouses.

The retailer has had to cutback on its original physical stores revamping out of concern for too much business disruption. We also noticed $80 million in charges for employee severance, which appears to be a sign of workforce reskilling. Praise to Kroeger for at least maintaining an average annual wage of $20 per hour.

The other complicating factor is shorter-term stockholder return. The retailer announced that after a long-term debt reduction, it will initiate a share repurchases in the fourth quarter under a $1 billion authorization. Apparently, shareholders do not have the patience to wait out an overall transformation. Recall that Amazon ignored that challenge by telling investors to be more patient, ample returns would follow.

 

Final Thoughts

Indeed, Kroeger’s strategic digital transformation goals initiated in 2018 were bold and visionary, especially since they involve an automated warehouse vs. in-store customer fulfillment capability. There will always be complicating business factors along the way, as well as learnings. What stands out, not only in the case of Kroger, but other firms as-well is that patience and stewardship of board members and stockholders, especially when executive performance is pegged to shorter-term shareholder value.

The upcoming final quarter of 2019, a quarter that has full emphasis on holiday gift giving as well as holiday parties will serve as the visible test of online grocery fulfillment models. Digital maturity may well be an important factor.

Stay tuned.

 

Bob Ferrari

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