A recent 25-year deal between supermarket chain Morrison (Wm) Supermarkets and online grocer Ocado Group PLC (LON:OCDO) offers a glimpse of how this area of the grocery business is attracting more and more customers looking for a more convenient way of shopping.
According to Reuters, after the deal was announced, shares of both companies responded positively on the London Stock Exchange — Morrison’s stock rose 2% and Ocado Group PLC (LON:OCDO)’s shares rose 47%. The deal helps Morrison tap into the online grocery market, an area that rivals like Tesco Corporation (USA) (NASDAQ:TESO) and J Sainsbury plc (LON:SBRY) are succeeding in.
Tesco’s business model
Tesco’s online shopping service began in 1997 and has grown to about $3.03 billion in annual sales. The company’s success in the U.K. market prompted it to launch online grocery shopping in South Korea, Ireland, and the Czech Republic. Tesco Corporation (USA) (NASDAQ:TESO)’s model offers the customer flexibility with its “Click & Collect” service that allows orders to be placed online and picked up at a local store.
Click & Collect for grocery items is currently available in 45 stores and the number is expected to increase. Tesco Corporation (USA) (NASDAQ:TESO) also uses uses four centralized “dotcom-only stores” that fulfill over 80% of London orders when demand is high. According to the company’s website, one of Tesco Corporation (USA) (NASDAQ:TESO)’s key performance indicators for 2012 showed an increase of 10% in U.K. online sales; grocery is considered the largest of their online businesses, and it “accelerated its already strong growth through the year.” Tesco Corporation (USA) (NASDAQ:TESO) plans to grow its online business in all markets and provide customers with multiple channels that enable them to shop at a store or via computer or mobile device.
J. Sainsbury’s success story
Another British grocer is J Sainsbury plc (LON:SBRY), currently ranked second in online grocery sales and considered the fastest growing online grocer in the U.K. Sainsbury’s grocery business is rapidly growing with annual sales rising 20% and weekly orders that surpassed 165,000 during 2012.
According to the company’s website, its online grocery orders generate nearly $1.2 billion in sales and the online business is considered a major part of the company’s growth strategy. J Sainsbury plc (LON:SBRY) finds the multi-channel strategy to be a profitable one because customers that shop both in-store and online spend more than customers who only shop in-store.
Deal promising for Morrison and Ocado
According to Reuters, Morrison had some misgivings on the profitability of the business deal due to the fact that Ocado has been in business for ten years and has yet to earn a profit. According to Reuters, skeptics believe that Ocado’s business model of filling orders from a central distribution center won’t be as profitable as Tesco’s or J Sainsbury plc (LON:SBRY)’s.
Ocado Group PLC (LON:OCDO)’s 2012 annual report showed rising gross sales, by almost 12% over 2011, dragged down by high cost of sales, high distribution expenses, and increasing administrative expenses. The deal with Morrison may prove to be beneficial as the company seeks to validate its business model. In a company press release, CEO Tim Steiner stated “we see Morrison’s decision to adopt our model to drive its online launch as a further endorsement of our technological and logistical excellence.”
According to Reuters, with this deal, Morrison is investing $306 million in the online grocery business, which is growing at about 16% a year and, in the U.K., is expected to double in the next five years to about $17 billion. Analysts at Credit Suisse estimate that Morrison’s initial payment should generate about $759 million in online sales. In addition to the initial $306 million payment, Morrison will pay Ocado annual service costs, a contribution for R&D expenses, and 25% of its annual earnings before interest and tax for 15 years.
Conclusion
With the popularity of online grocery shopping in the U.K. on the rise, it makes sense for Morrison to enter this market and compete for online shoppers along with Tesco Corporation (USA) (NASDAQ:TESO) and J Sainsbury plc (LON:SBRY). Both Ocado and Morrison can benefit from their arrangement. The rise in their share prices upon announcement of the deal shows that investors agree and believe this collaboration could be rewarding for both companies.
The article U.K. Grocers Take Their Business Online originally appeared on Fool.com and is written by Eileen Rojas.
Eileen Rojas has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Eileen is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
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