The insider's guide to the Jerome Fisher Program at the University of Pennsylvania

Director’s Corner: Why Online Groceries Shouldn’t Put All Their Eggs in One Basket

The below article was originally posted on LinkedIn by M&T Director, Dr. Gad Allon. 

Bloomberg had an interesting article about Amazon and online groceries with several interesting observations about the industry, as well as about Amazon’s efforts.

The first interesting observation is about the slow penetration of online grocery shopping:

“Only 4.5 percent of shoppers made frequent online grocery purchases in 2016, up just slightly from 4.2 percent four years earlier despite big investments from companies such as Amazon, according to the firm’s annual surveys. There’s just not a lot of demand there. The whole premise is that you’re saving people a trip to the store, but people actually like going to the store to buy groceries.”

I do not think people like to shop per-se, but rather people are unwilling to pay for the convenience of having someone else do the logistics for them. I have been teaching a case about Peapod (an early player in the online grocery market) for many years, and one of the things Peapod learned is that people are extremely price sensitive for activities they perceive as “essential”, like buying groceries, hunting or gathering food for their kids. It’s not that people are unwilling to pay at all, but people want to save money and are expecting an extremely convenient service, or else.

Inconvenience has several dimensions, but one way to see it is through the lens of basket abandonments, which is fairly high in online grocery shopping. Shopping online for groceries is vastly different than shopping for, say, a shirt or a book online. The two main issues are the fact that an online grocery basket contains usually many items, and the brick and mortar option, the local supermarket, is fairly convenient and familiar. The combination of these two means that for many people, if even one or two items are not available online, they will have to go to the local store, in which case, since the majority of the friction is the actual trip, they might as well abandon the entire basket and buy everything at the local supermarket.

But the convenience is also the flexibility of delivery windows. While there is a fixed cost associated with going to shop in the store, waiting for the delivery does come at a significant cost given the inconvenience of waiting at home, unless you manage to find a place for it in your weekly routine. In other words, while shopping online for groceries reduces the time shopping in the store, and may allow you to make more rational decisions away from the aisles, these do not come without any frictions.

Having said all of that, I will make a statement I made several days ago in class: I do not think our grandkids (or grand grandkids) are going to drive to the supermarket and buy groceries. Thus, finding a solution that is financially viable and can improve with technology is worth trying, as long as you can experiment and as long as you have the capital… and we are back discussing Amazon.

While the Bloomberg article discusses Amazon’s failure to penetrate this industry until now, one should not confuse experimentation with failure when it comes to Amazon. Jeff Bezos’ “two Pizza rule” and organizational structure are all about decentralized decision-making, and experimentation. Without such experimentation we would not see the firm moving from being a book seller to one of the dominant players in cloud computing, machine learning, and automated home assistance.

According to the article, Amazon is experimenting with three different configurations that have a brick and mortar element in them: Amazon Go (which are essentially convenience stores), the drive-in grocery kiosks, and a hybrid model:

“They worked out plans for a third approach: grocery stores closer in size to a Trader Joe’s than a Wal-Mart to offer easy access to milk, eggs and produce. Other items like paper towels, cereal, canned goods and dish detergent would be stocked on-site in a warehouse where they could be easily packed and delivered to shoppers at the location, according to documents reviewed by Bloomberg. It would also serve as a delivery hub for online orders.”

My interpretation is that Amazon believes that the solution to grocery has to be a mixture of local and online, but also must leverage these locations as hubs for online shopping. Since the economics of delivery depends on density more than scale, both due to the hyper-locality of the variety as well as the economics of delivery and the need to maximize “stops-per hour”, this model makes absolute sense. It alleviates many of the frictions we mentioned above, and does that while learning how to build the right variety and logistical capabilities for each location, based on geographical and demographical characteristics.

Will that be enough to significantly accelerate the penetration of online grocery?  I don’t know, but given the effort Instacart and Amazon are making, and the decline of driver’s license registrations, a change is around the corner.

Gad Allon is the Director of M&T and Professor of Operations, Information & Decisions at Wharton. He is also co-founder of ForClass, an edtech designed for educators by educators. Follow him on Twitter, @g_allon

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