U.S. Consumer: Opportunity in Online Grocery

With online grocery shopping growing in popularity, artificial intelligence can improve the customer experience while increasing efficiency.

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Brian Nowak: Welcome to Thoughts on the Market. I'm Brian Nowak, Morgan Stanley's U.S. Internet Analyst.

Simeon Gutman: And I'm Simeon Gutman, Hard lines, Broad Lines and Food Retail Analyst.

Brian Nowak: On this special episode of Thoughts on the Market, we'll discuss the significant opportunities in online grocery. It's Tuesday, October 3rd at 10 a.m. in New York.

Brian Nowak: Simeon, our work suggests that online grocery is the largest remaining category of offline spend, which makes it the biggest opportunity in e-commerce. When we talk about online grocery, do you think of it as pure dot-com? Do you think of it as omnichannel? How do you define online grocery and how do you think about the growth outlook for the industry the next few years?

Simeon Gutman: To settle that debate we think of it as omnichannel. The online market includes both delivery and pickup, which we actually think is a 50/50 mix. The market today, we think, is about 11.5% penetrated. That equates to roughly $190 billion of online and pickup sales. It's growing low double digits and we think over time it reaches about the high teens by 2027.

Brian Nowak: So 11% adoption now heading to teens penetration a few years from now. That's quite a bit below a lot of other categories in the United States. So let me ask a sort of obvious question. What new types of technologies or innovations have you seen in online grocery that you think are going to really drive faster, more durable adoption going forward?

Simeon Gutman: It's likely in the micro and macro fulfillment. I mean, online grocery is complicated. There's a lot of SKUs to pick. There's labor involved. We're seeing better ways that grocers are able picking and packing the groceries. I think still getting it to the end user remains a challenge and that's what we're going to see probably evolve over the next, call it, decade.

Brian Nowak: That's helpful. What are some of the other key debates in the online grocery space and what aspects do you think the market is missing or underappreciated right now?

Simeon Gutman: I think two key debates are the path to profitability, and if online grocery can reach that profitability threshold and two whether an online only player will encroach on the traditional share and disrupt the market. As for the path to profitability, we think eventually we'll see it. We don't have a lot of examples because we don't think we're there with scale today. But over time we think these models will show some level of profitability. It may not be a fully online model. It'll still be a holistic omni channel model. And then the second piece is we do think there is going to be an encroachment from e-tail or e-commerce only players. The market's big. It's one piece of the market that online only hasn't conquered, but it's such a big TAM, we think everyone has their attention on it. What are some of the most significant advertising opportunities when it comes to online grocery Brian?

Brian Nowak: To your point on profitability within online grocery, we think advertising is likely to be a key lever to drive profitability across the space. Historically, we have seen traditional grocers and retailers benefit from trade spend, advertising dollars spent essentially for NCAP placements, shelf space and really in-store marketing. As consumer wallets move online with an online grocery, we expect those dollars to shift toward the online players. And given the high incremental margin of advertising dollars compared to traditional grocery spend. We think that the advertising business is likely to be an important lever in online grocers, both traditional players moving online as well as e-commerce first players growing their business and their ability to build profitable long term ecommerce businesses. Now Simeon online grocery, to your point earlier, is an industry where the unit economics are quite tight and margins are thin. With that as a backdrop, what in your mind are the keys to driving long term durable profitability beyond advertising?

Simeon Gutman: Two things. First scale and then second capability. In terms of scale, the more densely populated or the more densely penetrated a grocer can be in a market, the more money we think they can make. And we think the same is true with online grocery. You have to have a high market share in a concentrated place, and that's happening slowly. And some companies are stronger in certain markets than others, but that needs to happen more broadly. Second is the capabilities. And as I mentioned earlier, we're starting to see the emergence of newer technologies, macro fulfillment methodologies, meaning automation in a large scale, micro fulfillment, automation at the local level. And these type of technologies remove the human element, the labor element, from picking a relatively large basket of items and can save a significant amount of money. And eventually the last mile needs to be figured out as well, whether the customer picks it up in store or who knows, one day a self-driving car brings it to someone's house. And of course, Brian, Online grocery will likely experience the impact of A.I., how do you see the role of A.I in this space?

Brian Nowak: We think artificial intelligence has the potential to create a better consumer experience with an online grocery and drive higher efficiency in the backend for the delivery companies as well. On the consumer front the capability for large language models and artificial intelligence to analyze more consumer data and essentially create what we think will be A.I powered personal shoppers with better suggestion, recommendation engines, recipe recommendations, auto replenish, auto reorder, we think is going to remove some of the friction that historically has held back online grocery adoption. On the back end, the use of artificial intelligence and large language models can be important in creating more effective driver routes for all the online grocery delivery companies, as well as ways to better manage inventory and supply in their logistics and fulfillment centers in order to operate more efficiently. So we do think artificial intelligence is going to be important to driving online grocery adoption on the front end and efficiency and profitability on the back end. Simeon, thanks so much for taking the time to talk.

Simeon Gutman: Great speaking with you, Brian.

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