Ocado: The key to unlocking groceries for Amazon?

LONDON/SAN FRANCISCO Fri Jan 28, 2011 8:42am EST

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LONDON/SAN FRANCISCO (Reuters) - Buying Ocado, the loss-making British online grocer, would give Amazon.com the model for cutting-edge customer service it would need to crack the market for selling groceries.

And if anyone can make money selling food online, it is surely the world's biggest internet retailer, which could add its enormous catalog of general merchandise goods to the range of products customers could buy with their regular grocery shop.

The question is, will it take the plunge?

Amazon appears undecided, no doubt mindful of the difference between selling books and DVDs by mail and delivering multi-temperature, perishable goods in fixed time slots.

But Greg Hodge, research director at consultants Planet Retail, thinks he knows which way the U.S. group will jump.

"Amazon have grown by adding more and more product ranges ... and there is a great growth opportunity in food," he said, pointing to British online grocery sales rising around 20 percent year-on-year.

Amazon, which has recently bought the owner of Diapers.com and Soap.com, has been expanding the number of household goods and groceries it sells in individual transactions to shoppers, and is also testing Amazon Fresh, a service on its home turf in Seattle where fresh groceries are delivered to your door.

What it lacks is the compelling offer to customers that has made it the scourge of entertainment and electricals retailers.

That could come from Ocado, which has spent a decade developing the world's biggest distribution center for online grocery orders and a fleet of vans to deliver fresh, frozen and ambient goods to customers' doors within narrow time slots.

"If they are serious about getting into food, this (buying Ocado) would be one of the easiest ways to do it," said Neil Saunders, consulting director at retail specialists Verdict.

"Amazon clearly sees there is growth in food. Buying Ocado would be a short cut to getting there," agreed an investment bank analyst who declined to be named in accordance with company policy.

Amazon stressed that Amazon Fresh was an experiment when it published fourth-quarter results on Thursday that showed a hit to margins from big investments.

Jim Hertel, managing partner of Illinois-based food retail consultancy Willard Bishop, thinks that caution is right.

WINNING OVER THE SCEPTICS

"You are talking about an economic model that is a real challenge to succeed against," he said, harking back to U.S. online grocery firm Webvan, which went bankrupt in 2001 with around $1 billion of losses.

Ocado, founded by three Goldman Sachs bankers, has suffered from this concern. After a troubled initial public offering (IPO), its shares plunged around a third in value last year.

But there are signs it is now winning some people over. The shares have bounced back and now trade above their IPO price, with a market value of 1.1 billion pounds ($1.8 billion).

There has been talk of hedge funds being squeezed out of short positions, and speculation a British grocer without a major online presence, like Wm Morrison or upmarket food seller Marks & Spencer (M&S), might make a bid.

Morrisons, however, said earlier this month it was focused on testing its own online business, while analysts think M&S would struggle to make an internet service work because it does not offer enough goods for customers to do a full grocery shop.

Barclays Capital analysts think Ocado could surprise investors by reporting an operating profit for the second half of its fiscal year with it publishes results on Tuesday.

And strong growth should continue, according to grocery industry body IGD. It sees UK online grocery sales doubling in value to 9.5 billion pounds by 2015, outpacing growth in the overall market and reaching 5 percent of the total.

Planet Retail's Hodge thinks there is no reason why internet grocery shopping won't catch on in other densely-populated areas around the world, and said that could attract Amazon to Ocado.

"If you look at the way Amazon has grown ... they have looked at a fast-growing online businesses, often loss-making, invested in them, and then swallowed them up," he said, noting how it built a stake in DVD and games rental firm Lovefilm before deciding last week to buy the rest.

Verdict's Saunders said any deal could hinge on Ocado retaining its relationship with upmarket grocer Waitrose, whose products it sells.

That might not be easy if Amazon wants to deliver non-food goods through Ocado's network, as it would step up competition to Waitrose's sister company, John Lewis department stores.

But it was not inconceivable, and also possible Ocado could strike a new supply deal, such as with M&S, or develop its own-brand business into a full grocery offer, Saunders said.

While British grocers are likely to be put off by Ocado's heady valuation, that may not be the case for Amazon, which had some $8.8 billion in cash and marketable securities at December 31.

Amazon and Ocado declined to comment.

(Editing by Sophie Walker)

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