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Pricing strategy   |   How Grocery Stores Should Respond to the Growth of Online
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Pricing strategy


HOW GROCERY STORES SHOULD RESPOND TO THE GROWTH OF ONLINE MARKETS

Lessons from Trader Joe’s, Wegmans, and Walmart.
by
 * Marshall Fisher
   and
 * Santiago Gallino

by
 * Marshall Fisher
   and
 * Santiago Gallino

July 31, 2024
SDI Productions/Getty Images
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Summary.    During 2020-21 online grocery shopping soared from 3.4% to double
digits as Covid-19 made customers reluctant to go into stores. Post Covid,
online grocery shopping is still high, forecasted by Forrester (2021) to hit
10.4% in 2024. How will grocery retailers service...more
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Grocery retailers face a challenge: What to do with the online channel, which is
growing and popular with a segment of their customers but is hugely
unprofitable? Based on research we have conducted in the last three years, we
offer three other options in this article.


A POPULAR AND GROWING CHANNEL

Over two decades have passed since Webvan pioneered the online grocery domain.
Since then, countless ventures have emerged in hopes of capitalizing on this
digital market. Despite these efforts,  online grocery sales in 2019 stood at
just 3.4% of total sales, the lowest of 31 segments tracked by CBRE.

Of course, the Covid-19 pandemic changed all of that. U.S. Census Bureau data
shows total online sales over all retail segments growing steadily from 6% in
2013 to 12% in the first quarter of 2020. Then, just three months later, in the
second quarter of 2020, the online share surged to 18%, and much of that growth
was in grocery.

But as grocers discovered, vastly more labor is required in the online channel.
An unpublished industrial engineering study we conducted that tracked labor from
the point a retailer procures a product at its distribution center to the moment
it lands in the hands of a customer showed that as much as 125% more labor is
required by the online channel versus the traditional mode where customers shop
the store and go through checkout at a cashier. These results are no surprise if
one thinks of the double-handling involved in paying workers to move product
through the supply chain and onto store shelves and then paying a different set
of workers to move the product off the store shelves, bundle it, and deliver to
customers.

So today grocery retailers face a challenge: What to do with the online channel,
which is growing and popular with a segment of their customers but is hugely
unprofitable? Two years ago, we embarked on a comprehensive study aimed at
delving deeply into this challenge. We engaged in insightful conversations with
15 senior grocery retail managers spanning 10 countries. These discussions not
only painted a vivid picture of the state of grocery retailing but also informed
the creation of a detailed survey which was administered to a curated group of
60 grocery retail executives in the 10 countries.


AN UNSUSTAINABLE APPROACH

Our findings: Grocery retailers, irrespective of geography, were grappling with
the trifecta of staffing shortages, wavering employee retention, and escalating
wage bills. They said that finding labor is moderately to extremely difficult
50% of the time, and in five years, they projected that number to grow to 69%.

However, despite the labor challenges, these grocery retailers were doubling
down on the more-labor-intensive online grocery service, a model which, at best,
offers slimmer profit margins and, at worst, treads into unprofitable terrains.
The respondents expected their online business to grow from an already high 17%
to 24% in five years.

To better understand the labor challenge, this year we teamed up with West
Monroe Partners, an IT consulting firm, to assess labor requirements for four
different delivery modes for a typical online order of 20 units across 15 SKUs.
The requirements were tracked at three to six locations for each of the four
modes. We estimated that the labor required from the point a procured product
arrives at a retailer’s distribution center to the moment it lands in the hands
of a customer. The base case in our model was the traditional mode: customers
shop at the stores, pay for their purchases at a cashier, and bring them home.
The table below shows the incremental labor minutes required for four delivery
modes relative to this base case, which requires 30 minutes of retailer labor.
(You can use this website to play with our industrial engineering model to
estimate labor required to pick up online orders under different approaches and
orders characteristics.)

Given that wage rates grew 8% in 2020 and are now increasing 4.2% annually, it’s
clear grocery retailers face a significant challenge.

See more HBR charts in Data & Visuals

What intrigued us was the discrepancy between the labor required and the
observed charges associated with online grocery services. While retailers often
charge customers for delivery, they rarely factor in the additional labor
involved in preparing orders for pickup or delivery. A “buy online, pick up
curbside” order that is gathered from the store’s sales floor requires 32.6
minutes of labor more than the 30 minutes in the base case, more than double the
labor required for in-store shopping, yet retailers frequently offer this
service free of charge. Equally perplexing is the fact that there are no
noticeable price differences between products the consumers buy in the store and
those they purchase online.

Traditional in-store customers, who still compose the vast majority of the
customer base, are effectively subsidizing online grocery services. Online
shoppers enjoy the convenience of ordering groceries and having them delivered,
but they are not being charged for the additional labor and resources required
to fulfill their orders.


THREE OPTIONS FOR GROCERY RETAILERS

One thing retailers cannot continue doing is the common model of free order
picking and curbside delivery. It’s doubtful retailers make any profit under
this model. We see three distinct alternative ways forward, each of which can
work for certain customer segments. The choice will depend on the
characteristics of the retailer and its current business model.


1. DOUBLE DOWN ON THE TRADITIONAL IN-STORE MODEL.

Trader Joe’s exemplifies this model, as its website clearly explains: “At this
time, we don’t sell any products (gift cards included) online, only in our
brick-and-mortar stores. We do not offer curbside pickup or delivery, and we
don’t work with third party delivery services like Instacart or Dumpling because
they can’t match our outstanding in-store value and shopping experience. We set
up our stores with care, finding just the right Crew and creating a rewarding
shopping experience, full of discovery, and welcome. After considering the
options, we’re still just big ‘ole fans of the neighborhood grocery store where
we can say hello when you’re looking around wondering — “what’s for dinner?”

For some customers, this response might be disappointing. However, in taking
this stand, Trader Joe’s is recognizing that it cannot be everything for
everyone. It is a thoughtful response of a grocery retailer that has considered
the options and concluded that everyone, customers and retailers, will be better
off without it offering online service.


2. MAKE ONLINE CUSTOMERS PAY EXTRA.

Offer online services to those customers who are willing to pay extra for the
convenience in the form of either service charges or higher product
prices. Adjusting the prices in this way can help retailers cover the costs of
online operations while also encouraging in-store shopping, which contributes a
significant portion of their revenues. Wegmans and Aldi have pursued this path.

Wegmans uses Instacart to service online customers, with both store pickup and
delivery available. Instacart covers its costs by charging, on average, 15%
higher product prices. For example, someone who buys a pint of blueberries in
its store in King of Prussia, Pennsylvanian pays $4.99, while someone who buys
it via the Instacart service pays $5.19, and a dozen eggs costs $4.79 in store
versus $5.59 via Instacart.


3. BECOME MORE EFFICIENT AT ONLINE.

Walmart has been pursuing this path via what it calls Market Fulfillment Centers
(MFCs). These are fulfillment centers colocated with a hub store in a major city
that assembles customer orders for curbside pickup. The business case for MFCs
is that curbside pickup at a fulfillment center requires just 0.7 minutes more
labor than in-store shopping does. Through automation and scale economies,
Walmart is seeking to enhance the efficiency of this mode still further.

So far, it has opened two MFCs — one in Bentonville, Arkansas, and the other in
Salem, New Hampshire — with many more to come.

The choices made by Trader Joe’s, Wegmans, and Walmart are instructive for other
grocery retailers as they formulate an online strategy. Trader Joe’s is known
for its excellent in-store shopping experience and easy-to-find, helpful store
associates, which enables it to “just say no” to offering an online option.
Also, its stores are a bit small, so adding an army of online shoppers to the
mix would erode the in-store experience.

The advantages of the Wegmans approach is that it covers the higher cost of its
online service (via 15% higher product prices) and is easy to implement (given
that it outsources the service to Instacart). Also, its stores are large and can
handle the extra traffic of Instacart shoppers (the people who pick the items in
stores for Instacart customers). We can see this approach making sense for many
grocery retailers.

Walmart is known for being good at store operations and technology but not known
for providing a great in-store shopping experience. Thus, its approach of using
its technical skills to provide free online shopping makes sense in that it
transfers some customer demand from stores to online.

What grocery retailers should not do is continue to lose money on online orders
by picking them for free. If you have a compelling in store experience, consider
Trader Joe’s approach. If you have or can create world-class fulfillment
capabilities, perhaps assisted by some automation, consider the Walmart
approach. Otherwise, the Wegman’s approach has the advantage of being minimally
disruptive because you hire others to do the heavy lifting and charge customers
to cover their costs.

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Read more on Pricing strategy or related topics Operations and supply chain
management, Business models and Retail and consumer goods
 * MF
   Marshall Fisher is the UPS Professor in the Operations, Information, and
   Decisions Department of the University of Pennsylvania’s Wharton School and a
   codirector of the school’s Fishman-Davidson Center for Service and Operations
   Management .
 * Santiago Gallino is the Charles W. Evans Distinguished Faculty Scholar and an
   associate professor in the Operations, Information, and Decisions Department
   the University of Pennsylvania’s Wharton School and a codirector of the
   school’s Fishman-Davidson Center for Service and Operations Management.

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Read more on Pricing strategy or related topics Operations and supply chain
management, Business models and Retail and consumer goods



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