Talk with Ocado CFO Duncan Tatton-Brown
Duncan Tatton-Brown: "Retailers have approached us from every continent"
The pure player, which posted £843m in gross sales for fiscal 2013, is spearheading a major channel shift in UK food retailing from bricks & mortar to clicks & mortar. Ocado’s business model is built on large, capex-heavy, fully-automated distribution centres, called Customer Fulfilment Centres, and its own delivery fleet. This throws down a direct challenge to competitors such as Tesco.com who either pick online orders in-store and/or use so-called dark stores.
Since 2002, Ocado has been in partnership with UK food retailer Waitrose and has the right to sell their goods online. The supply relationship was extended in 2010 until 2020.
Given its high-tech approach to retailing, CEO Tim Steiner now calls Ocado a "tech company" as well as a "grocery retailer". Further to a major deal in July last year with Morrisons, the UK's no. 4 grocer, Ocado is now looking to sell its know-how to other retail customers on an international basis. CFO Duncan Tatton-Brown explains why.
"We are negotiating with a number of international retail partners"
Mr. Tatton-Brown, as the recent Morrisons deal has shown, Ocado can successfully license its intellectual property. When in this context did you last speak to Rewe CEO Alain Caparros?
I will not be drawn into telling you any specific names. But I will say that retailers have approached us from every continent of the world and that we are negotiating with a number of international retail partners interested in our services.
How then may we interpret your giving us an interview today?
For the twelve years of our operational existence our focus has been on building our proposition in the UK. We now wish to grow the awareness of our company abroad.
What can an exclusively UK-based online delivery service offer international retailers?
They would buy our specialist, world-leading know-how in technology and operations that enables us to deliver groceries to online customers with the highest level of service and most economically.
How near are you to concluding a deal to compliment your longstanding partnership with Waitrose and your recent joint venture with Morrisons?
We have made it clear to our shareholders that we are not going to announce anything soon. Our first priority is to help Morrisons build a thriving online delivery service. But we are also working on making our services more attractive to new international retail clients.
We are developing our IT systems so that they can be replicated more easily for operators with different languages and national regulations. We are also honing our fulfilment operations so that they can be built more efficiently and quickly and preferably also slightly smaller.
Despite your technological efficiency, Ocado’s pre-tax losses rose from £600,000 to £12.5m in fiscal 2013. Why was this?
This was due to our making a significant investment in new capacity that opened last year. If you open a facility that can deliver £1bn in annual sales, but only use a fraction of the potential volume in the very first year, this will reduce profits initially.
But could one not make out the case that the more you grow sales with a new customer such as Morrisons, the higher your distribution costs etc. seem to be and therefore ultimately also your pre-tax losses?
Any new market requires investment before it can deliver a return. Our investments today will grow the business long-term and none of them affect the underlying profitability of Ocado.com. Our shareholders are clearly supporting the steps we are taking, hence the increased value of the company.
Over the last twelve months, the Ocado share price recorded the fastest growth of any European stock. But shouldn’t shareholders worry that you haven’t made a profit in your 12-year operational history?
Obviously they value our company on its future potential. The investment community clearly also believes that we shall make a profit this financial year even though we continue to invest for further growth.
And do you believe that you shall?
Yes, and, if I didn’t, I would need to inform the market that we had overstated our expectations. You will have noted that I made no such statement when we announced our 2013 results in February.
Co-founder Jason Gissing is retiring in May at only 43 and selling £15m in shares. Could this be interpreted as a warning sign?
Investors clearly don’t think so, and the share price has gone up since the announcement of his departure.
Why does co-founder Tim Steiner now also refer to Ocado as a “tech company”?
Obviously, we still own the physical assets involved in the picking of grocery. But we are partly a tech company because we write almost all our delivery order software and develop our websites and warehouse management systems in-house.
To what extent does this give you an edge?
So much so that we operate half the number of vans of one of our major competitors on a comparable sales basis. Also, it was this technological advantage that helped us win Morrisons as the first retail client for our services.
But aren’t the retailers who need your know-how and services ones like Morrisons who have been left behind in the online retailing race?
I don’t think so at all. The UK is the most advanced market worldwide in online grocery retailing, and the proposition of Morrisons today is the envy of many international retailers. That they were behind some of their competitors has turned out to be an advantage. They haven’t made the mistakes of many others who invested in solutions that aren’t economic long-term.
Meaning store picking?
Let us be clear. If you believe that online grocery is only ever going to be half a per cent of all grocery sales and therefore not at all significant, then the rational decision for most retailers would be to store pick. But, if you believe that online grocery retailing will be a significant proportion of the market over time, then store picking is completely wrong.
Because store picking can’t compete with our model that enables us to reap the benefits of automation and aggregation. We are able to bring a greater volume of goods to a single location in the most cost-effective way and to invest the cost savings in additional service.
Do you really believe, however, that you can compete with a retail brand like Tesco.com?
Yes, so much so that, even though we are still sub-scale, we make a better ebitda margin before overheads than any of our UK competitors. Despite matching them on prices, we even beat Tesco with their annual turnover of nearly €50bn and substantially better buying terms.
But aren’t you simply too small to compete long-term?
If you were to call our Customer Fulfilment Centres (CFC) shops, then we currently have only one and a bit shops. As we grow to two, three, and four CFCs, we shall reap the benefits of scale. So our overhead costs won’t double, treble and quadruple, and we won’t need two, three or four CFOs!
Why don’t you open a CFC in a high population area such as South London?
If you asked property agents to find a 35-acre site in South London, they would laugh at you! But geography isn’t as important for our model as you seem to think. Our original CFC just north of London was able to deliver north of Leeds and Manchester, west of Bristol, and down to the south coast. This proves that is possible to cover over 70 per cent of UK households from just one location.
Your deal with Morrisons last year was said to have hurt your existing relationship with Waitrose. Are you worried that your largest partner could leave and deprive you of 80 per cent of your current customers?
You are referring to some out-of-date comments in the press. Waitrose now say that their relationship with us is good and that they will continue to help us to deliver on the Morrisons contract.
So Waitrose won’t take the first option to leave in 2017?
That is the first date that either party can exit the contract, which makes the likely outcome difficult to predict. All I can say is that the relationship on a day-to-day basis with Waitrose is good. They are excellent partners and deliver their products to us both accurately and on time.
Clearly, you want the partnership to continue?
The contract clearly has benefits for both parties. We are their largest customer and increase the volume of their purchases. We are also growing much faster than them. Obviously we gain access to their quality range of products that are highly trusted.
Ocado is regarded as leading a significant channel shift in the UK. But isn’t Tim Steiner exaggerating when he claims that only those green-field superstores and High Street supermarkets will survive which devote an increasing amount of floor space to community services and leisure activities?
Let me refer you to what Morrisons, the number four retailer in the UK, announced as recently as March 14. I do not believe that they plan to open any new supermarkets beyond their current pipeline and will only open convenience stores in future. Even Tesco, the market leader, is increasingly inserting coffee shops and gastronomy into their hypermarkets because they recognise that they have excess floor space.
They have been growing strongly over the last few years and will continue to do so. But I think their success will affect us far less than other operators because discounters only appeal to price-conscious customers whereas we fulfil a far broader consumer desire for range, fresh produce, and exciting products. This benefits us because we can offer a far greater range than any other UK retailer.
How big a range?
We offer around 34,000 SKUs in food and near-food. Unlike many other online grocers, we are not limited to ambient products. In fact, 40 per cent of our annual sales are in fresh produce and chilled food in addition to around 2,000 deep-frozen lines.
Leaving the juicier non-food margins to Amazon?
We are also increasing our non-food ranges which could account for 10 to 20 per cent of our sales over time. The best example is our recent destination website, fetch.co.uk, which specialises in pet products. A typical supermarket or hypermarket might stock 300 viz. 500 pet lines, but we offer 6,000.
Related article in German: Interview by Mike Dawson in Lebensmittel Zeitung, no. 16, 17.04.2014