E-commerce won the COVID war, but what happens next? Kroger looks to the pursuit of digital profit in the Vaccine Economy

Profile picture for user slauchlan By Stuart Lauchlan April 6, 2021 Audio mode
Summary:
Kroger had 'a good war' when it came to the COVID crisis, benefiting from the online shift in grocery shopping. But as the Vaccine Economy takes shape, the challenge now is to turn accelerated revenue growth into long term digital profit.

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As society has leapt into a new digital era, so has Kroger. 

So says Rodney McMullen, CEO of Kroger, the second-largest US retailer, as he contemplates a bold new ambition on the back of the COVID-driven societal shift to online grocery shopping - doubling digital sales by the end of 2022 and doing so profitably. 

The second half of that goal may prove to be the more challenging. As noted regularly on diginomica, e-commerce can be convenient for consumers, but costly for suppliers. Even Walmart hasn’t cracked how to make its online operation profitable to date, although it’s putting in place the measures it hopes will address ‘traditional’ margins concerns. 

It’s the same story at Kroger. The pandemic has seen a massive uptick in online business - digital sales grew 116% in the most recent fiscal year, ended 30 January, to top $10 billion - and the expectation is that this is not a trend that will be negated in any meaningful way as the Vaccine Economy takes shape. While consumers will return to physical stores in greater numbers than we’ve seen over recent months, the genie is out of the bottle when it comes to innovations such as curbside pick-up and online ordering/home delivery. For example, Kroger now has 50,000 staff dedicated to pick-up and delivery functions. During the pandemic, Kroger added over 240 new pick-up locations to increase its footprint to over 2,200 locations, while expanding capacity in existing locations led to an increase in daily orders fulfilled of over 128%. That’s not going into reverse gear anytime soon. 

So Kroger, in common with all its peers and challengers, has to prepare for a new world of retail, one in which digital is, correctly, identified as a growth engine, but an engine that needs to be tuned to deliver profits as well as turnover. The firm’s Restock Kroger initiative, dating back to 2018, has arguably given the retailer a head start in pursuit of economies of scale, stripping over $3 billion of operating costs out of the business to date.

There is a huge challenge ahead, says McMullen, but also huge opportunity in digital: 

By digital, we mean the Kroger Seamless Ecosystem we've built over the past few years to be able to deliver anything, anytime, anywhere, regardless of channel, whether pick-up, delivery or shipped. Today, we are seeing more and more new customers engaging in our Seamless Ecosystem..We will continue to build on this momentum - and we have a clear path to drive profitability.

Experiencing digital 

McMullen argues that this ecosystem monetizes the traffic and data insights generated by customer experience - and experience is a critical word here, suggests Kroger CIO Yael Cosset:

We don't look at the digital customer as ‘better’ or ‘richer’. We look for to create an experience for our customers that allows them to engage with us in a relevant way that matters to them, so all digital customers across all of our customer segments are critical. If you look at the growth that especially accelerated in 2020, that has come from all of our customers across all of our customer segments, because the reach, the quality of the experience, the availability of that experience, the quality of the assortment, the importance of the personalization to create that convenience and that value for the customer, it matters to everybody indifferent ways depending on the customers.

Nonetheless, they may not be ‘better’ or ‘richer’, but digital customers are different in some commercially important ways, he adds:

It's a relevant engagement point. If you look at the 5.2 million households that we added last year to our digital family, they all engaging with us more frequently, visiting our stores or digital properties 1.5 times more frequently than our store-only customers. They are spending more than twice as much across all of the channels. 

They’re also ‘stickier’ to the brand it seems: 

Our ‘Seamless Customers’, which we define as customers who are engaging with us across more than one modality, shop with us more frequently, spend more than twice as much and are more loyal to Kroger. In fact, we see retention rates of our Seamless Customers reach 98%, which shows how much the Seamless Experience matters to them and how it will contribute to our long-term growth. Our Seamless Ecosystem is a competitive advantage and continues to contribute to establishing Kroger as the fresh food destination for our customers. 

Having that ecosystem in place was critical at the start of the pandemic last year, explains Cosset: 

[It] enabled us to immediately increase the capacity of our platform and meet the customer demand. We had weeks early in the pandemic where we 10x-ed our delivery volume. Early on, we more than tripled the number of orders from our stores in a matter of days across all of our stores. This agility relied on our technology capabilities and our store teams, who were able to respond quickly to the increased demand by leveraging our digital platform. Over the next few years, we plan to double our capacity just from our stores, making it ever more convenient for our customers to shop with us in-store, for pickup and delivery with the option in time that best fits their day.

Loving the stores

That expanded capability within stores mirrors the continued importance of the physical side of the overall omni-channel retail balance. Close to 2,500 Kroger stores now offer pick-up or delivery in as little as one hour, while the cost to serve from stores has been reduced by 14%, with a goal of that hitting 30% in the near-term. Gabriel Arreaga, Senior Vice President-Supply Chain, explains: 

Stores will always play a key role, where the majority of our shoppers live within two miles of a store and 45% of the US population is within reach…At the same time, we're rolling out our new Customer Fulfillment Centers (CFC), which will enable even more customers to access more products, even faster and in more markets. Our Customer Fulfillment Centers will create an opportunity to serve 75% of the US population within a 90-mile radius. 

Where our strategy gets really exciting is the interplay between our stores and dedicated Customer Fulfillment Centers working together to deliver for our customers, regardless of their set of needs. When combined, our stores and Customer Fulfillment Centers create an ecosystem where brick-and-mortar and distribution automation and AI can deliver to customers the most efficient solution, without sacrificing the customer experience or assortment. 

Mention of CFC expansion inevitably moves the focus to Kroger’s ongoing partnership with online grocery platform provider Ocado to invest in its automated ordering and distribution platform, with the intention of opening 20 centers in total. Over 2022 and 2023, the pair expect to open up to six more CFCs across the US, says Arreaga: 

We will scale faster. We've invested in Ocado, because it will supercharge our 'anything, anytime, anywhere' strategy for even more growth and profitability in the future. In the countries where Ocado state-of-the-art automation and AI are being leveraged, the result is a consistently superior customer experience. With 99% order accuracy and 95% of orders delivered on time, the customer experience is second to none. In Canada, the first North America location to go live, Sobeys have shared that they have achieved an 87% Net Promoter Score.

And again, the drive towards digital profitability is never far away as he adds: 

We expect overall profitability from our Customer Fulfillment Centers to be at least as high, if not higher, than our store profitability model. By Year Three, we expect our Customer Fulfillment Centers to achieve site profitability. And by Year Four, we expect the centers will reach parity with the store operating profit rate. Over the long-term we expect the unit economics of these facilities to be lower than our stores.

When it comes to the customer, a more personalized experience will continue to drive loyalty. We have a customer base with connections to over 60 million households that we are able to leverage into new growth opportunities and the scale of our digital business has grown so rapidly that during 2020, we had over 1.3 billion customer interactions across digital, a 30% increase over last year. Our significant reach allows us to meaningfully personalize the customer experience. At the same time,

 

Another key element of the Seamless Experience is greater personalization, a long term retail Holy Grail of course, but one potentially made more attainable by the accelerated shift to digital.  Kroger reckons to have connections to over 60 million households, while 2020 saw over 1.3 billion customer interactions across digital, a 30% increase over the previous year. That provides a strong foundation on which to meaningfully personalize the customer experience. CIO Cosset says: 

Our focus over the last few years in personalizing every touch point, leveraging terabytes of data being generated every single day and innovating in personalization science is a massive differentiator and contributes to our competitive advantage. To give you a sense of the impact of our personalization already today, last year alone we presented over 0.5 trillion personalized recommendations to our customers across our digital ecosystem. We apply it across the customer journey - while in-store, using our app, at home, through e-mail, push notifications, shopping online via our apps, relevance matters. We continue to see industry-leading open rates and redemption rates at four times the industry average. This is a critical unlock of how we continue to grow our digital customer engagement, shopping trip frequency and overall retention. 

Personalization and relevance make a huge difference to shoppers, he adds: 

Personalization is about simplifying the customer journey, making it more personal, making their lives easier, regardless of what matters most to them. It could be convenience, the items that are most relevant to me based on the day, the time of day, but also my shopping behaviors. It could be value, with offers most applicable to me as a shopper. Or it could be inspiration, presenting ideas, recipes or introducing new items that are relevant to me and make me more engaged. 

This mindset and the resulting strategy to support it saw conversion rates double last year, a key metric, says Cosset:

People tend to focus heavily on traffic growth - and it is critical, as growing traffic means you are a destination - but conversion is equally critical because it guarantees our customers come back and increase their loyalty. Personalization is what drives conversion. It is a critical piece of the puzzle, both for our top line growth, driving the repeat visits, the additional items, the additional [loyalty scheme] miles and also a critical component of our retail media platform, which supports bottom line growth. We will continue to drive personalized relevance through our loyalty and membership programs, applying it at every touch point across the customer journey. We believe that bringing a personalized dimension to our membership model will differentiate our offering from competitors.

My take

Last week saw the release of results from a survey of 7,916 grocery shoppers across the US - PowerReviews Evolution of the Modern Grocery Shopper - that highlight both the opportunities and the challenges McMullen alludes to. It found that 73% of consumers say they’ve purchased grocery items online within the most recent three months of being surveyed in February. Bear in mind that according to much-cited data from Bain & Company Research, only three percent of grocery shopping in the US took place online in 2019 to see the scale of the transformation that has occured.

And who’s made the move is of equal importance. Breaking down the demographics of those who have shopped online in the past three months, 80% of Millennial respondents and 74% of Gen Z had, followed by 72% of Gen X and 60% of Baby Boomers. And there’s a compelling fiscal allure here as well - the more money you make, the more likely you are to shop for groceries online. Taking those survey respondents again, 80% of those who earn over $100,000 have shopped online for groceries, compared to 64% of those who make $0-$25,000.

Of all the retail sectors that had ‘a good war’ during the pandemic, the grocery business saw the most seismic shift, particularly in the US which had lagged behind Europe - and most particularly the UK - when it came to adoption of online grocery shopping. That was the 2020 story; what’s now taking shape is how the enforced acceleration of a terrible year adapts and stabilizes in the Vaccine Economy. Mainstream attention inevitably tends to fall on Walmart in this respect, but Kroger’s story is one that is as compelling and to which diginomica fully expects to return in the coming months.