Colin Guheen, Wells Fargo Sector Manager, Packaged Foods, Restaurant, and Food Retail
Chris Innes, Wells Fargo Industry Risk Associate, Packaged Foods, Restaurant, and Food Retail
You can’t smell fresh cilantro through your computer screen or feel the ripeness of an avocado on your smartphone. That is, until such technology is developed. Over the next decade, as online shopping evolves as the fastest growing channel in the grocery sector, we will see if a true phase-shift emerges in food buying behavior, or if online grocery shopping plateaus and becomes an occasional option for “stock-up” packaged goods.
As young children, we enjoyed accompanying our parents on grocery buying trips. The supermarket was a 40,000 square foot, branded food maze with bins stacked high with cases of fresh bakery goods. Convenience stores accommodated the Saturday dash for a gallon of milk and provided us a chance to grab a candy bar. Unwittingly, we witnessed, and were part of, the demand evolution of the typical consumer and the subsequent supply response of food retailers.
Prior to 1988, the traditional grocery store accounted for roughly 90% of food purchases. In the decades to follow, retailers would adapt formats to meet the consumer’s different needs. The first major phase-shift in food retail was physical — a diversification in size and proximity — with varying blends of convenience and in-store experience aimed at capturing the typical consumer’s unique shopping occasions. The 125,000+ square foot warehouse/club stores emerged as destinations where shoppers traded in-store experience for bulk sizes offered at wholesale prices. Smaller-box convenience stores served the fill-in occasions where a full trip to the grocery store was not needed. Dollar stores arose to serve value-oriented necessities, and specialty stores provided a higher level of in-store experience at a premium price point. As a result, the estimated share of total food retail for the traditional grocery store dropped to 46% by 2015, and future growth is expected to underperform the overall food retail category over the next decade.1
The physical evolution of food retail has led to greater consumer choice, and as a result, heightened competition for a tepidly growing food dollar. Leading up to the global financial crisis, food shopping occasions per household peaked at roughly 160 trips annually. Shopping occasions decreased 16%, and in the following 8-year recovery, shopping occasions have still not rebounded, with the number reaching just over 130 trips by 2015.2
Since March 2015, year-over-year volumes for monthly supermarket sales, as measured by Nielsen and compiled by Credit Suisse, have been negative for 3 out of every 4 months. Is the persistent decline cyclical as opposed to secular? Partially. While in its eighth year, the current economic recovery has not been as robust as past recoveries. The labor force participation rate has not recovered to pre-crisis levels, wage growth has been mild, and consumers have tended to allocate additional income to debt reduction versus discretionary spending. We believe that behind the noise is the emergence of the second structural phase-shift for food retail, and one that is digital.
Source: Nielsen “What’s In-Store for Online Grocery Shopping” January 2017
As technology becomes increasingly interwoven in our everyday interactions, it has similarly impacted our purchasing behavior. According to Nielsen’s recent global survey of online consumers depicted in the chart above, the percentage of global respondents who indicate that they purchase household and paper products more often online (41%) outweighed those that purchase more often in-store (27%), and also those that purchase both online and in-store with the same frequency (32%).
For packaged grocery food, the largest group indicates that they purchase online and in-store with the same frequency (36%) when compared to more in-store purchases (35%) and more online purchases (29%). These types of fast moving consumer goods are considered wedge products for which digital adoption has already gained significant traction, and the term “add to cart” truly has a dual meaning.
The most obvious hold-out category is fresh grocery, which exhibits the lowest ratio of respondents who purchase more online (23%) relative to more in-store (44%). Although the level of penetration for fresh grocery to date is impressive, the global statistics are influenced by a more mature e-commerce market in China where the number of respondents who indicated they have purchased fresh groceries online (40%) was over four times that reported in North America (9%). The U.S. is early on the adoption curve, but as we become a more urban society aided by technological and structural distribution improvements, the foundation for rapid growth of the currently small base will be bolstered.
The Food Marketing Institute estimates the current U.S. consumers’ share of retail food and beverage spending online is 4.3%, but also estimates that share will quadruple to 20%, or nearly $100B, by 2025.3
Source: UN World Urbanization Prospects
The multi-billion dollar tech “unicorns” are popular topics in financial news in part due to the broader market’s current state of above historical average valuations. Blue Apron, the forerunner in the meal-kit segment, recently made news for garnering a $2B valuation following its most recent round of fundraising. Meal kits have made a large enough dent in the food retail market that the large-cap food companies are trying their hand: Unilever most recently invested in Sun Basket, Tyson introduced Tastemakers, Kroger is piloting Prep + Pared, Whole Foods has partnered with Purple Carrot, and Hello Fresh is already well established in this meal-kit space.
According to Food Market, the meal-kit segment is expected to generate $1.5B in sales in 2016, and is anticipated to double over the next few years. On a standalone basis, meal kits have attracted attention and venture funding due to popularity among consumers, however a positive side effect for the larger food retail industry could be the further normalization and acceptance of online fresh grocery delivery.
A consumer who has not yet purchased fresh grocery online may become an occasional meal-kit user, exposing himself/herself in small increments to the quality and consistency of fresh product ordered online. On the heels of fast-moving consumer goods and packaged foods, meal kits can serve as the logical next step in the routinization of online consumer buying behavior.
Currently, Nielsen measures the largest hurdles for online fresh grocery as the inability to inspect product and concerns about freshness and quality. A majority of survey respondents indicate that they prefer to shop for fresh grocery in person, and for many it is considered an enjoyable experience. Nielsen’s 2015 e-commerce survey found that 61% of respondents considered going to the grocery store an “enjoyable experience” and 57% even considered it “a fun day out for the family.” 4
As the growth in online grocery (13.5%) is expected to outstrip traditional grocery (2.5%), and even non-traditional grocery (6.4%), the impacts of the digital phase-shift will create opportunities for all participants.5 Brick and mortar retailers will be forced to adapt their own digital strategies (coupons, social media) and experiential (in-store Wi-Fi) strategies to maintain engagement with consumers, like our younger selves, who enjoy the in-store visit.
Going one step further, Nielsen surveyed consumers regarding e-retailing strategies that would entice further online adoption. Ranked in order of preference are money back guarantees, immediate product replacement, and free delivery over a certain basket size. Delivery has been the lowest hurdle to clear particularly for the larger, transformative e-retailers such as Amazon Prime, offering free delivery for an annual fee, and Walmart.com offering free 2-day shipping.
In the current landscape, as the products purchased skew towards perishability, online purchasing is meaningfully lower since product satisfaction without in-person inspection is harder to achieve. To become a permanent share-taker versus traditional grocery, providers must succeed in incentivizing buyer behavior into successful trials. This will be layered with the parallel growth of intermediary products and services that will allow for further normalization of the process and perception of online purchasing. Time will tell if the sensory interaction with our food, available only during in-store buying, is too high of a hurdle to overcome.
1. Willard Bishop, “The Future of Food Retailing” 2016
2. Nielsen, US Shopping Insights Quarterly
3. FMI & Nielsen
4. Nielsen, “The Future of Grocery” April 2015
5. Technomic, “Food Industry Transformation: The Next Decade”
Colin Guheen is the sector manager for Packaged Foods, Restaurant, and Food Retail within Wells Fargo’s Food and Agribusiness Industry Advisors Group. Colin’s specialization is investments in the restaurant, food retail, packaged food, and beverage spaces. He collaborates with various lending groups to monitor and manage risk, shares industry insights with customers and industry groups, and publishes a monthly Food and Agribusiness industry update.
Colin joined Wells Fargo in March 2016, having previously spent 3 years at GE Capital working in a similar capacity with food and beverage companies in the lending, sponsor finance, and minority equity portfolios. Prior to GE Capital, Colin worked for 10 years in investment banking at Cowen Group as an equity analyst covering restaurant, food retail, packaged food, beverage, and protein companies. In 2011, Colin earned top ranking among analysts in the Wall Street Journal’s Best on the Street survey in the food and drug retail sector.
Colin is a CFA Charterholder and holds a bachelor’s degree in international political economy from University of Puget Sound. Colin is a member of the finance committee of New England Science & Sailing Foundation, and lives in New York City with his wife and son.
Christopher (Chris) Innes is an industry risk associate with focus on the Packaged Foods, Restaurant, and Food Retail sector.
Chris joined Wells Fargo in March 2015, having previously spent 1.5 years at GE Capital working in a similar capacity with food and beverage companies in the lending, sponsor finance, and minority equity portfolios. Prior to GE Capital, Chris worked for 3 years in investment banking at Cowen Group and Stifel Nicolaus as an equity analyst covering restaurant, feed retail, packaged food, beverage, and protein companies.
Chris is a CFA Charterholder and holds a bachelor’s degree in economics from Colgate University.