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Friday, March 15, 2013

Morrisons and Ocado: a match made in purgatory

Story originally appeared on The Guardian

The alliance between the supermarket and the online operation will be painful for both even if it is right in the long term

"The proposed deal with Morrisons … is the first public acknowledgement by a competitor that Ocado's knowhow has value and that years of investment and trial by error has perhaps not been in vain." So says Fidelity, which, as the owner of a 5%-plus stake in Ocado, will be pleased by the 24% rise in the online grocer's share price.
Hold on a minute, though: why does selling your proprietary software to a direct competitor count as a triumph? If the knowhow is as good as it's cracked up to be, shouldn't Ocado be aspiring to eat Morrisons' lunch? Proposing instead to share a table with a late convert to online food retailing is strange thinking.
This turn of events says a lot about Ocado's rollercoaster ride as a public company. Profits did not arrive on schedule (and still haven't, at the pre-tax level) and the shares have been all over the place; even after trebling from the low point, they still sit slightly below the flotation price of 180p in July 2010. The good news is that a licensing arrangement with Morrisons could offer greater stability. In the current retail climate, Ocado is probably right to grab any deal that makes sense for it.
The problem doesn't lie with Ocado's centralized and automated task management tool for business model, which may or may not be superior to the "dark stores" model pursued by Tesco and others (that debate can be left to rage). The issue instead is the almighty sums of capital piling into the online grocery market and undermining returns for all. Tesco, Sainsbury's and Asda can see the shift in shoppers' habits and, it seems, are willing to tolerate the financial damage they do to themselves via the cannibalisation of sales and low delivery charges.
So, yes, a partnership with Morrisons could make life less sweaty for little ol' Ocado, which has just opened its second vast distribution centre, capable of handling £1bn worth of orders a year. If Morrisons pays to shove orders through the Dordon depot, the capacity can be put to productive use sooner. Alternatively, showing Morrisons how to run "dark stores" could bring in useful fees.
As for Morrisons, it's hard to know whether to applaud or laugh at its delayed online entry. On one hand, it has shown admirable discipline in refusing to play a game where it couldn't see how to make profit. On the other, its reward has been weak sales (like-for-likes down 2.1%) and a 4% fall in underlying profits to £901m. It's a classic case of "damned if they do, damned if they don't," as Investec's Dave McCarthy has long described supermarkets' online options.
Morrisons' chief executive, Dalton Philips, decided two years ago that an online offer had to happen but the planning has been tortuous. Kiddicare was bought to gain knowledge, followed by a stake in a New York online grocer. Now, it turns out, the answer may lie down the M1 at Ocado. There could be a "last mover advantage", suggests Philips.
Well, maybe: let's see the business plan first.