Published on: March 23, 2016
Content Guy's Note: The goal of "The Innovation Conversation" is to explore some facet of the fast-changing, technology-driven retail landscape and how it affects businesses and consumers. It is, we think, fertile territory ... and one that Tom Furphy - a former Amazon executive, the originator of Amazon Fresh, and currently CEO and Managing Director of Consumer Equity Partners (CEP), a venture capital and venture development firm in Seattle, WA, that works with many top retailers and manufacturers - is uniquely positioned to address.
And now, the Conversation continues...
KC: So there's been a lot of Instacart news since last we talked. Let's start with the story about how Instacart now is asking manufacturers to help pay for the act of delivering their products, essentially asking for promotional fees or discounts, or charging them to advertise on its website.
It seems to me that one of the things that Instacart will have to be careful about is getting in between the retailers they serve and manufacturer allowances … it has been my impression that this is a dangerous place to me, like between a lion and a hunk of raw meat. What do you think this tells us about Instacart's profitability and competitive issues? Does it suggest weakness or strength?
Tom Furphy: Instacart is a bit of an enigma to me. I’m sure they have a very smart team that has a vision for the model that gets it to scale and to profitability. And their list of investors is second to none. They’ve raised a significant amount of capital at progressively higher valuations. I would assume that these investors did their proper diligence and they see a path to true disruption and industry dominance. That leads me to think that there is more to the Instacart model that is yet to be revealed.
That said, a fundamental challenge with the current model is that it relies on picking from stores, then has to cover the cost of delivery. Instacart’s supply chain / fulfillment cost structure starts at the retail shelf, where products are already fully burdened financially. By the time a product gets to the shelf, it has already gone through the manufacturing process, through manufacturer warehousing and distribution, through retail and/or wholesale distribution and has absorbed the labor of being stocked on the shelf. Even after 10-15% manufacturer funding, the item only has a few points of profit left. That’s why manufacturer funding is so important to retailers, even in a traditional brick and mortar environment. They cannot be profitable without it.
To accommodate the additional costs of Instacart’s picking and delivery service one or a combination of the manufacturer, retailer or customer has to pony up. So it’s not surprising that Instacart is asking manufacturers for funding. To Instacart’s defense, they are providing a value-added service by marketing these products and enabling them to get into shoppers’ hands in the way these shoppers are asking. And it’s likely that manufacturers have a little more margin room than retailers do to cover the cost.
Ultimately, Instacart has to get their model to the point where they can pick 4-5 orders per hour and then follow that with strong delivery density. That is, they need to get to the point where their “drivers” are delivering 4-5 orders per hour. Even at that rate, manufacturers, retailers and/or customers will have to pay to cover the costs. So, to answer the question, I’m not sure if that exposes any kind of flaw in the model. It just is what it is. That’s why I’d have to think there is more the model that we haven’t seen. If not, it will be a tough slog to make it work.
KC: Agreed. I continue to think that the real play here for Instacart is to create enough volume that it looks attractive as a takeover target ... and that when retailers decide to go with Instacart, they are looking for a turnkey solution to an e-commerce challenge that requires a lot more than that.
Which leads me to the other Instacart news that I found interesting. There actually were two headlines. First, the news that Whole Foods is doubling down in its Instacart relationship, expanding the number of cities and stores where they work together. And the other was the news that in Washington, DC, Ahold-owned Giant is going to use Instacart to supplement its Peapod offering in certain neighborhoods. My reaction to the first is that Whole Foods has so many things on its plate that it does not want to get any more involved in e-commerce than it has to, and therefore is outsourcing this business to Instacart; as for Giant, I have to wonder if this has to do with fast scalability once Ahold's acquisition of Delhaize takes place. Your thoughts?
TF: From everything I’ve read, Whole Foods has been happy with their Instacart relationship. They are quoting that a strong and growing portion of sales are moving through the service, at basket values much higher than their average store baskets, showing shopper appetite for the convenience. That’s not surprising, given that their higher end customer has the financial wherewithal to pay a delivery fee to cover at least some of the costs. Also, Whole Foods does tend to be a higher margin operator than many in the grocery industry, so they can absorb a bit more of the service cost than others. In light of the factors we discussed in the question above, I’m not sure that the Whole Foods / Instacart partnership is profitable, but I can understand why Whole Foods would double down in store rollouts and make an investment in the company. It enables them to play in e-commerce in a way that appeals to their customer. It creates momentum in the space that they can build upon with different models like Click & Collect.
Also, the investment allows them to participate in any financial upside that may result when the company is sold or goes public. Interestingly, as an investor they are likely granted certain information rights in the company. This would enable them to better understand and influence the economics of the model. It would also allow them to a view into the extent to which other retailers are using the service. Ironically, their investment may actually work against itself by scaring other retailers off.
I admit that I was a little surprised to see the Ahold / Instacart partnership. But it does give Ahold a chance to see the model up close and understand how it might work for their stores and customers. It also is a potential way to participate in same-day delivery, which is difficult in a fulfillment center / delivery model like Peapod’s. And in the event that they like what they see, it does provide them a potentially fast-scaling model for e-commerce after the Delhaize acquisition. It will be interesting to watch how that unfolds.
The Innovation Conversation will continue ...
- KC's View: