The Future of Food (and other retailing) : No Advertising?

Technology and information will increasingly determine our consumer product choices and change the way food and other consumable goods are marketed, distributed, and sold

I spoke at the Techspo Conference (Dirt-Data-Droids) in Western Australia last week on the future of agriculture in 2027. In part that future is tied into the future of retailing of food and fibre. On the consumer side I proposed that we are on the verge of a complete disruption of the retailing of food around the world. This will be led by changes in the advertising and distribution model as well as other factors. (see: The Supermarkets Demise – A Scenario which is also linked to an earlier post ). This piece expands some of the thinking in those posts further.

These changes to food retailing will be part of a larger change in retailing. Technology will play a much larger part in determining our purchasing preferences.  There will be two parts to this story.

Firstly, we will move some of our purchasing decisions into the hands of technology in a similar way that Nespresso has influenced the purchasing of coffee. It will be far more sophisticated, and less subject to product substitution by the consumer than the Nespresso process. This will be because the systems will provide complete supply solutions in a way that makes our lives easier. The technology and purchasing will disappear into the background, and it will be too much effort to change them. This will solidify our habits

Secondly, technology developments at the consumer level will facilitate the use of information in a way that has not been possible to date. This will increase the value of influencers. Additionally, new technologies will provide more detailed, and continual information about the products we purchase.
The combination of these two changes will alter the advertising and distribution models for consumer goods.

Jeff Bezos has long been famous for stating that “your margin is my opportunity”.  One of the major margins in consumer goods is marketing and advertising. It is the reason why branded products can sell at much higher margins than home brands. What if Jeff Bezos (and others) can eliminate most of the advertising costs. Statista has estimated that global advertising costs in 2017 will be US$547.37 billion. That is a hell of a margin to take advantage of. Statista has also shown that advertising has been steadily growing. This is happening even while digital advertising takes over from more traditional methods. This means that I am bucking against that trend so let’s look at the logic of how it might happen.

Last week CNET published an article on a concept scanner from Bosch (pictured).

bosch-x-spect-wand-7

The X-Spect scanner is a combination of two optical scanners. Together they are able to determine which stains are on your clothes, and how they should be washed. It does this by uploading the data it creates from the scanner to the cloud. An algorithm then determines the result which is sent back to the scanner. You can then send the washing instructions to your washing machine. It is not a long leap from that process to Bosch having partnerships with laundry detergent companies. Bosch will recommend, direct order, and deliver three or four varieties of detergent to go with several wash settings. Possibly in partnership with Amazon as a logistics back end. The process of washing your clothes will be: scan, separate into piles, press this button and add this detergent for the first pile, and so on. It is not hard to then imagine that the detergent will come in pods like your Nespresso machine and pressing the wash type button will add the decided detergent. As soon as that detergent type is below a certain level in your machine it will be automatically ordered and delivered to you. You do not care about your detergent type, you care about getting clean clothes. Think about Nespresso advertising. Are they advertising the coffee or trying to get take up of the machines to lock you in?

How Stuff Works says that the average life of a new washing machine is 11 years. If the system as described above works, you will hand over your preference for washing detergent to Bosch for 11 years once you buy the system. You are no longer a viable prospect for advertising for laundry detergent on any media. This adds to the fragmentation of audience that is occurring as media choices widen. If less people in a group are valuable to advertise to then you either target them more specifically, or you come up with an alternative model.

This is an extension of the sort of work that Amazon has been doing on the Amazon Dash Button and the Amazon Wand.  Amazon has been making these products free for Prime Subscribers (around 85 million people) by giving subscribers a credit to the Amazon store of equal or greater value than the hardware price. They are doing this in the same way that printers, and Nespresso machines are subsidised. They are chasing the lifetime value of the customer rather than the hardware margin. This is the opposite of the Apple model where the business is designed around locking you into constant high margin hardware upgrades. In Amazon’s case the prize is much larger than printer supplies, or coffee pods. They attempting to capture most of consumers spending on consumables, and consumer goods.
This sort of change drives changes around the retail market:
  • Direct delivery is determined by the technology. The machine will automatically replace its consumables. The button or wand will deliver products to you at the touch of a button. There is no longer any need or desire to buy these products at a shop. This reduces retail volumes at physical shops.
  • The Wand technology is more complex in that it is seeking to create a wider ecosystem using recipe recommendations. This is because food involves more detailed purchasing decisions. If it is successful then the results are similar – your influences and decisions are tied to the Amazon system and their direct delivery.
  • If advertising spend is reduced then Amazon (and others) can use that margin to compete and/or subsidise delivery systems.
So in a world that looks like this what happens to advertising and discovery?
  • First of all the advertising margin for the consumables could be re-purposed to reducing the costs of the hardware. Just like ink or laser cartridge margins are used to subsidise printers. Imagine a washing machine that can do all the things described above but is cheaper than a current model that can’t.
  • Secondly they could be tied to a leasing arrangement where you agree to a forward contract for consumables. The reduced advertising spend reduces your lease commitments.
  • Alternatively more marketing dollars will be focused at the point of purchase of the hardware.
  • fouthly information and influencers may become more important in these decision points.

 

If we look at this third point then obviously our decisions on food products can occur without connections to the technology discussed above. But they will still be mediated by technology. The launch of the Apple iPhone X may represent a tipping point here. The new iPhones have been built with augmented reality experiences in mind. We are already seeing some interesting applications using the developer kit. However, the process of pointing your phone or tablet towards an object to use augmented reality is still somewhat clunky.
What we need to remember is that the iPhone is 10 years old this year. If you compare the technology difference between the new iPhone and the original iPhone the changes are stunning. If we extend out another 10 years to 2027 we are likely to see a similar level of technology differences. We may be in the early stages of technology that powers glasses or contact lenses that can perform augmented reality processes. If this comes true then we will see information attached to every object in the world.
So if we look at food and other consumable goods, easily accessed information changes buy decisions. We are not going to dive down into every piece of information that is available every time we buy something. Most of us are too lazy or hardwired into habits to do that. When we look at discovery and trial of new products or an alternative it does matter. In this area information and influencers will be very important. In a shopping ecosystem like Amazon search is vital for discovery rather than advertising. Jeff Bezos does not want people spending on advertising inside the Amazon store. What drives purchasing decisions is a great search capability, and the capacity to look at the views of people that you trust inside the review environment. What happens if you can access that system and that information any time you are thinking about buying stuff? That is what augmented reality in a more usable form can bring. That can displace advertising.
Which takes us back to my presentation on agriculture. My key message was that information was becoming more and more vital to farmers. In agriculture we are starting to enter an era where farmers will have more and more information. They will be able to see continual streams of data from their land,crops, and animals using systems like The Yield. They will be able to get frequent data from the air using drone systems. Farmers will use this information to reduce their operating costs. At the same time they will be able to communicate more to consumers about their product. That communication can be direct to the consumer for farmers that are value adding their own products. It will also be a requirement of supply chains into larger scale markets.
A lot of people are concerned that the advent of augmented reality in glasses/lens form will result in a polluted visual environment where we are continually bombarded with advertising related to our location and our personal data. Paradoxically this may drive people towards less advertising. The changes i have described here may assist that change.
If I am right then the nature of shopping changes, and along with it the nature of advertising. Along with business models that depend on advertising. It could be a very different world.
Paul Higgins

 

 

 

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The Supermarkets Demise – A Scenario

Back in November I wrote a post entitled: Are The Two Major Supermarkets in Australia Doomed?

If you are at all involved in the retail food chain I suggest you go and read it in full. The short answer is yes, but it will be a slow train crash.

A story in MIT Technology Review last week illustrates one of the possible models that can replace the supermarket model of today:

Autonomous Grocery Vans Are Making Deliveries in London

 

Of course supermarkets will be trying to incorporate such systems into their business model as well but my view is that because of their underlying legacy systems they will find the transition close to impossible.

The story is about a quite limited trial but it points towards a possible future:

“On the back of the vehicle are eight pods, each with a crate that can hold three bags of groceries. The van is filled by human hands from a small distribution center—in this case, a larger Ocado van, which stores 80 of those crates—and sets off following a route to its drop-offs, which is broadly planned in the cloud but ultimately executed by the vehicle. When it arrives at an address, the customer is alerted via smartphone and must press a button on the vehicle to open a pod door and grab the groceries.”

In terms of the final use case:

“Clarke imagines vehicles like these being used to provide on-demand delivery of groceries from a small nearby distribution hub, so that instead of booking a delivery slot customers hail their groceries—when they arrive home from work, say, even if it’s late at night.”

This ties in with an interesting analysis of the IPO for Blue Apron, the food company which delivers meal recipes and the main ingredients for those meals to your door. In that analysis in the New York Times, chef Amanda Cohen theorised that the Blue Apron model may destroy itself. She describes the fact (which went against her initial view) that many people she has spoken to said that the Blue Apron process had given them the confidence to cook more. If she is correct then this means that Blue Apron is training its customers not to need it any more, not a great business model as it means lifetime value of a customer may be severely limited.

The combination of these stories may point to a completely different future. As Amanda Cohen says:

‘” In Hong Kong, many people swing by a “wet market” on their way home from work and pick up the vegetables, fish or beef they’re going to eat that night. Same thing in France, Latin America, South Korea or pretty much everywhere people don’t load up their giant S.U.V.s with giant quantities of groceries to store in their giant fridges once a week. The meal kit model of keeping some staples in the cupboard and getting the fresh stuff as you need it is the market way of doing things”

One of the major problems with food delivery systems and in particular with automated delivery systems is what do you do with the fresh stuff because timeliness and the refrigeration process really matters. This is exacerbated by the fact that people are home at different times of the day or night and cannot necessarily take delivery when the delivery system wants to deliver . Various ways of solving this have been proposed including smart delivery lockers in apartment buildings or the local post office, etc. I can see that models emerging where all of the non-fresh goods can be delivered by an automated delivery system from a small local storage facility where you request delivery when you are home, just like you do when requesting an Uber right now. There may even be discounts for people who take quick delivery so storage space is always available, or people who will take a shared delivery and therefore will wait longer.

If this is part of a wider adoption of driverless cars then it can be part of a larger change. Driverless cars do not need to park, or at least do not need to park in busy or congested areas. I am an advocate for a driverless car adoption model where government or privately owned fleets provide transport as a service and surpasses the personal vehicle ownership model that has dominated the last hundred years. Even if that does not come true individual owners can hire out their driverless car when they are not using it so it does not have to be parked in front of the house or the office, or at the train station.

I I imagine a changed urban environment where mass adoption of autonomous vehicles changes the urban landscape by freeing up parking areas on streets and parking facilities . The freed up space on streets creates the capacity for more foot traffic, and increases in safe bike lanes while, driverless vehicles increase the capacity for people to travel for short trips locally. The parking facilities can be repurposed for storage and/or specialty markets for fresh products.
In that changed local environment we could see a model where large scale supermarkets are no longer the norm, where specialty fresh food stores spring up everywhere within easy travel distance of people’s homes. These specialty stores would be powered by the back end logistics that Amazon creates for Whole Foods, or their competitors (go read Ben Thompson’s excellent post: AMAZON’S NEW CUSTOMER for more details on their strategy) You would pick up your fresh product and speciality items on your way home from work or by a short walk or bike ride, or driverless car ride to the local store. Automated vehicles would deliver the staples to your door on request using pre planned orders or automated ordering systems like the Amazon Dash Wand.

In many areas this could revive the concept of neighbourhoods that really work in urban environments.

There are many ways the supermarket model will be attacked in the future. This is just one possible scenario. Given the pace of driverless car adoption and capacity for the car industry to deliver the full model is still a fair way off. The automated delivery system is not so far off. It fits the four level of automated driving systems by being in a geofenced area (local delivery only from a small storage/transfer facility), and carried out at low speed to reduce the risk of accidents. Full level 5 driving automation where vehicles can go anywhere in all conditions and no driver actions required are a lot further off. That does not mean there will not be continuing experiments with automated food delivery systems.

As Ben Thompson states in his article groceries are about 20% of consumer spending (USA). That is a big prize and lots of people are going to be going after it. Long term an automated vehicle delivery system will be a part of that. How big a part, and in what form remains to be seen.

 

I am writing a book on the adoption of driverless cars with Chris Rice entitled Rise of the Autobots: How driverless vehicles will transform our societies and our economies. Follow me here or on Twitter for more updates as we write and publish.

Paul Higgins

 

 

 

Are The Two Major Supermarkets in Australia Doomed?

Yes but it will be a slow train crash

Following stories in the Australian Financial Review and News Limited last week (Amazon delays Australian launch to September to include fresh goods and Amazon to ‘destroy’ Aussie retail ) I decided to complete this analysis which has been kicking around in draft form on my system for a few weeks.

It is not just Amazon that is the problem. A combination of threats on margin, volume, and customer traffic is threatening the existing business model of the major supermarkets. Not all have to be successful for there to be major effects. To understand how that is happening we need to understand the business model.

A long time ago I tried to get ex Woolworths Chief Executive Paul Simons to come on board to market Australian Pork by becoming Chairman of the Australian Pork Corporation. That bid failed but something he told me about the supermarket business when we met has always stuck in my mind. Paul told me that there were five things that attracted people into supermarkets and while they were there they bought a heap of other stuff. Those five things were discounted bacon, Coca Cola, Pal Dog Food, fresh meat and fresh vegetables. A quick look at the Woolworths weekly specials catalogue for Victoria for the week starting August 31st (when I first started putting together this article) shows discount bacon, a discounted leg of lamb and a discounted whole duck front and centre on the first page. That is followed by  a full page spread on fridge mate packs featuring Coca Cola and two full pages of double points on fresh fruit and veg.

woolworth special august 31 2016

Source: Woolworths

 

Given that was the early nineties we could probably add rotisserie chickens, specialty pet foods, Huggies, petrol vouchers, and reward points to the list. That does not change the point that there are major group of items that get us in the shop and we buy other stuff when we are there. We certainly might buy half price Edgell Red Kidney Beans when we are there over another brand or product because they are on special but it is not going to get us in the door.

Later I chaired a board where a senior executive of one of the major supermarkets was also a board member. He told me that the supermarkets did not make money out of selling things. Their main two sources of income were the cash difference between when customers paid and when suppliers got paid and selling prominent shelf space to suppliers. While the story is illustrative of the business model rather than a statement of fact it does help understand the model.

If we look at the cash from customers as a source of of revenue then inventory turnover is important. The faster the inventory turnover the more money the supermarkets get in before they have to pay their suppliers.There are various numbers available for supermarket inventory turnover rates. The Inland Revenue Department of New Zealand reports median turnover of 14 times with a range of 10-19 for large supermarkets and grocery stores). The ratio of sales to inventory in the Woolworths annual reports 2011-2015 vary from 12.46 to 14.81 although these are affected by their non supermarket sales. Because this is not an investment analysis I think that it is safe to assume that the inventory turnover for Woolworths and Coles supermarket business would be at the higher level of the IRD estimates. If we use 16 x turnover that is equal to turning over inventory every 22.8 days. If the average payment terms to suppliers is 90 days (personal experience) that means that on average the supermarkets have customer cash for 67 days before they have to pay suppliers. With daily sales of  Australian Food and Liquor of $115.4m that is a whole lot of cash in the bank. Of course lower interest rates will have damaged the revenue the supermarkets receive form having that cash on hand.

When we look at paying for products to be on shelves and supplier rebates it was reported in The economist last year that In Australia supplier rebates had boosted margins for the major supermarkets by 2.5% point to 5.7% over the past five years (Buying up the shelves)

The other part of the business model puzzle is that the supermarket business is generally a low margin business once all costs are taken into account, although margins in the Australian market have been higher than the rest of the developed world. The Woolworths five year financial summary  to 2015 shows that margins for the Australian Food, Liquor and Petrol operations have been between 6.63% and 7.20% before interest and tax. While this is generally a low margin for businesses it is 30-42% higher than the margins in the Woolworths New Zealand supermarkets in the same report.The margin before interest and tax for 2016 fell dramatically to 4.43% as Woolworths lowered prices to compete with Coles and Aldi. The margins before interest and tax for Coles supermarkets in 2016 and 2015 were 4.73% and 4.67% respectively ( http://www.wesfarmers.com.au/docs/default-source/Quick-guides/2016-full-year-results-shareholder-quick-guide.pdf?sfvrsn=2).

While this net margin is quite low the gross margin is much higher For example the gross margin for Woolworths was 25.37% and 26.19% for 2016 and 2015 respectively ( Woolworths Financial Reports (pdf )) .

The gross margin is essentially sales minus the costs of purchasing goods for sale. This means that the difference between gross margin and net margin is all the other costs such as property leases, energy, staff, etc. This is a critical point because it means that the contribution to profit of the last customer or the extra sale is much higher than the average across the business. What this means is that if I drive down the road and turn left to shop at Woolworths or turn right to shop at Coles the loss in sales to the one I do not choose is very high. Whether I turn right or left both those businesses still have to pay their staff, pay their energy bills, pay their property leases, etc. That means that if roughly 18% of customers disappear and they cannot adjust their costs then their profit disappears, and adjusting high fixed costs like leases, staff and energy is very difficult.

The same applies to sales volumes. If the same amount of customers go through the door but buy 18% less in volume the supermarkets do not make 20% less profit, they make virtually nothing if the same costs structure remains in place.

So the supermarkets run a high turnover, low margin, high fixed cost business where they make lots of money on inventory turnover and payments/rebates from suppliers. This gives is the basis to look at their strategic future. Attacks to their profitability can come from primarily three points:

  1. Lower margin business forcing them to reduce margins as Woolworths has done in 2016 to combat the threat of Coles and Aldi in particular. This may be extended further in a major Amazon push into fresh produce.
  2. Customers being drained away so the high costs structure causes problems for profitability.
  3. Customer numbers staying the same but buying less every time they go to the supermarket.

Lets look at each of those individually:

Customer numbers staying the same but buying less every time they go to the supermarket.

This is the most serious threat to the long term viability of the supermarket businesses. The threat is analogous to guerrilla warfare or asymmetric warfare. Only some of the attacks need to be successful for the supermarkets to be in trouble. People will still go to the supermarket but there purchases will be reduced.There have been lots of efforts to look at direct delivery models with varying success but we are now reaching the point where multiple models are developing that have a good chance of being successful. This is devastating for the supermarkets because if 40% of people reduce their purchases by 30% that is a 12% reduction in  overall sales. But the supermarkets will still have to operate their existing business model to retain the other 60%of customers  as well as to be able to retain the people that have reduced their purchases but are still coming into the store. Lets look at some of their threats:

Dollar Shaver Club

dollar-shaver-club

These guys run a direct delivery service for razors direct to your door. They combine an irreverent marketing attitude with social marketing that gives you free blades if you recommend a friend.  They promise to reduce your costs of shaving and take all the friction out of the process. I don’t use a razor any more as I use clippers to manage my George Clooney like designer stubble, but if I did use razor I would sign up today – no longer buying that product from the supermarket. A small individual purchase perhaps but they start to add up.

Blue Apron

blue-apron

Blue Apron promotes direct delivery of all the ingredients you need to prepare a healthy great tasting meal. I met with one of the Nokia trends scouts in Austin Texas a few weeks ago and she is an avid fan. As Blue Apron delivers the exact amount she needs to make a meal there is no waste and she said that the service is not costing her any more money than shopping for the ingredients. It is estimated that Australians throw away about $8 billion dollars of food a year (fact checked by the ABC) so certainly there is a cost saving there. While they are not yet in Australia the business model is one that is easily transferable here.

Youfoodz

youfoodz

Youfoodz is a company that will deliver a week’s worth of fresh (non frozen) meals direct to your door in Australia. You can choose all meals or a proportion of meals and snacks. I have done a cost comparison on their service and while they are slightly more expensive than making your own food for quality meals the difference is not large. Again there is no waste and for the time poor there is no shopping or preparation to be done. For people working long hours or running their own businesses where more time means more money this is a very viable alternative.

Amazon Dash

amazon-dash-button-washing-machineAmazon Dash is a programmable button that you can put in your house. The example here is one of putting one on your washing machine so that when you run out of washing powder you just push the button and washing powder is delivered into your house. It takes all the friction out of buying and I imagine them building in services integrated with Alexa (the interactive home system) so that rather than just buying your normal brand the system can queue up order requests and talk to you about special offers, etc at your convenience. Once adoption gets high enough then Amazon can use its considerable logistics and information system to package up multiple orders, supply weekly orders based on your usage, and give you special offers.  It has not really caught on yet but the system is adding more and more brands and Amazon is pushing it out to more countries (Amazon triples Dash Button brand lineup, orders surge 75% in Q1  andAmazon brings its Dash buttons to the UK, Germany and Austria for ordering staples with one touch). It has the smell of a long term strategy to harness all of their capabilities into an offering that makes sense, especially for dry goods.

So if we think of an example household of an above average income couple (the most attractive customer) that are busy with work or their own business you can imagine a combination of all of these services. They use a service like Youfoodz to have a couple of meals pre-supplied on their two busiest days of the week when a combination of work and commitments for kids activities have them stretched. They use a service like Blue Apron once a fortnight for a lunch or a dinner where they want to cook but want to eat healthy and not think about recipes or shopping. They use Dollar Shave Club for monthly supplies of razors. They install Amazon Dash buttons for washing powder, toilet paper, paper towels, dish washing liquid, and cereal and it all gets delivered. Gradually Amazon influences them through their Alexa to buy more dry goods because the marginal cost of freight is so low the system is cheaper. Convenient and lower cost is a killer combination.

They still go to the supermarket they always went to but slowly but surely the amount they buy there until it is down to 50%. Some families at that level then start questioning the trip to the supermarket and start changing their total shopping habits.

The problem with all this from the major supermarkets point of view is that they don’t really have a strategic response that makes sense because of their legacy model. They cannot abandon the majority of their customers so their model stays the same and their margins get steadily eroded.

If they reduce stock lines then they slide more towards an Aldi/Costco model and they don’t want to go there. If they move to more and more online systems they can sort of compete but they still have to supply their standard customers and that model is based on big stores based in solid catchment areas. If they close one of them or move to a small store model a lot of customers probably end up with their competitor who did not close. So neither wants to be the first to do that. It is a little like the banking branch model problem. Less and less transaction are being carried out in branches but people will not travel far to conduct those less frequent transactions so banks keep branches open for fear of losing customers.

At every step of the way their business model is eroded:

  • Lower customer traffic/less spend per customer reduces cash held in the money market.
  • Lower customer traffic/less spend per customer erodes margins as there are less customers/customer dollars to spread non cost of goods costs over.
  • Lower customer traffic erodes the capacity they have to charge for shelf space. It is a bit like television advertising rates. If you have less eyeballs watching your shows you cannot charge as much for advertising.

The final straw in this nightmare scenario for the major supermarkets may be Amazon moving its vision to applying its impressive logistics and intelligence systems to support a national network of independent specialty shops. This is where the high margin customer of the future, who has already reduced their supermarket purchases as described above, may be headed. If that is the case then the major supermarkets are caught trapped in a legacy business model they cannot get out of and assailed on all sides.

Only 5% of each attack has to be successful. No-one has to destroy them.