Ocado’s ‘Sci-Fi Ballet’

Ocado is often thought of as an online alternative to incumbent food retailers. But the operational sophistication, backed up by 400 programmers and a clutch of patents, reveals a business that is taking a very original approach to grocery.

Ocado is an online supermarket, founded in London in 2000 by three former investment bankers who sought to fundamentally change the way people shopped for groceries.

Tim Steiner, CEO and founder of Ocado Pictures by Glenn Copus
Tim Steiner, CEO and founder of Ocado

Superficially, the Ocado value proposition is that of the wider ecommerce sector, offering range and convenience through reliable online ordering and delivery. However, what differentiates its business model – for example, from Amazon Fresh or ‘taxi for grocery’ players like Instacart – is its operational sophistication.

Rather than rely on third party stores and delivery infrastructure, as many competing services do, Ocado has developed a capital intensive operating system that allows it to out-compete incumbents and challengers alike in terms of reliability, range and convenience. At scale, the cost advantages of such an operating model drive a virtuous circle of operating leverage, investment and innovation in the business. Despite some challenges in its technological development, the company is expanding across the UK, has signed a fulfilment deal with a major UK retailer, and is likely to strike a deal to license its IP with a major retailer in Europe or the US in the near future.

Operations

ocado2

To understand the operating model, the company’s first market, London, serves as a good example.

  • Inbound trucks deposit food directly into the company’s main warehouse, situated 20 miles outside Central London.
  • Once unloaded, food is sorted into categories, and loaded onto conveyors which whisk items to the relevant ‘aisles’ (e.g. meat is kept in a chilled area of the site; fresh groceries are stocked in another cooled area). All SKUs are tagged and sorted by product type.
  • When an order is placed by a consumer, a one hour delivery slot is offered instantaneously based on predictive algorithms.
  • At the same time, pickers select items from shelves and loaded them onto conveyors; items are then sent to be bagged.
  • The algorithms developed by Ocado’s 300 developers ensure the vast network of conveyors can group orders which sourced from the warehouses various departments into a single batch by the time they reach the bagging area.
  • Here, orders are deposited into plastic bags by an automated machine, and loaded into plastic crates. These are lifted into trucks, which drive to one of Ocado’s ‘spokes’, situated at strategic points around London. While throughput times vary according to shelf life, fresh goods can pass from an inbound to an outbound truck in 2 hours.
  • Once at the ‘spokes’, trucks load into smaller vans, which complete deliveries on pre-automated routes optimised for time. The operational precision is such that crates are loaded in the same sequence as the order route: a driver simply has to pull out the next crate, knowing it will be the next one on the delivery route.

This short video details some of the technology behind the Ocado operation. In the words of one reporter, to watch the operation in action is like having a seat at ‘a kind of sci-fi ballet.’


How do the business and operating models support each other?
The business model – to deliver leading customer service, range and convenience – is supported wholly by the innovative operating model. Ocado has relatively small overheads compared to peers, will enjoy tremendous operating leverage as it scales, and has a production and distribution system that is rapid and flexible enough to deliver excellent service at a price point that will be able to become more competitive as time goes on.

The capital intensity and the focus on intellectual property and innovation are at the heart of the company’s success. The company has spent 15 years iterating on its model, developing solutions in-house, and sustaining losses in order to achieve a competitive advantage over other retailers in terms of delivering the key value proposition to consumers. This translates into 99.3% order accuracy, and 95.3% on-time delivery.

While the ride has been rough for investors, who endured a decade of operating losses, Ocado’s long term approach appears to be finally paying off.

Sources:

  • Ocado’s customer website: www.ocado.com
  • Ocado’s corporate website: http://www.ocadogroup.com/investors/results-centre.aspx
  • Financial Times coverage: http://www.ft.com/cms/s/2/64e18c6c-8144-11e5-8095-ed1a37d1e096.html#axzz3t08vJZxq
  • Metro (UK newspaper) coverage: http://metro.co.uk/2013/07/08/xbox-controllers-and-19-miles-of-conveyor-belts-inside-ocados-warehouse-3867993/
  • Telegraph (UK newspaper) coverage: http://www.telegraph.co.uk/finance/newsbysector/retailandconsumer/11376182/Ocado-to-open-fourth-distribution-centre.html
  • Own research (site visit, 2013)

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4 thoughts on “Ocado’s ‘Sci-Fi Ballet’

  1. Interesting piece. I hadn’t heard of Ocado before, but find the points you list on its operational sophistication to be really interesting. You mentioned Instacart (which I use here in the US) and Amazon, which launched Amazon Pantry in the UK in mid-November. Do you think that Amazon Fresh is replicable (as “Pantry”) in the UK market and could their size force Ocado to start thinking about competing on price earlier than expected? Separately, I read some commentary on Amazon Pantry that mentioned that UK consumers are particularly loyal to supermarket label products. How does this impact Ocado in the long-run? Do you think other online grocer services grow the market for all players or do you think that Ocado’s operational efficiencies actually make it harder for others to enter?

    1. Hey – thanks for the comment. My understanding is that Amazon have struggled with Fresh – this complexity of warehousing and delivery is not their core competency. On the warehousing side, the negative press about their warehouse conditions for employees is in stark contrast to the high degree of automation at Ocado. Amazon don’t have conveyors and robots, just loads of very unhappy minimum wage employees who get fired if they don’t cover enough miles in a day. On the routing side, Ocado has a neat hub and spoke system and proprietary routing algorithms, which enable it to obtain the order density necessary to spread the cost of delivery across users – again an area where competitors who are accustomed to 3P/decentralised delivery (Amazon, Instacart) have a disadvantage.

      On the supermarket label products, I’m not sure that’s right – I think own-brand is viewed less favourably than branded product. But Ocado can be agnostic about this – it can either continue developing higher margin own branded products to sell directly, or it can pursue more partnerships with UK (and international) partnerships to license its IP and work along the lines of a ‘Whole Foods Online, powered by Ocado’ model. The margins are fine either way.

      I do think the head-start Ocado has got is pretty formidable; however, they have been helped in the UK by an incumbent oligopoly that has been price-gouging consumers. There’s now a price war, driven by brick and mortar discount retailers who have entered the market from Germany. So it will be interesting to see the company’s response to this tougher climate. However, they remain the foremost online-only operator in the world’s densest e-commerce market: I’m comfortable in the longer term they will continue to be the primary beneficiary of changing consumer habits.

  2. Great post and discussion. It would be fascinating to do a real detailed comparison of how Ocado and AZN compare in their operating strategy and how each supply chain is designed for operating model focus vs. breadth. I agree in that it seems like they are optimized around different problem. I haven’t seen really useful research on how one can stretch the focus of a supply chain across different dimensions… sounds like a fantastic research project. Let me think about this… 🙂

  3. Nico,

    Thanks for sharing it!!

    As a former Ocado customer and fan it is great news that they have been able to turn profit after many years.

    I also enjoyed a lot your discussion on the operational sophistication that Ocado has been to build. Business models such as Ocado as you suggest are so much capital intensive and require so much patience but then they become totally uncomparable to other competitors in the grocery sector (Instacart can be a product competitor but it is in my opinion totally on another business side).

    Marco

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