Amazon set for rapid Kiva deployment - the robot race is on

As outlined in this GeekWire article Amazon recently announced it expects to have 10,000 Kiva robots operating in its warehouses globally by the end of the year, up from around 1,000 currently. CEO Jeff Bezos did not elaborate on the reasons for this massive ramp-up in automation, but a spokesperson for the company said it will not affect employment levels or the rate of hiring in the warehouses. 

This move towards goods-to-picker technology is consistent with reports of Amazon's plan to extend its Fresh grocery business to 30-40 US markets this year, supported by a major re-organisation of its distribution network and fulfillment model (see our blog on 21/3/14). Improved picking efficiency is an essential part of this strategy. 

Kiva, which Amazon bought just over two years ago, has a number of drawbacks compared to other existing and planned automated grocery picking systems. Most notably, it is generally only cost efficient to operate at ground level, which makes it far less space efficient than multi-level solutions used by Ocado and Tesco in the UK, for instance. Kiva's robots are also relatively slow, which limits throughput rates. However, we estimate Kiva's autonomous robots could enable Amazon to roughly triple its current pick-rates of 100-150 items per person per hour. Amazon also has the advantage of being able to deploy this technology at cost, instead of paying Kiva's high gross margin, and the ability to develop future enhancements to optimize its utility in their applications. 

So now we can see Amazon starting to execute its strategy of using Fresh to deliver more products more frequently to more people, which will justify the operation of its own delivery fleet (at least in urban areas) and hence enable it to provide next and same-day delivery at a lower cost. This will further erode one of the main advantages of physical stores - immediacy.

All the more reason for brick and mortar food retailers to start considering how to automate online order fulfillment, if they haven't already done so. The good news is that Kiva is not best in class, even by the standards of what is currently available today, let alone what is being readied for tomorrow. 

Running faster to stand still

Food retail is a fiercely competitive business that demands consistent execution of numerous complex processes in order to get the right product in the right place at the right time, at the right price. It is also very people-intensive, requiring excellent soft management skills. The growth of new channels, notably premium/natural, limited range discount and online, is starting to put even more pressure on mainstream operators' profit margins. The normal response is to accelerate existing cost-cutting, store renovation and organisational change programs.

The problem with this approach is that it prevents companies from testing or even thinking about new ways of responding to the changing market place. Managers are so tied up with the immediate demands of ensuring the basics continue to run smoothly, while attempting to implement the latest new initiative, that they simply have no time to prepare for the future. The result is an industry that is increasingly playing catch up with itself and its customers. 

Now is the time to think about how to get off the treadmill, and to reconsider a self-service model of grocery retailing that is nearly a hundred years old. This will require vision, bravery and greater appetite for risk. However, running faster just to stay still may be the riskiest strategy of all. 

How online's "endless aisle" affects balance of power in grocery market

Given the imperative for supermarkets to maximise the productivity of their limited physical selling area, it's not surprising that suppliers have to fight so hard and pay so much to secure shelf space. The downside for consumers - and inevitably retailers - is that this can lead to product ranging being determined more by suppliers' ability to pay for the space, through slotting fees or promotional rebates, than customer preferences. This problem is exacerbated when buyers and store staff are not given sufficient training or incentive to properly understand the products they are providing to customers.

A recent meeting with a small, niche producer of fresh pasta to the UK market highlighted how the balance of power can shift once the selling area constraint is removed, as is the case with pure online grocers such as Ocado or Amazon Fresh. As warehouse space is so much cheaper than retail, these operators can make specialty products available to a far broader range of customers at marginal extra cost.

As Mark Garcia-Oliver, founder and MD of The Fresh Pasta Company, says "Online unleashes the power of the product, where the success of the product is defined by the end consumer and not by the retailer." Indeed, part of the attraction of Amazon Fresh's current offering on the West Coast of the US is its extensive selection of products from local specialty food suppliers, in addition to standard grocery items. This is surely good news for consumers and small suppliers, but could present new challenges for traditional food retailers, especially those that pick their online orders from stores. 

Click & collect vs home delivery

According to a recent report by strategy consultants OC&C, growth in the volume of non-food orders made online for collection at store is set to surpass those delivered to the home in 2015, by a margin of 53m vs 38m.  This is not surprising given that the proportion of Tesco.com's non-food orders that are picked up in-store has been around two-thirds for several years. More interesting perhaps are recent efforts by the major UK supermarket operators to accelerate the growth of click and collect for groceries, mainly by adding drive-through locations at stores. Asda, Waitrose and Tesco are also experimenting with temperature-controlled lockers at stores and car park pick-up pods.

Grocery click & collect makes sense for customers who do not want to pay a delivery fee, or wait at home, or like the option of choosing their own fresh food in-store. It also means retailers do not have to subsidise delivery costs, making click & collect less margin dilutive (despite the service being generally free in the UK) and potentially more revenue accretive than home delivery. However, it still leaves brick and mortar grocers with two major longer term problems.

First, the incremental cost of picking orders rises significantly once the volume reaches a level (c10% of a store's sales for Tesco, higher for outlets with lower sales densities) that requires fulfillment to be transferred to a dedicated facility, or "dark store".

Second, as we've mentioned before, pure online grocers such as Ocado and Amazon Fresh may well be in a position to undercut brick & mortar supermarkets on the price of both delivery and products as they scale up their operations. This is a possibility that few traditional supermarket chains appear to be considering seriously - it's much easier to dismiss out of hand or simply ignore, especially given the difficulty of just keeping up with the current pace of change. However, it's worth noting Redburn, a leading European independent equity research house, is forecasting that Ocado's return on capital will be over three times higher than the sector average in five years' time. This sort of mid-long term forecasting carries a high level of uncertainty and may significantly overstate the potential of the pure online model. However, it's also worth noting that Redburn has called the stock perfectly in the last 12 months, putting a buy in May last year at just over 200p and cutting to Neutral when the price surged to over 600p earlier this year. Also, their forecasts do not allow for Ocado's future fulfillment centres to become smaller and more scalable, which would lower distribution costs and make its technology and services easier to sell abroad; nor do they factor in improved capital efficiency. These are both key strategic goals for Ocado. 

Tesco's announcement a few days ago that it will be cutting the price of one-hour delivery slots in the UK to as little as £1, along with more price cuts on commonly purchased items, represents the classic way for a market leader to deal with competition from smaller players. However, it may just end up driving more people online, which is ultimately bad for the economics of the largely fixed cost brick & mortar model and good news for pure online operators. 

In the end the question is not whether click & collect will become more popular than home delivery for groceries. Rather it is whether traditional supermarket operators can find the time and mindset to look beyond current issues and take much bigger, bolder steps today in order to be better positioned to meet the even greater challenges of tomorrow. One of these steps involves combining click and collect with a vastly improved in-store experience (Novastore). 

Tesco - too little too late?

Along with a 6% fall in underlying profits for its financial year ending February 2014, £1.3bn of asset impairments and goodwill written down, and a 3% decline in same store sales for the fourth quarter (vs -1.3% for the full year), the UK's largest retailer Tesco today announced it will be stepping up investment not just in price but also in service. This includes specialised courses for staff working in meat and produce. 

Last year Tesco put hundreds of staff through special Silver and Gold fishmonger courses that covered fish sourcing, processing, preparation and cooking. This gave the people working on the counters greater confidence when talking to and advising customers, resulting in mid-single digit sales uplifts. I was fortunate enough to be invited by Tesco to attend one of the Gold courses down in Cornwall last year, and was able to see for myself what a positive impact it had on not just attendees' filleting skills, but perhaps even more importantly their motivation and feelings about their employer. The course was run by Tesco's fish specialist, who is also President of the National Federation of fishmongers and a really nice guy, assisted by his teenage son, a true fish geek (in the best sense of the word). I also got to meet Sam, who catches most of Tesco's sardines (one of the healthiest, local, most sustainable and cheapest fish varieties sold in the UK), as well as one of their main fish processors/suppliers. The relationship between Tesco and its fish suppliers seemed to be one of genuine collaboration and mutual respect - the opposite of stories of bullying and short-termism one sometimes hears about the way Tesco and large retailers treat their suppliers. 

While it's good to see Tesco investing more in training, it needs to go much further and faster, given the extent to which its market share is being squeezed by the German hard discounters, the trend away from large out-of-town stores towards convenience, as well as increasing sales cannibalisation and margin dilution from the online channel shift. It is also possible that pure online operators such as Ocado and Amazon Fresh will become significantly more profitable than brick and mortar operators as they scale up and technology improves, enabling them to undercut on price. Enabling and empowering staff to provide a new kind of in-store experience is surely the best defence against such threats. 

Proof that you earn more by spending more ... on staff

A recently published book "The Good Jobs Strategy" by MIT Sloan professor Zeynep Ton explains how "the smartest companies invest in employees to lower costs and boost profits". The four that are held up as models - Costco, Trader Joe's and QuikTrip in the US and Mercadona in Spain - are part of a very small group of retailers (we would also include Wegmans) that treat staff as assets to be nurtured rather than costs to be cut. By paying their staff more, ensuring there are more than enough on hand to do the job properly, and investing more in training, they end up delivering consistently superior customer satisfaction and value, which translates into consistently superior financial results. 

Despite such a clearly positive correlation between greater investment in labour and productivity, the majority of food retailers remain stuck in the "staff as a cost" mindset. The author interviewed many store managers at various retailers who said that the pressure to meet short-term performance targets led them to reduce employees even though they knew that the workers who remained would cut corners and make mistakes, and they suspected that this could hurt sales and profits. This is exactly what led to Tesco's decline in the UK in the latter years of Terry Leahy's reign as CEO, which is proving so difficult to reverse today. 

As a (presumably little-read, long forgotten, or just plain ignored) study by the Coca Cola Retailing Research Council has pointed out, cost reduction is so ingrained in supermarket management’s thinking that it seems not so much a strategy for productivity improvement as the only strategy.

However, it is worth remembering that instead of decreasing the amount of input relative to output, it is also possible to raise productivity by increasing input in such a way as to increase output proportionally more. Humans - assets Jeff Bezos has reportedly described as "annoyingly variable" - respond particularly well to this approach, especially in a low-paid industry such as food retail. This is the basis of our unique "SEE" method of taking in-store service to a new level while reducing staff cost ratios. 

The ideal solution would be to combine both methods of raising productivity, using robots to do boring, repetitive tasks (such as re-stocking and checking out) more cost-effectively, and investing more in training staff so they are able and willing to offer informed advice on food preparation, storage, and nutrition.  This is the basis of Novastore, a semi-automated store concept combining the best of the online and in-store experience. 

Amazon Fresh "ready to rollout to 30-40 cities in 2014"

According to This article in DC Velocity magazine published on 12/3/14, Amazon is set to roll out its Fresh grocery business to 30-40 US markets this year, supported by a major re-organisation of its distribution network and fulfillment model. The article, which quotes a supply chain consultant with close connections to Amazon and has been corroborated by other industry sources, confirms Amazon's strategic intention to combine delivery of groceries with general merchandise using its own fleet of trucks to lower distribution costs and improve service levels in urban areas.

Meanwhile Amazon is working hard to integrate Kiva's automated goods-to-person picking systems in its warehouses. This should enable it to achieve the kind of pick rates necessary for grocery order fulfillment - i.e., at least triple the 100-150 items per hour it manages with traditional person-to-goods picking. By lowering fulfillment and distribution costs in this way, Amazon could soon be in a position to offer fast, efficient and low-cost grocery delivery to around half the US population. Are you ready for that?