After weeks of speculation, during which one of Ocado’s distribution centres burned to the ground, High Street stalwart M&S has stuck its neck out and penned a deal with Ocado that will enable it to sell its groceries nationwide for the first time.
It has been dubbed a ‘transformational’ partnership for the grocery sector, and is a characteristic move by M&S’s veteran chairman Archie Norman, who had been expected to be dynamic in his dragging of the retail juggernaut into the 21st century.
‘It is the biggest and boldest moment so far and a game changing moment for reshaping M&S,’ thundered CEO Steve Rowe.
The City is scratching its head as it digests details of a joint venture between M&S and Ocado
But, given the plummet in M&S’s share price in early trading today, not everyone is best pleased about it – least of all its long suffering investors who look set to foot most of the bill.
What’s more, the joint venture means that Ocado will, in 18 months’ time, terminate a near-2 decade long supply contract with Waitrose. That means a lost revenue stream for Waitrose and a potential loss of loyal customers for Ocado.
Have the firms bitten of their noses to spite their faces? Who are the winners and losers of today’s grocery tie-up?
The potential winners
1) M&S food customers
Today’s deal is a coup for lovers of M&S groceries, who have never before been able to buy its products online.
Rowe said today that he had received strong demand from shoppers, urging him to ‘do it’. ‘Customers are all looking forward to getting their Percy Pigs at home,’ he joked.
He added that the deal could mean lower prices for M&S shoppers, as the firm benefits from greater buying power.
M&S may eventually stock some Ocado own-branded products in its stores, giving the customers an entry-price option (should they want it) and a broader range to chose from.
Global Data’s UK Research Director Patrick O’Brien tweeted about the deal as details emerged
But it’s also a mark of commitment from the typically slow-moving M&S in its promise to evolve. Rather than just talking about becoming a ‘digital first retailer’ fit for the 21st century, the firm is putting its money where its mouth is.
It may be well behind some of its rivals – Tesco launched online nearly two decades ago – but it is at least on the right track, with the Ocado partnership coming with the added benefit of the business being fully scaled from day one.
‘Our investment in a fully aligned joint-venture with Ocado accelerates our Food strategy as it enables us to take our food online in an immediately profitable, scalable and sustainable way,’ Rowe argued.
Ocado looks set to benefit from the M&S deal as it frees up cash to expand its tech division
2) Ocado plc
Clearly, this is a great deal for Ocado, which has recently been far more focused on its fast-growing technology solutions business and less interested in mundane UK retail operations.
As the increase in shares in early trading today would suggest, investors are pleased to have divested 50 per cent of that division, which the deal generously values at £1.5billion.
For £750million, M&S has picked up a 50 per cent share of Ocado’s UK retail business, which includes eight UK distribution centres and a fleet of refrigerated lorries, but Ocado still gets to pocket half the profits.
Ocado.com will get a whole lot of new visitors as some of M&S’s 12 million food shoppers try out the new service. And, as Ocado boss Tim Steiner said today, M&S will be a useful partner in terms of filling the gaps in its own product range.
‘We’re not experts in that so M&S innovation teams will help us find the best product,’ he said.
Plus, with M&S providing its 7000 lines, Ocado no longer needs its long-running supply agreement with Waitrose. The termination of that contract relieves Ocado of its sourcing fees to Waitrose, which last year came to more than £15million.
The possible losers
As its contract with Ocado is now set to come to an end in September of next year, analysts are concerned that sales at upmarket supermarket Waitrose will suffer.
It will lose a valuable revenue stream than currently comes through the Ocado platform.
Grocery expert Steve Dresser comments that the joint venture may be bad news for Waitrose
Retail expert Maureen Hinton says that, even with its own online service, Waitrose could be set to miss out on the revenue stream through Ocado
But Waitrose argues that termination of the supply deal will give its own online proposition, which now covers four fifths of the country, a boost.
Rob Collins, managing director of Waitrose & Partners, said: ‘We have strengthened our own online business significantly and said last summer that we will double Waitrose.com within five years.
‘Today’s announcement will be a major part of achieving this and in future Waitrose.com and our shops will be the exclusive places in the UK to buy Waitrose & Partners products.’
Collins said the firm was panning a second fulfilment centre to support growing volumes in London and will have the capacity to welcome ‘thousands more online customers’ by the end of the year.
Waitrose said it will use the opportunity to expand its own in-house online service
2) Waitrose-food lovers
The flip side to this is that, as Ocado dumps Waitrose products for M&S, loyal Waitrose fans may turn their backs on Ocado.
Ocado is taking a risk on customers being happy to make the swap.
Steiner acknowledged that ‘there will be the odd customer who will leave’, but he added that ‘if we were going to make a change in product then there is no better alternative that M&S’.
Shoppers will ultimately have to decide between the Waitrose product, and the Ocado service.
‘There is a high risk of customer leakage as consumers rotate to Waitrose’s in-house delivery service,’ said Neil Wilson from Markets.com. But other analysts argue shoppers will be loyal to the service, rather than to the brand.
3) Perhaps the biggest losers, in the short term at least, are M&S shareholders.
Shares tumbled 10 per cent today after the firm said it would tap investors for £600million in cash, which has been underwritten, to help pay for the bulk of its share in the joint venture.
M&S, which carries a net debt of £1.8billion, has also slashed the dividend by 40 per cent to a level that Rowe said was ‘sustainable’.
‘The deal looks rather like one of M&S’s own ready meals – expensive, not very good for you but easy, quick and ready to heat up,’ scoffed Wilson. ‘Investors were happy with the deal outline yesterday but they won’t be too chuffed that the board is slashing the dividend by 40 per cent.’
Investors are concerned that M&S is over paying, even if it is getting an ‘off-the-shelf, oven-ready online delivery platform’, Wilson adds.
‘It’s hard to see how paying £750million for a bunch of fickle customers will deliver on the promise – it’s certainly bold and it gets M&S in people’s minds for online groceries at last but it just smacks of paying too much and acting too late.’
Bosses of both firms defended the deal
Retail analyst Nick Bubb added: ‘M&S still haven’t proved that they can generate a high enough shopping basket to make Online grocery pay, so this seems a huge leap in the dark for them.’
At a press conference today, M&S’s Rowe fiercely defended his decision and said: ‘We believe we got a fair price. This is not about the short term. This is about the transformation of M&S.
‘I would not go online if it was unprofitable to do so and would destroy shareholder value.’
He reasserted that the retailer was set to benefit from £70million in synergies within three years, mostly through greater buying power, and argued that it was necessary to buy into a joint venture for the deal to be truly ‘transformational’.
‘If you’re just a supplier, you can’t really drive the direction of the company,’ he said.
Steiner said it was a ‘win win’ deal too. ‘M&S is buying a business that’s already profitable and already customers’ favourite. If anything we should have charged them more!’ he said.