Tesco bids for a virtual supermarket sweep

The supermarket giant already dominates Britain's grocery market, and has signalled its intention to do the same online. James Thompson looks at its prospects

Tesco has turned the screws on the online grocer Ocado by opening a huge delivery facility in north London, as it closes in on grabbing half of the market for food on the internet. The 115,000 square foot facility in Enfield is not only Tesco's fourth so-called "dark store", but is also its most automated to date, which enables staff to pick twice as many products an hour as the existing three virtual stores.

Ken Towle, Tesco's director of internet retailing, said the retail giant now has 48 per cent of the UK online grocery market, based on Kantar Worldpanel data, and it expects overall demand to double over the next five years.

Its huge market share lays bare the challenges faced by rivals including the second-biggest player Asda, Sainsbury's and particularly Ocado, the Hertfordshire-based specialist that delivers the bulk of its revenues inside the M25. Ocado, which floated at 180p in July 2010, has never made a profit in more than 10 years.

Clive Black, an analyst at Shore Capital, said: "Tesco is not going away and is seeking to get better at online grocery and that is constraining for Ocado. Sainsbury's and Asda are also growing faster online than Ocado, and Waitrose is now delivering within the M25. We believe that Ocado is largely Waitrose on wheels."

He added: "What Tesco is doing in London is taking much more of the market in areas where it can deliver from these dark stores, which have demonstrably lower capital expenditure deployed than Ocado."

Tesco has invested up to £30m in the Enfield facility, which is roughly in line with a big store development. Its core, online grocery model remains picking in nearly 300 stores, and its first dot.com-only store did not open until 2006 in Croydon, south London.

The latest site in Enfield provides a much higher level of automation, with conveyor belts dispatching trays to pickers, who have handheld devices strapped to their arms, to fulfil orders from 178 stations. In the other dark stores, pickers move around with a trolley.

Another difference is that the Enfield facility delivers all of Tesco's 26,000 groceries, as well as a full range of prepared foods, such as sliced cheese and meat, from its deli counters.

The site's biggest vans, which run on compressed gas, are also able to hold enough orders to remain on the road for an entire shift, as opposed to returning to collect additional orders during the day.

Overall, the Enfield site demonstrates the importance of online to Tesco, which issued its first profit warning in 20 years last month and suffered a 2.3 per cent fall in UK underlying sales over Christmas. This contributed to its share of the physical grocery market falling to 29.9 per cent recently.

But there are no such problems online. Tesco's UK online grocery operation delivered "high single-digit" growth over the six months to 27 August.

Mr Towle admitted the new Enfield facility, which has more than three kilometres of conveyor belts and processes 12,000 food baskets a day, is in Ocado's "heartland".

But he said Tesco had launched the London site and its three other virtual stores in Croydon, Aylesford, Kent, and Greenford, Middlesex, to meet soaring demand in densely populated areas.

Mr Towle said: "As demand rises in urban areas, there will be the opportunity to deliver these type of sites."

The grocer plans to open a fifth such facility in Crawley early next year.

Mr Towle declined to say when Tesco would hit a 50 per cent share of the online grocery market, but said "mathematically" it will happen. "We have got a very strong position in online food market share and we have been pleased to see that, despite the fact we have got the biggest and most mature [operation], we are effectively growing in-line with the market."

Ocado's market share is believed to be about 14 per cent or 3.5 times smaller than Tesco's. An Ocado spokesman said: "As the online market gets bigger, we don't expect to get smaller."

The internet accounted for 3.8 per cent of total grocery spend last year and is forecast to rise to 6 per cent by 2016, according to statistics from the trade body IGD.

Mr Towle said: "We are working on the basis that demand will roughly double over about five years."

A key driver of this demand will be ordering food on smartphones, with people increasingly using such devices to top up their baskets, says Tesco.

Mr Towle said: "One of the big phenomenon of the last year has been the number of orders that have been placed by mobile phones."

Less well-known is that the dark stores, such as the one at Enfield, also help to increase sales in the big stores in surrounding areas, as customers prefer less staff picking in the aisles.

"There is an appreciable improvement in the business stores from where we remove dot.com," said Mr Towle.

With this sort of flexibility and its near-50 per cent share of the market, it's easy to see why in the long term online grocery is more likely to be dominated by Tesco than Ocado.