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Could Walgreens Play a Role in Kroger's Ocado Strategy?

Loop Capital analyst Andrew Wolf is watching

Could Kroger’s tests with Walgreens lead somewhere big? In WGB’s “10 Items or Less” podcast, Loop Capital analyst Andrew Wolf speculates how Walgreens could play a role in an “asset-light” solution for Kroger’s forthcoming rollout of automated pick centers with Ocado. Wolf also discusses the lure of retail research, and whether scale is truly necessary for digital success. As crowd noise during recording resulted in a less-than-ideal sound in some places, a transcript follows below.

Jon Springer: This is Jon Springer with "10 Items or Less," the "Winsight Grocery Business" podcast. I’m here today with Andrew Wolf, an analyst at Loop Capital in Boston. Welcome aboard, Andrew.

Andrew Wolf: Thank you Jon. Great to be with you.

You are one of the veteran financial analysts out there. How long have you been doing this, and how did you come to focus on supermarkets and retail business in general?

A little over 20 years. I first was in New York on Wall Street living my dream, then relocated to Richmond, Va., where I learned about how a lot of retailing is really done in suburban and typical markets. I joined Loop Capital a few years ago. Literally, I was in a MBA class and my professor was a marketing professor. He was a big, well-known consultant, [and he] did some amazing research that tied in marketing surveys into financial metrics.

I literally went to him and said, “I’d love to do this with you and then go to Wall Street with it.” He said, “I can’t do that for you. I have a partner. But what I’ll do is I'll write you some recommendation letters.” And I’ll tell you at a job interview, somebody said, “I can't believe this recommendation letter you wrote was so flat!” You know, because most people write their own letter and the professional signs it. I said, “I’ve never seen that letter!” The terms were he would never let me see it. But he wrote a very good letter for me.

I love retail research. It’s a fascinating industry. And to our topic at Groceryshop, I mean food retailing has now become probably the most innovative sector of retailing going on, so it’s really fascinating.

You stole my next question. But let’s just continue with that thought. Probably for the last five, six, seven years, it’s really been changing quite a bit. Was there a moment for you where things changed?

Absolutely. I mean, I’m an admitted Luddite—or I was—about Amazon. And I don’t know about the moment, but it’s somewhere a couple of years ago I realized [that] everything’s changing. And then you come to an event like this and you get to really be in the milieu of it—and more than that, in the mix of it. And it’s accelerated. It’s just an amazing process.

Twenty years ago, natural foods was like this. And it was like, a lot of people didn't believe in it. And I knew, at that time, from my own personal experience, that they were wrong. And that’s what’s going on here. It’s the same dynamic going on. It’s really very revolutionary.

Solving Scan & Go

Right. Here at Groceryshop, we’re hearing a lot about automation, checkout-free shopping, etc. Have you seen any particular technology that strikes you as significant or potentially impactful?

Well, you know, I was just [at a presentation by] Sam’s Club, and believe it or not, they were talking about scan and go, and it sounds like they actually solved it. So you know, scan and go has, sort of, been this, kind of, like, you go into your grocery store, pick up your scanner and you’re like, “Nobody uses it.” Ends up looking like a kind of junky-free-markety-thing, that you wonder what the heck it is. I know, but you wonder if anyone else knows.

But, I think they’ve really solved for that. And that, you know, that’s important because you look at Amazon Go and what they’re doing, the retailers are going to have to use their existing stores and have to come up with something that can somewhat replicate that. Just a few minutes ago, the head of SamsClub.com was talking about that. So, that was one big kind of a light bulb going on. There’s a lot more I’ve seen, some back-end stuff, but I’ll just leave it at that.

At the same time, Walmart’s Supercenters discontinued their scan-and-go tests because there was a lot more go than scan, if you know what I mean. But I guess that speaks to the notion that different stores have different solutions.

It does and yeah, I mean Sam’s has limited SKUs. … They now have the technology, you don’t even need to read the barcode, they can actually figure out [the difference between] lettuce and spinach. And with the limited SKUs in the club, it’s easier to focus on that than on the huge amount of SKUs in the Supercenter. Plus, you don’t have someone at the door seeing what you’re doing.

But, as we’re seeing here today, technology is changing so rapidly, you know, that it’ll be solved. All these things are going to be—not all, but many of them will be—solved through trial and error. And some won’t, to your point. Not everything is solvable.

It would seem to me that the Omnichannel movement has turned out to be a great gift for Walmart because theyve been able to use their considerable investment to really lean into it. And does it follow necessarily then that omnichannel is going to be the thing that separates the well-funded from the less well-funded?

It does at first, because it looks like a scale solution, but I’ve met with a couple private folks in data processing, and in back end and fulfillment, and there’s a distinction going on between a platform solution, which is scale and as-a-service solution, which means we’re going to bundle all this stuff, and just sell you a cloud idea ... the idea of the cloud as-a-service solution in general. And so there is a chance to do that as-a-service solutions can aggregate a lot of retailers, use all the information with the aggregated stuff to get the same solutions for smaller players, and just charge them, a la carte, as a service.

So, that’s something that I am beginning to see. ... You know, you can kind of see the cost of applied technologies going down, but that’s exactly the distinction I learned today, the go-to-market distinctions.

A little bit broader discussion here. Kroger just announced earnings, and it was a good quarter for them. However, it also came with this caveat that they were discontinuing their long-term financial goals for their Restock program, which is kind of a big deal. So, a little bit of a mixed bag for Kroger. What do you expect from them next?

Well, they’re going to have an analyst day, I think Nov. 5th and talk about whatever their views are now, I think for not just 2020, but for beyond. Nobody on Wall Street had estimates close to what they were talking about. So, we already were quite skeptical, so it’s fine. I mean, there wasn't a big expectation built into it. The stock itself didn't even wreck. What it means for them is, they’re just behind on some aspects of what they were planning to do, and they’re going to have to flesh that out for us.

Whether it’s more, do they have to invest more competitively than last year for the Aldi-Walmart phenomenon, is their media plans with advertising and other stuff, alternative revenues as they call it. Is that going slower than expected? Other technology aspects going on. ... They haven’t given us the full panoply, or spectrum, of what it is, but it’s probably a combination, I would imagine.

Where else are you looking in retail? We mentioned Walmart, we mentioned Kroger. You know, who else is capturing your attention as a retailer?

Well, you know, the very first thing I saw here [at Groceryshop] was a big European-based mall developer talking about how they’re putting, at least in Europe, a lot of supermarkets into malls. And right where I live, the Metro West area of Boston, Wegmans came in to the Natick Mall, one of the biggest malls in the country.

And it’s interesting because, you know, they are … very experiential. They realize, if you’re going to get people to come into the store, you’ve got to give them a reason, because the delivery time on home delivery, or click-and-collect, both of those are extremely convenient, and they don’t cost much anymore.

One aspect of experiential retail, like the comingling of having a really good grocer in the mall … they’re making really mini town centers. And then expand that. Just the idea of experiential retail … means a lot. A lot of it is around digitalization, making your trip more meaningful with using mobile devices.

When you mentioned Europe, I immediately thought of small stores in cities. It seemed like a couple of years ago there was going to be this wave of small stores, but there’s been some fits and starts. There's been some brands that tried to take off and did not. And even some of the faster growing guys are seeing their growth slow a little bit in terms of same-store sales, like Sprouts. Where do you see store sizes and small stores in the U.S. going?

Target has talked about that. They seem to be a bit of an exception. I agree with what you’re saying, there’s not a lot of new stores, anywhere.

Whole Foods used to be the big urban new store grower; they’re not public, so we don’t know. And Amazon doesn’t talk to people about much of anything, but we hear that they’re growing a little bit.

In any case, Target does talk to people and they feel as a public company some responsibility to tell people what they’re doing. And they are growing well with smaller stores in urban environments. You can imagine the Target brand resonates very well most places. But they have five stores in Manhattan now: They had only one a few years ago. And it’s a really a small-store concept. The other thing going on with smaller stores, just stores in general is, putting in pick areas, micro-selection areas for grocery and that can be a small store concept.

I’ll tell you one last small store concept that I think is just something to keep an eye on in our industry, is the partnership, if you will, between Kroger and Walgreens. They’re building an Ocado fulfillment center near Orlando. And you know, Kroger doesn’t have stores there, and I don’t know if there's enough home delivery business there to support that huge a center.

So, I’m really looking toward seeing how their new iteration in Knoxville, where they're now testing putting in Kroger mini stores inside the Walgreens, how that’s going to go. Because it just stands to reason that that could be a very big launch—a de facto way to put Kroger physical stores, and digital home delivery, and pickup because you could pick up into Walgreens too, right in Florida in a pretty asset-light way, except for the Ocado expense.

$70 million asset-light!

Yeah, but on the store side, it’s pretty asset-light, if you use Walgreens.

Last question I'll steal from James McCann, who asked Albertsons’ digital SVP this question: Sheds, micro-fulfillment centers or store pick? Do you have a preference? Do you have an inkling as to what’s going to work?

Well, I think he was diplomatic and analytic actually. I mean they’re working with microselection, so that’s the direction they chose. So even though he’s diplomatic about it, that’s what they’re doing. And I think that’s essentially right because America is about a two-thirds suburban country. Most of Europe is one-third suburban, two-thirds urban. So, generally we don’t have the densities to have the larger combo centers. I mean, even Kroger is kind of backing away from the big centers so they can roll them out smaller in the module.

These things are about throughput. And like any other distribution facility, they need throughput to get over, break even and to make money. And, like Walmart was talking about this in a breakout session we did with them and some other analysts, in very small rural markets, it might still make the most sense just to pick at the store. … And then as that gets more throughput, you’ve got to go to at least a micro selection in the back room, because your pickers are going to bump into your shoppers. It’s going to be inconvenient.

And then the economics begin to work. Eventually, with enough throughput, you can do a shed because you've got enough throughput on the system. It’s really volume-based, but right now there’s just not enough volume in most markets. Right now in Manhattan, FreshDirect is, something of a shed operation, but other than that, there’s not enough volume.

Andy, we’re about out of time. I really appreciate you having come on here and come back anytime.

It’s been a pleasure. Thanks, Jon.

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