Dive Brief:

• Kroger announced it has signed an exclusive agreement with Ocado that will bring the British e-grocer’s automated fulfillment capabilities to America and help Kroger compete in the rapidly evolving home delivery market.
• The grocer will leverage Ocado’s Smart Platform technology, which offers online ordering, automated warehouse fulfillment and delivery logistics. The terms of the service agreement are still being worked out, but they include building a network of up to 20 of Ocado’s signature automated fulfillment centers over the next three years, with the first three sites being identified this year. Kroger says it will also increase its investment in Ocado in a subscription rights agreement, bringing its total investment in the company to more than 6%.
• "We are actively creating a seamless digital experience for our customers,” Kroger CEO Rodney McMullen said in a release. “Our partnership with Ocado will speed up our efforts to redefine the food and grocery customer experience — creating value for customers and shareholders alike."

Dive Insight:

Kroger has seen improving results from its Restock initiative, but to effectively compete with Amazon and Walmart in the online shopping age, it needs a transformative deal. It struck out with Boxed and has been linked with a few other companies, including Alibaba, but now comes this — an agreement with the world’s largest online grocer that will rapidly accelerate its automated fulfillment capabilities and position it to compete with Amazon and Walmart.

Ocado has $2.2 billion in annual sales. It serves millions of consumers in England through its pure-play operation. It has also, like Instacart and Shipt, partnered with grocers to offer online ordering and home delivery. But instead of relying on store fulfillment, Ocado uses dedicated warehouses and dark stores that are optimized for picking and packing orders. The company has partnered with Waitrose and Morrisons in the UK, and has accelerated its movement abroad recently with deals in France with Group Casino and in Canada with Sobeys.

Ocado’s technology is dizzyingly complex. Its distribution facilities utilize a network of robots to fill orders, and it has proprietary technology that optimizes everything from delivery routes to customer service procedures. The company currently employs 1,300 engineers, holds more than 200 patents, and spends less to deliver products to a customer than its closest U.K. competitor, Tesco, spends putting those same products on store shelves, chief executive Tim Steiner said in a presentation earlier this year.

This technology is also incredibly expensive and time-intensive to build. But it promises greater efficiency over the long run compared to the store-fulfillment model that Instacart and Shipt offer, according to analysts. After Amazon bought Whole Foods last summer, grocers raced to cement deals with both services, and both now offer home delivery nationwide.

“Instacart is a good stepping stone for many U.S. grocers because it lets them quickly sell online, using their existing stores,” said Keith Anderson, senior vice president of strategy and insight with e-commerce consulting firm Profitero, in an email sent to Food Dive. “But there are trade-offs to fulfilling orders from stores versus dedicated, automated distribution centers (DCs). Dedicated DCs can be run much more efficiently, perishables are fresher, and online orders don’t disrupt in-store inventory or shopping experience.”

The deal, which comes on the same day Walmart reported a 33% increase in its e-commerce business, will help Kroger compete with the industry’s biggest players. Walmart offers click-and-collect fulfillment from hundreds of stores and has begun offering home delivery in select markets through on-demand services like DoorDash and Postmates. Amazon, which controls 18% of the online grocery market, has introduced Prime Now delivery to Whole Foods stores in ten markets, offering free two-hour delivery to the company’s Prime members.

Kroger currently offers click-and-collect fulfillment from more than 1,000 stores, and has partnered with Instacart, Uber and other services on home delivery in select markets.

“The way for Kroger to beat Amazon and Walmart was to gain a price and supply-chain competitive advantage, and this is what will give that to Kroger,” Brittain Ladd, a supply chain expert and former Amazon executive who Kroger hired to evaluate the Ocado partnership, said in an interview with Food Dive. “This deal greatly reduces their cost and greatly increases their efficiency in meeting customer demand.”

The partnership could have other benefits as well, Ladd said, including helping the grocer expand its footprint in hotly contested East Coast markets.

“Going big with Ocado will greatly reduce costs and complexities in Kroger’s current supply chain,” he told Food Dive. “But it will also allow them to expand into the states where today they have no presence.”

Ocado’s technology could also optimize Kroger’s store distribution system, Ladd noted. Kroger operates 42 distribution centers, which Ladd characterized as outdated, and he estimated half could close if it effectively leverages Ocado’s capabilities.

For Ocado, meanwhile, this deal comes as a major victory after years spent trying to crack into the U.S. market. Grocers have been reluctant to spend the time and money a partnership would require, but speculation heated up after Amazon’s Whole Foods acquisition, and as consumer demand for online groceries is accelerating.

Kroger’s expertise in the U.S. market combined with Ocado’s technology and logistical prowess will be a powerful force in the grocery market. But the companies will have a battle on their hands, particularly in urban markets where shoppers already have several options to choose from.