SUPERMARKET chain Wm Morrison is investing more than £200m in a 25-year deal with online grocer Ocado, as it attempts to catch up with its rivals in the home delivery market.
Bradford-based Morrisons, which trails Tesco, Leeds-based Asda and J Sainsbury in annual sales, has suffered falling profits and market share, partly due to its late entry into the online grocery market, which is growing at about 16 per cent a year.
Morrisons and Ocado said their deal would not affect Ocado’s arrangement with upmarket grocer Waitrose, which is due to run until 2020.
However, Waitrose, which provides many of Ocado’s products, said it had instructed lawyers to advise on whether there had been any breach of contract.
Waitrose, part of the John Lewis group, said it had asked to see details of the agreement between the two companies. “Once we’ve done that, we’ll decide what appropriate action to take,” a spokesman said.
Morrisons, which already sells non-food items online, has held back from selling food because of doubts about the profitability of delivering groceries to customers’ homes. Ocado has yet to make a pre-tax profit in a decade of business.
“We think that the deal is easily a better one for Ocado than it is for Morrisons,” said analyst Philip Dorgan at brokerage Panmure Gordon. “The agreement lasts for 25 years which seems unnecessary to us, given the pace of change online.”
Ocado’s shares have had a rollercoaster ride since the company listed at 180p in 2010. Heavily “shorted” before the announcement by market participants speculating they would decline, they jumped as much as 47 percent to a record 296.8p, valuing the company at £1.72bn.
Ocado’s admirers point to the rapid growth in online grocery, with the UK market expected to double in value over the next five years to £11bn. Ocado has state-of-the-art distribution centres and high customer service ratings.
Sceptics, however, note it has not made a profit since it was founded by three Goldman Sachs bankers in 2000.
Some doubt that its model of filling orders from central depots will ever be as profitable as online operations at grocers like Tesco and Sainsbury, which fulfil orders from existing stores.
Ocado forecast that the Morrisons deal would deliver an annual profit contribution in the “mid-teens millions of pounds”, while Morrisons’ upfront payment of £170m would enable it to pay down its debt of £85m.
It said the deal was a vindication of its business model and could lead to overseas sales of its technology.
“This validation should support the internationalisation of our model as well as the growth of our UK business,” said CEO Tim Steiner.
Ocado entered a small supply partnership deal with French supermarket firm Carrefour in 2011.
Morrisons’ chief executive Dalton Philips said the Ocado deal would help to achieve the company’s home shopping aims, though it was not expected to make money until the 2016-17 financial year.
“This is a Morrisons website, it’s Morrisons food, in a Morrisons van, with a Morrisons driver, it’s Morrisons the whole way through,” he said.
“It’s a very different arrangement from the sourcing arrangement Ocado has where they source Waitrose food,” he said.
Morrisons’ online offering will be serviced from Ocado’s recently opened distribution centre in Dordon in the Midlands.
It will make an initial payment of £170m to Ocado to acquire Dordon and associated equipment, as well as a licence and integration fee.
Morrisons said a further £46m will be invested to expand Dordon to accommodate its range, integrate its systems and establish a delivery network.
The retailer also expects to incur a further £25m of development costs this year.
“The deal gives Morrisons access to, we estimate, around £500m of online sales for an initial outlay of £200m,” said analysts at Credit Suisse.
Morrisons will also pay Ocado annual service costs and a contribution to research expenditure, as well as at least 25 per cent of Morrisons.com’s earnings before interest and tax for 15 years.
When asked whether the service would be rolled out across the whole of Britain from its inception, a spokesman said: “Morrisons has not given that level of detail.”
Catherine Shuttleworth, of retail marketing agency, Savvy Marketing, said: “A combination of Morrisons ‘market street’, and Ocado’s operating platform could catapult them (Morrisons) forward to give them the nationwide coverage which they’ve been unable to achieve through bricks and mortar.”