The staggering challenges of the online grocery business

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The online grocery delivery business seems to get more crowded–and more competitive–by the minute. Tech giants Google and are offering it in some major cities, and so are upstarts such as Instacart, Postmates and FreshDirect. These newcomers are battling with more established businesses such as Peapod, which has been delivering groceries for more than 20 years, and services from companies such as Wal-Mart that allow customers to place orders online and pick them up at a nearby store.

It’s a business that everyone seems to want in on, even though new data show it’s awfully hard to do profitably.

In some ways, the enthusiasm makes makes sense: According to a report from IBIS World, a market research firm, online grocery sales grew at an annual rate of 14.1 percent over the last five years and they are expected to grow at a rate of 9.6 percent between 2014 and 2018.

But look more closely at the report, and you see the major challenges these companies will face as they try to make these fledgling businesses viable. IBIS World estimates that the online grocery business collectively brought in $10.9 billion in sales in 2014. Profit, it estimates, was just $927.1 million, or 8.5 percent of total revenue. By 2018, the researchers project that profit margins will slip to 6.9 percent of sales. In part, that’s because these operators will continue to contend with the high distribution costs associated with getting perishable items to customers.

The report also predicts that big players, particularly AmazonFresh, will play a role in compressing margins for the whole industry. Amazon has often sought to vanquish its competitors by undercutting them on price, and the report suggests that the company may use that tactic in the grocery business, dropping their prices as low as possible and, in doing so, pressuring their competitors to make similar price cuts. (Jeffrey P. Bezos, the chief executive of Amazon, owns The Washington Post.)

Even though it’s a tough business model right now, report author and industry analyst Will McKitterick says companies of all stripes feel they can’t afford not to take a chance on it.

“For larger companies, it’s definitely a process to build the infrastructure, develop the delivery networks,” McKitterick said. “All of that takes a lot of time, and if they miss the boat now, then they’re going to be in a pretty bad position” later on if throngs of consumers take to online grocery shopping.

For all the speculation about how potentially disruptive these businesses are, IBIS World’s report reveals that they so far have a very low penetration in the overall grocery market. Online grocery sales were only 1.9 percent of total grocery sales last year; by 2018, even given the rapid growth the researchers anticipate, online sales are still expected to equal only 2.9 percent of total grocery sales.

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