Ocado aims to expand and conquer

After a shaky start the Waitrose-backed online grocery service is growing business fast

The cavernous, hangar-size warehouse is oddly quiet, with only a few staff wearing purple and green fleeces working away. But the buzzing sound of technology is everywhere.

Remote-controlled machines take pallets of carrots, Coca-Cola and Pampers nappies from the "goods inbound" bay to precisely the right slot in the four-storey high racking system. Other robot-like machines called "trains" whirr along the racks, guiding human pickers to the right location so they can select each customer's grocery order more quickly and more accurately.

At the front of the building the orders are packed in to bags, put in green trays and lifted in to "pods", lorry containers which are coloured strawberry red, apple green, lemon yellow and blackberry purple, as well as orange. The pods are loaded on to vans which speed away to take the weekly grocery run to homes across the South-east.

Welcome to Ocado, supermarket shopping 21st-century style. There are no shops and no trolleys, no check-outs and no queues. There is just a warehouse in Hatfield, Hertfordshire, and a website which takes customers' orders.

Ocado is one of the most interesting retail businesses currently being developed in Britain. In many ways it shouldn't exist at all. It should have been sunk long ago by the collapse of the dot.com bubble. At first glance its prospects do not look impressive.

Ocado's business model was adapted from WebVan, the American internet grocery business which collapsed after devouring more than £1bn of investors' cash. Ocado's idea of a dedicated picking centre has also been tried and abandoned by larger rivals such as J Sainsbury and Asda.

By contrast, Tesco, Britain's biggest supermarket group, has developed a highly successful home delivery service based on the low-tech approach of picking customers' orders from its stores.

But Ocado is growing strongly. Its annualised sales are currently only £35m, equivalent to the yearly takings of a single supermarket. But revenues are growing at five per cent a week. It recorded a loss of £30m last year on sales of £8m, but Ocado believes it can break even on sales of £90m.

It is also thinking big, very big. Its vast warehouse, which is about the size of the old Wembley stadium, has been built to cope with annual sales of £750m. So far only a third of the space is being used, though the company has already built a full array of refrigeration and freezer kits.

The service currently covers North London and Hertfordshire, as well as a chunk of South-west London and the home counties, which are served by a small loading station near Weybridge in Surrey.

Ocado claims it will cover the whole of the M25 area by the end of the year. The long-term plan is to build five depots round the country to generate sales of £3bn.

The business owes its existence to two things: the brainpower of the three former Goldman Sachs bankers who founded it, and the financial backing of the John Lewis Partnership, owner of Waitrose.

Jason Gissing, the company's chief financial officer, credits the idea of Ocado to Tim Steiner, the company's 33-year-old chief executive. "He was working in the States and looked at WebVan. He thought it would work in the UK better, where population densities are higher," he said.

Mr Gissing is anxious to list the differences between WebVan and Ocado. He says: "WebVan was badly run, had no industry experience, no brand and no partner. They also over-expanded."

Ocado, he says, has the benefit of Waitrose's backing (it owns 45 per cent of the company) which means it can source goods from Waitrose at cost prices, as well as direct from major manufacturers.

The service is highly regarded by the 7,000 people a week who use it. Orders can be placed 24 hours a day for deliveries timed in one-hour slots between 10am and 10pm. Delivery is free for orders over £75. So far the average order is £95, compared with an average basket size of £15 at Waitrose.

Accuracy levels are also high, it says, with the number of products substituted per order running at just one per cent, compared to 10 per cent at Tesco. A new system being introduced by Ocado soon should improve this further.

But can it work? Analysts are sceptical, pointing to the long list of well-funded enterprises which have tried it and failed. One said: "It sounds good in theory, but nowhere in the world has the depot system worked in the sense of actually making any money. My instinct is to be sceptical because the up-front costs are enormous."

Raising money was a struggle, according to Mr Gissing. "We actually had some people laugh at us in presentations. We'd say, it's an internet business and our major competitors are going to be Tesco, Sainsbury's and Asda. They'd say, 'I'm sorry, but I don't think I've got time for this'," he said.

But some serious players did. John Lewis has invested a total of £70m for its 45 per cent stake. UBS, the investment bank, has 11 per cent and Jorn Rausing, the Tetra Pak entrepreneur, has six per cent.

Mr Gissing says: "He said to us that his family benefited in a step-change in the development of grocery shopping when different packaging was demanded by the major supermarkets. He said he wanted the family to be part of another such change."

A modest three per cent of the equity is held by individual investors who provided seed capital at the start, with the remaining 35 per cent held by the management. As well as the former Goldman trio of Tim Steiner, the chief executive, Mr Gissing and Jonathan Faiman, its chief technology officer, these include two former Marks & Spencer directors, Roger Whiteside and Nigel Robertson. The total investment so far is £170m.

The link with Waitrose has caused tension at John Lewis, where staff bonuses have been reduced by the Ocado losses. But John Lewis insists it is happy with the investment and the way Ocado is performing. "This is quite an adventurous deal and a very significant investment for the partnership in to an area we believe represents a very attractive business opportunity," a spokesman said.

There has also been some concern that if Ocado is floated on the stock market, a large slice of the value will go to three bankers who have invested only modest sums. But John Lewis says it was right to spread the risk.

There have been fears Ocado will compete with WaitroseDeliver, which operates out of Waitrose branches. The company denies this, saying the store-based service is aimed at less densely populated areas while Ocado will bring the offer to urban locations where Waitrose is under-represented. These areas include the M25, within which there are only 30 stores.

The challenge for Ocado is to achieve sufficient scale quickly enough to cover its costs without jeopardising standards. That will be the difference between it becoming a successful new business, or just another dot.com casualty.

NET RIVALS HOW THE ONLINE GROCERY SERVICES COMPARE

Tesco: The Big Daddy of internet grocery shopping has always operated from stores. Orders are picked by staff wheeling large trolleys. Tesco can do four orders at once following a computer system.

Two-hour delivery slots.

Delivery charge: £3.99 for off-peak times rising to £5.99 during busier periods. Sales: £447m in 2002-03.

Profits: £12.2m.

Up to 100,000 orders a week

J Sainsbury: Tried a van-style depot system and built warehouses in Park Royal, London, and Manchester but it proved too costly. It closed the Manchester depot and switched Sainsburys2You to a store-based picking system.

Covers 70 per cent of the country and has 33,000 customers a week.

Sales not disclosed. Losses of £29m last year, down from £50m.

Delivery charge: £5.

Asda: Like Sainsbury's Asda has tried and abandoned a depot-based system when it closed its original two fulfilment centres in Croydon and Watford. It now picks 30 from its 259 stores nationwide to enable a more efficient service.

Delivery charge: £4.25 but there's no minimum order. The giant supermarket chain also offers free delivery on online orders priced £99 or more.

Ocado: Operates out of a single depot in Hatfield, covering the western side of the M25 plus parts of Surrey and Hertfordshire. Plans to cover the whole M25 area by the end of the year.

One-hour delivery slots.

Delivery charge: free for orders over £75.

Achieving 7,000 customers a week.

Losses of £30m last year on sales of £8m.