Internet grocery shopping shrugs off basketcase image

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Five years ago it seemed as though online grocery shopping was going to be everywhere - and that the five main supermarkets would dominate it and make huge profits.

Instead, the sector looks at first sight to be in disarray: only Tesco is making a profit online, while Safeway has withdrawn completely, and others such as Sainsbury and Asda are nursing large losses.

Also losing millions of pounds is Ocado, which is half-owned by the John Lewis partnership and delivers goods for Waitrose. Last year it had losses of £39.1m, according to documents filed at Companies House. Yet Ocado insists it will eventually make money - thinking that is shared by independent analysts who see huge potential in online retailing.

James Roper, of the Internet Media in Retail Group (IMRG), who has studied the sector for nearly 10 years, thinks that online grocery shopping is only just starting to show its power.

"The key is the recognition that transactions used to be about buying things in a store, but the future is that the transaction is about the person buying things wherever they are. They might be online, they might do it through their mobile, they might even be in the store. The thing is, it will all be about me, not my location."

He believes Ocado can turn a profit. "They're going for Middle England: the average online shopping basket is huge. It's a very good model," he said.

And an analyst at Goldman Sachs - the former employer of Ocado's founders - said: "If their population is reasonably concentrated, then they can reach profitability, and then it will grow exponentially."

For Ocado, location and some extras - such as a guaranteed delivery slot just one hour wide (rather than the many hours of other online retailers) and far less substitution of out-of-stock goods - in return for higher prices, are the key to its success.

It operates out of a huge warehouse the size of the old Wembley Stadium in Hatfield, Hertfordshire, and serves customers in north London and Hertfordshire, as well as parts of south-west London and the Home Counties. If those areas seem oddly disparate, it's only geographical; for they are very similar in that they contain some of the biggest-spending, best-off people and families in the country. Think of Wimbledon, Islington and Surrey, and you glimpse the outlines of the stockbroker and solicitor belt.

Analysts can see what it is going to do already: "Ocado isn't going to go for 15 or 20 homes in the same street the way that Tesco does," said one, who asked not to be named. "They're going to pick off the top of the market, the prestige market. And their model works very well."

Indeed Jason Gissing, its chief financial officer and one of the three founders who left Goldman Sachs in 1999 to start the company, is buzzing with excitement. "In August our sales were the equivalent of £35m annual sales; since then it's grown from 7,000 orders per week to 11,000, the equivalent of £50m. And we reckon that once we hit £90m we can break even."

The warehouse in Hatfield is big enough to handle annual sales of £750m. Mr Gissing and his colleagues thought big, which is why they have so far tapped investors for £170m, including £15m from Jorn Rausing, the Tetra Pak billionaire.

Things are not so rosy though for bigger competitors who might be expected to have long since squashed any such start-up competition. Asda made a stumbling start, setting up two warehouses. "I heard the director responsible for it telling a conference in London that one of the warehouses was in 'a place called Croydon' [in south-east London]," says another analyst. "Which just showed how much of a handle they had on it. They closed it all down about six months later, which meant Tesco could just grab all that market share."

Safeway started online shopping in 2001, and then simply abandoned it in June 2002 after a short trial; at the same time, Woolworths shut its own online business, taking a £12m loss. The other supermarkets are still there, but struggling with the problem of how to bring their store system together with the requirement of individuals ordering online.

Mr Gissing points out that Ocado, which buys its goods at wholesale prices from Waitrose (rather than full price, as the ill-fated Webvan did in the US), has huge advantages over any would-be rivals now.

"The barriers to entry in this market are huge; there's only Tesco, Asda and Sainsbury who can even play in it. And you know, grocery retail is a £107bn business.

"We only need a small percentage to go online to be a substantial opportunity."