Q1 2020: How supermarkets are digesting the COVID-19 shock

It’s too early to assess the full financial impact of COVID-19 on supermarkets, but the disruption caused is plain to see: shelves empty only seconds after being restocked and long queues to get into stores and pay. It has been, and continues to be, chaotic to say the least — and behind the scenes is no different. 

COVID-19 is having a material impact on business operations, disrupting supply chains, influencing customer behaviours and stretching workforces. UK-headquartered Tesco, for example, estimated¹https://www.tescoplc.com/media/755651/tesco-plc-preliminary-results-1920.pdf that the impact on its retail cost lines will be circa GBP 650m-925m — depending on the scenario — and cited significant cost increases in payroll, distribution and store expenses. But while supermarkets share the same fundamental building blocks, no two business models are identical. Although each player is encountering its own challenges — and relative opportunities — some common themes have emerged in Interviews with industry experts.

In terms of supply-chain agility, “supermarkets are used to moving stock around through key trading periods like Christmas and Easter… they can be very, very reactive”. However, aggressive consumer stockpiling has sent supply chains into disarray as demand continues to outpace supply. For example, consumers spent an extra GBP 1.9bn in the four weeks ending 21 March, the Financial Times reported, citing Nielsen figures. This is inevitably putting considerable downward pressure on supply and demand dynamics. 

Reducing the amount of choice consumers have is one method of rationalising supply chains, but this can put too much pressure on larger suppliers and potentially send smaller ones bust. “I wouldn’t range edit unless… it made the whole machine 20% more efficient,” one specialist said. While this might make sense in some scenarios for a player like UK-based Morrisons, which owns many factories, editing down third-party suppliers could create “an awful lot of problems”. For example, not only could it damage the relationship, but “potentially mean that food that could be produced isn’t getting to the general public”. On the other hand, a US-based expert commented that the most-feared word right now to many suppliers is “allocation” because they cannot meet the demand. “Who do you allocate product to? The retailers will remember once this is over, so that’s a big challenge they’re facing right now.”

Another notable theme is the increasing amount of money that is being spent online, with such operations running at full tilt. “For grocery, the normal penetration will be around 7%, it’ll probably be above 10% now,” according to a UK-based specialist. Although it is likely to bounce back somewhat after the crisis, he expects it to catalyse new shopping behaviours among some consumers. “Basically, it’s a fantastic mass sampling exercise, and as with all of these sampling exercises, some people will stick,” he said. “I can see it getting to 8-9% on the back of this, this time next year, assuming we are back to normal this time next year.” 

Engendering loyalty within an existing customer base is also important in these times. The UK’s Sainsbury’s has been praised for prioritising its elderly and vulnerable customers in a “tactful and intelligent” way by analysing customer data, an expert pointed out. The store contacted those it identified as either vulnerable or elderly and automatically offered them a delivery slot. “The amount of loyalty generated from those customers is ridiculously high,” he added. Retailers have also been expanding their click-and-collect capabilities, sometimes at the expense of delivery, where it’s more difficult to add capacity because of the need to find vans and train drivers. Essentially, it’s “a big spreadsheet… that people have got to get right at a 300-store level”. 

Interviews also revealed that while “most retailers are winning because of this”, some are faring better than others. In the US, Costco is doing particularly well because of its simple business model of buying a few items in large sizes, which is appealing to suppliers. “If you have a recession, they win. If times are booming, they win”, the expert said. Meanwhile, Kroger has had a “big lift” because of its strong manufacturing capability (about 40 plants). “They’re doing their own spices now, so with that full integration, they’re less dependent on the other branded and private label co-packers out in the marketplace, so this is really a nice win for them.” Another “big mover” is United Natural Foods Inc (UNFI), a distributor to Whole Foods, which is “still very busy”. UNFI’s acquisition of SUPERVALU in 2018 also bolstered its offering with a traditional goods range, which was a “huge liability” in the beginning but is now a “huge asset”. 

Despite the challenging environment, retailers are not desperate to increase their prices, an expert said. However, he anticipates there will inevitably be some cost inflation because of the impact of disruption on operations. For example, labour inflation could, in a worst-case scenario, cause a 3-4% impact to operating costs. “I don’t think anyone can absorb that and that’s why I do think, as potentially as unpopular as it may seem, prices are going to have to rise, but not at a huge level,” he said. Disruption costs are also likely to intensify over time. “I think you might see 2%, 3%, 4% inflation coming through as we roll through this,” he added. “I don’t think it’s going to be double digit or anything like that.” Indeed, even with rising sales, margins “are probably coming under pressure”, particularly with more lower-margin items being sold and other factors such as rising freight rates at play. 

Although on the face of it soaring supermarket sales are a sign that business is booming, the sudden — and drastic — changes in consumer behaviour triggered by COVID-19 have seemingly inflated such data artificially. Adding to the pressure of skyrocketing demand, certain items have been significantly more popular than others, including toilet roll, hand soap and cleaning products. This requires a careful balancing act by supermarkets when it comes to ordering from suppliers, compounded by the unpredictable nature of consumer behaviour. Given the severity of the pandemic, certain buying patterns and behaviours are likely to persist even after the most drastic containment measures are lifted, as no one will feel safe until a vaccine or treatment is identified. For example, some consumers may now prefer to do one big shop once a week instead of three times with top-ups in between. This could have a longer-term impact on how supermarkets operate than is perhaps apparent at present, including at the expense of smaller convenience stores. It will undoubtedly offer some food for thought for players big and small in terms of how to make supply chains more resilient and adaptable in a changing world.