Last year we wrote about disruption in the retail industry, and this year we looked at the opportunities that artificial intelligence provides across all industry segments. Here, we link the two, because our research analysts see the synergies as critical for meeting changing consumer preferences. For example, what would a consumer do to recapture two weeks of time each year? Replenishing frequently purchased grocery items using a digital device such as the Amazon Dash button or Facebook Messenger can do just that.

The use of digital technologies to cut costs or improve customer experience is not a new concept. Food retailers use self-checkout registers to reduce labor costs, and e-commerce attracts customers looking for convenient shopping without the costs of maintaining a physical store. Investors notice this and reward, via higher stock valuations, those companies that have streamlined operations, greater customer counts, and improved earnings growth. But e-commerce and self-checkouts are just the tip of the iceberg.

This technology revolution has the power to disrupt the grocery industry. Picking the winners means identifying those companies that digitalize meaningfully—to strengthen and grow their business—from those that chose the wrong strategy, or fail to embrace change at all or quickly enough to get ahead of competition. This is especially true in the highly fragmented US market, where there are over 36,000 grocers.

Why retail needs a digital transformation

It’s no surprise that traditional food retailers are facing challenges. Over the last several years, many, including national grocers, have declared bankruptcy, in part due to rising online competitive pressures and high legacy cost structures. In this environment, food retailers need to cut costs and improve margins by roughly 60 basis points (0.6%) every year just to stay even. To get ahead, more is needed. That’s where digital technologies can help.

It’s easy to see the complementarity between grocery and technology. Retailers bring locations, scale, and merchandising skill; technology companies offer the know-how to digitalize rapidly. Such partnerships may help level the playing field against competitors and reduce costs, thus allowing retailers to benefit from, instead of fall prey to, the disruption that is sweeping the sector.

Technological advancements

We estimate that if retailers implemented several of the possible digital technologies, they could reduce costs or add extra margin of up to 1000 basis points, or 10% of sales, but even implementing just one could make a big difference for food retailers who often survive on razor-thin margins. Below we highlight three digital technologies that have the capability to meaningfully boost food retailers’ margins:

Camera sensors and AI-enabled optics systems

For years, retailers have used cameras to thwart theft. But theft prevention is only a small fraction of how camera sensors and other optics systems can transform retail. Amazon Go stores, for example, rely solely on cameras to track what people take from the shelves to charge their accounts. Implementing this ‘Just Walk Out’ system on a larger scale could mean consumers will no longer have to wait on long lines, while retailers can save on the cost of cashiers, which is estimated to be up to 3% of sales.

Beyond payroll cost savings and a better customer experience, these cameras can enable artificial intelligence(AI) to improve inventory management. Store-based retailers are disadvantaged compared to online retailers who can quickly adapt their pricing: raise prices when strong demand makes a product scarce, or lower prices when there is less demand. Now cameras with AI can help store-based grocers do the same. For example, electronic shelf labels can make real-time price updates to help manage inventory. This is especially valuable to control waste—saving up to 1% per year—when food is near expiration and needs to be cleared out.

Lastly, cameras can provide insights into the physical layout of stores. They can show where customers spend time in the stores and track their typical path, monitor which displays or promotions consumers create engagement, and detect when checkout lines are forming. These insights can improve marketing efficiency, and aid in store design — to target or influence customers in their normal traffic pattern and to maximize space.

Shopper data=targeted advertising

Online retailers are advantaged in using data to enable targeted advertising. Some store-based retailers tackle this on their own, while others form partnerships or acquire companies. Take national grocery chain Kroger’s partnership with UK online grocer Ocado, for example. Kroger will be leveraging Ocado’s fulfillment and delivery system. Ocado also has an online platform which benefits from targeted ads, as well. Here’s how it works:

Ocado collects data on shoppers’ online habits. Through AI, it uses this data to populate consumers’ baskets—by identifying what a shopper likely needs and probing to ensure nothing is forgotten. Ocado even knows how brand loyal a shopper is.

The combination of this knowledge on shopping needs and brand preferences provides invaluable consumer insights. Ocado applies its knowledge to sell advertising on its website, mobile apps and mobile websites to product companies who want to get their products front and center of the digital customer. These targeted ads are a valuable source of revenue for Ocado. In fact, ‘supplier income’ is growing at a much faster rate than total revenue for the company.

Inventory management, tracking, and delivery

Inventory management, control and delivery are key to the bottom line of retailers. AI can simultaneously track thousands of data points that are relevant for forecasting sales to maintain the optimal level of inventory. AI’s machine-learning forecasts are believed to be cheaper and more accurate than conventional forecasting. For example, UK supermarket chain Morrisons implemented an ordering system, Blue Yonder, designed by machine learning specialists, which has reduced gaps on shelves by 30%.

Carrefour is introducing blockchain in its supply chain to trace the origins of its food products. In a world where consumers are increasingly concerned about the sustainability and integrity of their food, this becomes an invaluable service.

Delivery, too, is increasingly demanded by consumers, but it can be expensive for many retailers, especially the last mile. Several companies—Ocado in conjunction with UK tech company Oxbotica, and British retailer Tesco, for instance—are experimenting with using robots to deliver the final mile. This alone could save an estimated 3% of delivery costs for the retailer.

Who wins?

Food retailers have historically needed to innovate, and those that transformed faster outgrew their competitors. The main difference now is that the rate of innovation appears faster, and the skills and capital needed are a bigger hurdle.

There are numerous examples of digitalization in retail beyond just these few, and we expect it will drive the industry over the foreseeable future. Most retailers do not possess these skills on their own. Hence the need for tech companies. Choosing the right tech alliance and doing it quickly can mean the difference between survival and extinction.

Processing threats and opportunities through the lens of objective, thoughtful research can help investors profit from this changing landscape.

An information edge can mean the difference between getting ahead—or being left behind. That’s why many of our entrepreneurial clients look to us as a source of intellectual capital. For more insights on disruption, check out the related blogs here.

The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AB portfolio-management teams.

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