Almost two-thirds of average supply chain expense for UK supermarkets comes from the cost of taking goods the 'last mile' to stores, according to research by strategy consultants Roland Berger.

The consultancy says this high proportion 65 per cent - has increased sharply in recent years as the large grocery groups have focused their expansion on convenience stores. These produce better margins than hypermarkets but it costs more to keep them stocked. The rise in cost also reflects the growth in online grocery sales, which are more expensive to pick and deliver.

'Most grocers, if they had the chance, would open only large stores,' says Neil Saunders of retail consultancy Verdict. 'But geography and the state of the market work against that. Grocers have all been pushed down this convenience route in a much greater way.'

Between 2010 and 2014, the four biggest supermarket groups - Tesco, Asda, J Sainsbury and Wm Morrison - together plan to open or extend stores equivalent to about \(19 \mathrm{~m}\) square feet, and much of that space will be in smaller outlets. Michael Jary, partner at OC\&C Strategy Consultants, forecasts that sales through the online channel are likely to more than double to around 8 per cent of all grocery sales by 2020. The challenge for addressing the 'last mile' costs is acute.

'The major multiples have made great strides in optimising the back end of the supply chain by close collaboration with their suppliers, through activities such as central warehouse delivery and other practices,' says Tim Manasseh, a partner at Roland Berger. 'But the costs involved in servicing the "last mile" have escalated considerably.' For convenience stores, he cites factors such as the high cost of in-store storage space, and the expense of writing off unsold fresh food.

Karen Hubbard, operations director at Asda, responsible for stores between 5,000 and 25,000 square \(\mathrm{ft}\), says the distribution system must also take into account factors such as restrictions on when deliveries can take place. Asda also operates 100 smaller stores where the issues are similar to those facing the classic convenience store.

The answer for Asda has been to build a supply chain from scratch just for its smaller stores to help keep prices in line across all its formats. It has also reduced the size of its computers in smaller stores and split them up into units that can fit into limited space. 'They are cut up into little pieces and kept under the check outs,' Ms Hubbard says.

Despite the inherently higher expense involved in keeping convenience stores stocked, industry experts believe grocers can still bear down on costs.

One way is scale. Mr Saunders says the density of Tesco and Sainsbury convenience stores, for example, in London gives them an advantage because a few lorry loads of deliveries can service several stores. 'If you are dealing with just one or two, then it's not very efficient in terms of fuel, driver time, and staff time picking the goods for delivery.'

Another approach is to improve sales by ensuring that the store is not just a cut-down version of a supermarket. Asda is tailoring its offer to local demand, for example, stocking more Asian ingredients in its store in South Harrow, and reducing the amount of space it would typically give to beers, wines and spirits. Managing demand also means making sure the store does not waste shelf space: if a group knows that its convenience stores need big orders of bread on Monday morning but not on Friday, it can adjust deliveries accordingly.

Thirdly, there is persuading customers to buy premium products, increasing the size of the average spend and boosting margins.

Wm Morrison, which is conducting a trial of three convenience stores in the north of England, stocks fresh meat and fish in its pilot store at Ilkley, Yorkshire, since these can easily be prepared at its nearby supermarket at Keighley. The llkley store also boasts features such as a 'grind your own coffee' point and a fresh orange juicer.

'If people are going to come in and buy steak and a bottle of wine it completely changes the economics,' says Miles Foster, who is leading Morrison's convenience store trial. The group has promised that fresh products will cost no more in convenience stores than in other formats, but even so the amount spent by the average customer in the llkley store is 'well above' the industry mean of about \(£ 5\), he says.

Managing costs in grocery internet sales is even trickier. 'This is why people like Ocado have struggled so much,' says Clive Black, analyst at Shore Capital. 'If you take it from the farm gate to the kitchen, the biggest cost of the supply chain is the customer picking the product off the shelf, putting it in the car and taking it home.'

In the mature and competitive UK food retailing market, convenience and online shopping offer the best prospects of growth. So though different supermarkets are working on different solutions, they must share a common determination to crack the costs.

Discussion points

1 How does the description of cost control cover costs of materials, labour and overheads?

2 Which of the costs to be controlled are variable costs, and which are fixed costs?