Marks & Spencer could team with Ocado for online food delivery — here's what analysts think

Marks & Spencer announced last week that it is planning to launch an online grocery service this autumn.The Telegraph reported on Sunday that the department store and food retailer is considering partnering with online grocer Ocado to handle the fulfillment of the orders.

The tie-up makes sense (I flagged it as a possibility when M&S first announced its plans).

M&S has a strong own-brand food business but has never done online groceries before and has struggled with online delivery in the past. Ocado, meanwhile, is a pioneer of online groceries in the UK and has the logistical know-how to pull it off. It has done similar deals with Morrisons and Waitrose in the past.

Credit Suisse said in a note published on Tuesday that it believes the most likely deal would see M&S products stocked on Ocado's website, rather than have Ocado provide the white label plumbing for a new M&S Food website.

"M&S's range is too narrow and its basket size too small to offer a credible standalone online grocery service," said analyst Stewart McGuire in a note.

However, Bernstein believes that an "in-store picking" model is more likely. Rather than having all of M&S' food stock stored in Ocado's central warehouse to be distributed as part of bigger orders, an "in-store picking" model allows M&S to pick products for home delivery from its own stores, using Ocado's technology.

Bernstein's Bruno Monteyne said in a note on Tuesday: "Typically M&S has customers shop smaller baskets, serving customers in the 'something-for-tonight' or 'top-up' shopping missions rather than the 'main shop.'

"The economics of central fulfilment are hugely in favour of bigger baskets. Hence, it's more likely that a solution would be in store pick for M&S."

Amazon & Waitrose could stand in the way

Credit Suisse flagged two major obstacles for any deal being done between the two: Amazon and Waitrose.

On the Amazon front, Credit Suisse said that the online retail Goliath could be tempted to make an attractive offer to get M&S' high-end food onto its platform.

"The potential to access a loyal and lucrative segment of the market may provide enough of a draw to offer lucrative terms to M&S," said McGuire. But he adds that the fact M&S has already pulled its clothing from Amazon makes a deal less likely.

McGuire also warned that Ocado's contract with Waitrose could make a deal with M&S difficult. Under the terms of the deal, 70% of all non-own brand products sold on Ocado have to come from Waitrose. If you count M&S as a brand, this would make a deal impossible as Waitrose can't and won't stock its competitor's products.

McGuire said: "It is unclear whether M&S product would be considered 'branded', thereby preventing their listing, but the ability to renegotiate the contract is always available."

What does it mean for both companies?

If a deal does go through, what would it mean for M&S and Ocado's businesses?

Credit Suisse said that for M&S "it might be better for sentiment than its financials as we would assume 25-50% of online sales would be cannibalised from stores, and the split with Ocado would reduce margins below 33% retail gross margin."

Meanwhile, Bernstein forecasted that Ocado could make £2-4 million in profit over the medium term from a deal with M&S. However, Monteyne added: "This could be significantly lower if there was a competitive bid process with other players vying to provide an in-store pick solution for M&S."