(2023-09-02) Instacart Is The Best And Worst Grocery Business Imaginable

Instacart is the Best and Worst Grocery Business Imaginable (grocery store). Growth investors are rarely excited to underwrite a business that hires 600,000 people to perform a repetitive task like picking items off grocery store shelves and delivering them

it knows consumers' ordering patterns, knows the cross elasticities of demand across different products and categories, and can capture the upside from consumers trading up or trying new brands via ads

can present every customer with a set of offers perfectly customized to a) get them to continuously shift more of their shopping onto Instacart's platform, and b) to get CPG companies to pay as much as possible for ads.

ads and recurring membership revenue continuously improve the margin profile of the company

Instacart also works with consumer packaged goods companies, which market directly to customers but which also market through stores, both by subsidizing stores' ads and by paying for prominent in-store placement (advertising)

Kroger reported vendor allowances equal to almost $8.7bn, or 7% of revenue in 2017, before they stopped breaking this out, for example. That compared to Kroger’s operating profit of $2.1bn in the same year. So in a sense the default model for the grocery business is that an efficient, well-run grocery store will lose money on the business of selling food and other consumables to customers, but more than make up for it by selling direct or indirect ads to the companies that make those products

Instacart's ad revenue is 2.6% of gross transaction volume

They're nudging customers towards commoditizing almost everything they want, and searching by category rather than by brand name.

One thing that makes the business hard to evaluate, as with many other businesses, is Covid-19. They reacted reasonably quickly

But this also makes their financials hard to read

This is a chart of six years, one corporate entity, but basically three different businesses

Early on, it's a classic growth story

Then they had their massive Covid surge: eyeballing the chart, a majority of 2020 revenue came from customers who had never used the service before. Those customers were a unique group, though, and some of them churned out

And then we get to the last cohort with year-over-year spending data, 2021, and net dollar retention is—right back to 129%! But now they're in a more mature category

more of the large chains are handling it themselves.

Another complicating factor in the model is Instacart+, their membership program.

Instacart+ partly makes sense due to the usual subscription economics of capturing consumer surplus in a fixed payment, enabling a lower marginal cost that enables a higher share of wallet. And that's interesting because of the ad business. By getting customers to sign up with Instacart+, Instacart is trading some variable revenue from the customer for higher order frequency, more searches, and thus more opportunities for ad revenue

Instacart does look like a good way for small CPG brands to rapidly scale

One way ads show up long-term is in a higher revenue take rate, but the real magic happens at the gross margin level

A final piece of the puzzle is retailer retention

every chain that works with Instacart knows it's ceding some customer information, some brand recognition, and some lock-in

Their top three chains are 43% of revenue, which is a lot of dependence on customers who are all continuously re-underwriting the relationship.

And really, all of these are part of the same question. Instacart might be the most challenging business imaginable: operating in a low-margin category with a cost disadvantage, coordinating a four-sided network where some sides have opposing interests

As capital-intensive as the business could theoretically be, they built an impressive company without burning too much cash.