In 2022, European grocery was characterized by unprecedented inflation and increasing consumer price sensitivity. Consumers traded down, and grocers experienced substantial cost pressure. The impact of the COVID-19 pandemic on the sector had largely concluded by the end of the year.
In the second half of 2023, we expect European grocery to start recovering. Key trends that will shape the sector this year include a gradual normalization of price and volume, a search for cheaper food, continued margin and cost pressure, a race for economies of scale, profitable online growth, retail media expansion, accelerated technology deployment, and intensified collaboration of grocers with their suppliers to drive sustainability.
Did anyone say inflation?
Inflation was the leading topic on the minds of consumers, grocery retailers, and suppliers throughout 2022. General inflation in the European Union increased from 2.9 percent in 2021 to 9.2 percent in 2022, reaching a peak of 11.5 percent in October. Food inflation was even higher—in some countries, as much as twice as high as general inflation. Household economy experienced a significant pressure as expenses increased much faster than disposable income.1Disposable income based on Oxford Economics data. In response, many consumers traded down.
Overall grocery sales in Europe2Includes Belgium, Czech Republic, France, Germany, Italy, Netherlands, Poland, Portugal, Spain, Sweden, and the United Kingdom. grew by 2.9 percent in 2022 compared with 2021. This growth was the result of 10.7 percent higher prices, a decrease of 3.6 percent in volume sold, and a downtrading effect of 3.6 percent (Exhibit 1). This implies total grocery volume at 2.3 percent above 2019 levels, with significant variations among countries (see “Food and grocery market KPIs”).
Across Europe, consumer downtrading has led to substantial growth for private labels. Compared with 2021, the value share of private labels increased by 1.9 percentage points. However, only 0.8 percentage points of this increase can be explained by same-store downtrading. The remaining part is caused by faster-than-average price increases for private-label goods (0.8 percentage points) and above-average growth of the discount channel, which has a higher private-label share (0.3 percentage points).3Based on Europanel data.
Discounters gained 1.4 percent in market share in Europe relative to 2021. This was largely driven by a combination of aggressive footprint growth in recent years, recovery from the pandemic-related sales dip, price inflation faster than market average and an increase in price sensitivity in the market. Discounters grew at the expense of all other channels: traditional trade declined by 0.8 percentage points, hypermarkets by 0.2, online by 0.3, and supermarkets by 0.1. Online penetration mostly stagnated in 2022, except for the United Kingdom and Sweden, where it declined by about one percentage point.4See Food and grocery market KPIs.
About this research
The State of Grocery report is an annual global publication covering three continents, with dedicated reports for Asia, Europe, and North America. This year’s report, Living with and responding to uncertainty: The State of Grocery Retail 2023: Europe, is a continuation of a partnership between McKinsey & Company and EuroCommerce, designed to provide executives with a comprehensive view of the market and future trends. In preparing the report, we surveyed more than 12,000 consumers and around 50 grocery executives across Europe. We interviewed three industry thought leaders and pioneers. We combined EuroCommerce’s policy and sector knowledge with McKinsey’s global expertise and analytical rigor. We hope this report will offer new insights and perspectives that will help grocers living with and respond to uncertainty.
Because of cost inflation, lower volumes, and more price-sensitive customers, the margins of many European grocery retailers came under substantial pressure. Between 2019 and 2022, the average margin of European grocers decreased by three percentage points, our analysis shows. The EBITDA margin decreased by one percentage point, while the EBIT margin stagnated.
2023: Are we out of the woods?
Consumer confidence is returning as inflation eases, although it is still below prepandemic levels. According to most forecasts, inflation in Europe will continue to abate over the course of 2023. Consumer confidence in the EU has been rising for five consecutive months; the level measured in February 2023 (–20.6, compared with –29.8 in September 2022) was the highest since the beginning of the war in Ukraine. That said, consumer confidence is still lower than it was in January 2022, before the war in Ukraine (–10.9) and much lower than it was in January 2019, before the pandemic (–5.9).
Grocery CEOs also remain cautious. According to our survey of 47 European grocery CEOs, 44 percent expect 2023 to be worse than 2022, and 33 percent think it will be as challenging as 2022. Only 23 percent believe 2023 will bring an improvement in market conditions. Respondents agree that the key themes for 2023 are rising costs and margin pressure, downtrading, and an increased focus on private labels.
Drawing on our consumer research, CEO survey, and market analysis, we identified eight trends that we believe will shape the grocery landscape in 2023 and beyond. Some of these themes represent an acceleration of trends we outlined in last year’s report, while others are new and will likely prompt grocery executives to reassess and adapt their existing strategies.
1. Gradual normalization of price and volume
We expect the first quarter of 2023 to be the turning point after which volume stays relatively stable and inflation gradually normalizes.
In 2022, we saw retail volumes decline across Europe by 3.6 percent compared with 2021. However, most of this drop in volume happened in the second quarter of 2022 because of fading effects associated with the COVID-19 pandemic. In the second half of 2022, volume stayed mostly stable compared with the previous quarters.5See Food and grocery market KPIs.
We therefore expect that volume will remain stable or slightly decline through 2023 versus the fourth quarter of 2022 run-rate levels, with lower volumes in the first quarter of 2023 than in the first quarter of 2022. Starting in the second quarter of 2023, we expect volume development to be flat or only slightly negative relative to 2022. This would result in a volume decline of 1 to 2 percent for the full year compared with the previous year.
While general inflation declined at the beginning of 2023, food inflation was still rising. However, food commodity prices have passed their peak and decreased significantly in the first quarter of 2023.6“Agriculture price index,” updated March 31, 2023. At the time of writing, the global agriculture price index was 12.8 percent below its April 2022 peak. Also, the household energy price index decreased by 8.3 percent in February 2023 compared with January 2023, taking the index 23.9 percent below its October 2022 peak. According to our analysis of historic data, food retail prices adjust to changes in commodity prices with a time lag of about six to twelve months. We therefore expect food inflation to slow down significantly in the second half of 2023.
2. A focus on cheaper food through private labels and discounters
Saving money on food remains a top priority for both high- and low-income consumers in 2023.
All income groups were trading down in 2022, and the difference between income groups diminished. At the beginning of 2022, respondents to our consumer survey who said they wanted to save money on food represented predominantly low-income households. Now, this intent can be observed across income brackets. The share of private labels increased across Europe by 1.9 percentage points on average, and the market share of discounters increased by 1.4 percentage points (see “Food and grocery market KPIs”).
In 2023, consumers plan to trade down further. According to our survey, 53 percent of consumers say they want to save more money on food, and 36 percent want to buy more private labels than they did in 2022. Consumers also plan to spend less on premium, healthy, and sustainable products to make ends meet. That said, healthy eating remains a key concern for consumers. Depending on the income group, 24 to 37 percent of consumers intend to focus on healthy eating in 2023.
Even if market conditions improve, consumers might continue buying private labels and shopping with discounters. Consumers are highly satisfied with private-label products, with 84 percent of respondents saying the quality of private labels is similar to or better than the quality of branded products. The average consumer is also quite satisfied with discounters. Our survey shows that the weighted average customer satisfaction score in Europe was 14 points higher for discounters than for other formats in early 2023. As a result, we expect that some consumers will not switch back from discounters to supermarkets. As the pressure on household budgets eases, supermarket operators may want to sharpen or upgrade their value propositions to lure target customers back into their stores. In 2022, we saw a strong correlation between market share development and the attractiveness of a grocery retailer’s private labels as perceived by consumers. We expect this to stay true in 2023.
3. Continued margin and cost pressure
The profitability of grocers was hit hard in 2022, and the pressure on margins, cash flows, and the cost of capital is likely to stay high in 2023.
Margins decreased for both grocery retailers and food processors (consumer-packaged-goods companies) between 2019 and 2022. The EBITDA margins of grocery retailers decreased by 1.0 percentage point, while the EBITDA margins of food processors decreased by 0.8 points (Exhibit 8).
We expect cost and margin pressure for grocery retailers to remain high at least in the first half of 2023 because salaries are likely to grow and many cost increases have not yet reached grocery retailers. According to our CEO survey, dealing with cost and margin pressure is a top 2023 priority for 88 percent of grocery leaders. While energy and many food producer prices peaked in the third quarter of 2022, it will take time for these increases to affect food processor prices and ultimately reach consumer prices set by grocery retailers. In addition, if governments were to introduce new regulation to limit retail prices, this would put further pressure on the margins of grocery retailers.
At the same time, the level of required investments for grocery retailers is increasing, putting additional pressure on the industry. Between now and 2030, the industry needs cumulative additional investments of €70 billion to €125 billion to drive sustainability, digitalization, IT improvements, and automation—an increase of 25 to 50 percent relative to current levels.7Transforming the EU retail & wholesale sector, a joint report from McKinsey and EuroCommerce, October 2022. Margin pressure and the increasing cost of capital will make it harder for grocery retailers to finance these investments. The weighted average cost of capital has increased from 2.6 percent in 2021 to 6.7 percent in 2022 because of higher interest rates. This makes it more expensive for grocers to borrow money or raise new capital.8“Cost of equity and capital (Europe),” Damodaran Online, January 5, 2023; “Cost of equity and capital (Europe),” Damodaran Online, January 5, 2022.
4. A race for economies of scale
Structural measures to achieve synergies and economies of scale are likely to intensify as smaller grocery retailers are disproportionately affected by current market developments.
The current environment has placed significant demands on grocery retailers to manage cost. Scale has long been a benefit in the market. For example, bringing large volumes to the table in negotiations with leading brands can lower the cost burden substantially. Similarly, investments in technology and sustainability are easier to absorb if they can be spread and leveraged across a large network of stores. In a situation characterized by increasing price sensitivity, margin pressure, and substantial investment needs, the value of scale will further increase.
In 2023, we foresee an accelerating race for economies of scale. Larger players may pursue more intense M&A strategies or seek to form broader partnerships—strategies that have often proved valuable in times of turmoil. In contrast, smaller players are likely to explore alternative ways of achieving scale, such as through bundle purchasing, joining franchising networks, and forming partnerships for joint investments. Some indications of this trend were already apparent in the second half of 2022. For example, Rewe has announced that it will invest €5 billion by 2025 to expand its footprint in Europe through targeted investments and smaller acquisitions. Ahold Delhaize took on the Jan Linders chain as an Albert Hejin franchisee. Aldi North announced that it will exit the Danish market, while Coop Denmark is merging formats to capture synergies. The Scandinavian purchasing group Coop is teaming up with the French retailer Carrefour to make French, Italian, and Spanish private-label products available in the Nordics.
5. The quest for profitable online growth
After a period of postpandemic stagnation, we expect that e-grocery will return to moderate growth and that players will maintain a strong focus on profitability. Incumbents will face increasing pressure from pure players. Meal delivery will likely overtake e-grocery in terms of market size.
E-grocery penetration stagnated in 2022, but we expect it to return to a long-term growth trajectory going forward. Most EU countries have retained the growth they have seen during the COVID-19 pandemic.
Increasingly, consumers consider online and offline as independent channels with different value propositions. In the United Kingdom, for example, according to our Consumer survey, around 75% of customers shop online sometimes or always with a different banner than offline. Consumers choose the best offline offer and best online offer for respective journeys, and this requires retailers to ensure a strong offer per channel.
Some pure players, such as Rohlik, have already reached profitability and raised additional capital despite the challenging investor environment . In contrast, quick-commerce players (instant grocery) might face another difficult year as economics and investor sentiment remain challenging. In the long run, we still see a market for instant grocery in Europe, but with higher price points than mainstream online supermarkets.
I believe online can be more profitable than offline, as long as you don’t try to be all things to all people.
The market for meal delivery looks more promising. Meal delivery continues to grow more quickly than e-grocery. If the growth trajectory continues, meal delivery will overtake e-grocery in terms of market size in the next two to three years. Given the higher margins of meal delivery, the potential profitability of this market is also attractive.
Reaching profitability in e-grocery is a challenge, but we see an increasing number of players either reaching a break-even point or on a clear path to achieve it in the next year or two.
6. Retail media as a core profit center
Across Europe, top players are either launching or expanding their retail media businesses, which are likely to become a substantial EBIT driver for the grocery industry.
The emergence of retail media (RM) as the third wave of digital advertising puts grocery players in a favorable position to provide targeted advertising opportunities and helps boost their profitability. RM is highly attractive to advertisers because it allows for much more granular targeting than other forms of advertising. In addition, it allows advertisers to measure the return on ad spending (ROAS) much more accurately at the product level by using the retailer’s sales and website data. In the United States, RM sales make up to 10 percent of online food sales and yield EBIT margins exceeding 50 percent.
While RM is not a new phenomenon, there is a lot of growth potential yet to be captured in Europe. In 2022, the European RM market was worth about €10 billion, less than one-quarter of the value of the US market.9In 2022, the US retail media market reached $41 billion and about 12 percent of total media spending, while Europe reached €10 billion and about 7 percent, respectively. Total media spend based on Statista data. The European market is expected to grow to about €21 billion in 2025.10Daniel Knapp, “Retail media – megatrend for the next digital decade?,” IAB Europe, May 25, 2022. According to a McKinsey survey, 90 percent of CPG advertisers plan to increase their spending on RM in the next 12 months, compared with a cross-industry average of about 60 percent. This spending will mostly add to existing CPG spend allocated to grocers. To take advantage of this trend, 18 of the 30 largest European grocers have already launched or started to develop their RM businesses.
Looking forward, RM is likely to become a must-have for European grocers. Leaders are already scaling up their ecosystems beyond the core offering. For example, Carrefour has entered a partnership with Publicis and Citrus Ads to monetize joint capabilities and provide an RM platform for smaller grocery retailers (“RM as a service”). Ahold Delhaize has declared that it will buy stakes in the adtech platform Adhese. Tesco and Sainsbury’s have announced TV network deals to leverage their data for tailored TV advertising.
7. Systematic scaling of automation and technology
Technology remains an important driver of value creation for the industry, but it will require €40 billion in additional investments by 2030. Generative AI is emerging as a potential next frontier.
The automation of warehouses and stores continues to accelerate. In 2023, the EU-27 automation market for retail was worth €2.5 billion. It is expected to grow at an annual rate of 13 percent in the coming years, reaching about €6 billion in 2030. Grocery retailers increasingly automate their warehouses fully, including through automated picking and depalletizing. Automation is expected to be one of the largest investment categories required to enable the digital transformation of grocery in Europe. Cumulatively, the investment need will total about €18 billion by 2030 across the European grocery retail industry.
At the same time, IT modernization is becoming a key enabler of the technological transformation of grocery retail, and it puts a strain on investment budgets. IT modernization includes the migration of older legacy systems that are no longer supported to new systems, the acceleration of IT development to keep up with pure players, cloud computing, omnichannel implementation, and the adoption of new analytical tools. These efforts will cost grocery retailers up to €19 billion cumulatively by 2030.11Transforming the EU retail & wholesale sector, McKinsey, October 2022. However, IT modernization also offers a massive opportunity for value creation if it is set up and conducted as a true business transformation.
Advanced analytics is becoming more mature, and it is increasingly part of the DNA of grocery retailers. We see more grocers moving beyond exploring and testing to building core capabilities for executing high-impact use cases. The EBIT margins of grocers can be improved by about one percentage point with analytics applications that were ready to deploy at the time of writing. About 80 percent of this potential is linked to ten use cases, including pricing, store-specific SKU selection, and supply chain planning.
Looking ahead, generative AI (GenAI) has the potential to unlock new value pools. The most promising examples of GenAI applications are expected to be in marketing (for example, creating personalized creative content and messages) and customer interaction (for instance, enhancing conversational chatbots and virtual assistants).
8. Supplier collaboration to solve for sustainability
The importance of sustainability continues to increase for grocers, despite the current dip in consumer demand. While the investments required to reduce Scope 1 and 2 emissions are substantial, the necessary actions are clear. In contrast, Scope 3 requires further understanding.
Defining scope emissions
Scope 1—direct emissions generated by an organization
Scope 2—emissions generated by production of purchased energy
Scope 3—indirect emissions from up and down the value chain
Regardless of the current dip in consumer demand for sustainable products, the decarbonization of grocery is picking up speed, driven by the European Green Deal, the expectations of investors, and a shift to green debt financing. The number of retailers with operations in Europe that have set science-based targets for decarbonization increased from 56 in 2021 to 110 in 2022. Among grocery retailers, this number increased from 22 in 2021 to 36 in 2022.12“Companies taking action,” Science Based Targets, accessed April 5, 2023.
Retailers have a clear understanding of the initiatives that are required to address Scope 1 and 2 emissions. More than 60 percent of greenhouse-gas emissions in Scope 1 and 2 can be abated in a way that saves cost and yields a positive net present value (NPV)—for example, investing in more energy-efficient freezers. However, these initiatives require substantial capital expenditures that could total €25 billion to €65 billion by 2030 across the European grocery retail industry.13Transforming the EU retail & wholesale sector, McKinsey, October 2022.
Since Scope 1 and 2 emissions represent only 7 percent of all emissions associated with retail (Exhibit 12), engaging suppliers and consumers to reduce Scope 3 emissions will be crucial to reach net zero. Meat and dairy production should take priority, as these categories represent half of all Scope 3 grocery emissions.14Bartosz Jesse, Alessa Perotti, and Daniel Roos, “Decarbonizing grocery,” McKinsey, July 22, 2022.
To move the needle on Scope 3, retailers are starting to establish joint initiatives with their suppliers. For example, Carrefour has engaged suppliers to commit to reducing their CO2 emissions by 20 megatons by 2030. Tesco has partnered with a bank to offer preferential borrowing rates to suppliers that disclose carbon data. Programs for consumer engagement are also emerging. For example, Kesko has launched an app through which consumers can set and monitor climate targets for their shopping baskets.
Implications for grocers
The current environment is challenging, but it offers opportunities to grocers that act boldly. According to our research, companies that took decisive action during the global financial crisis of 2007–08 performed better throughout the crisis and experienced higher growth once the crisis was over than those that did not. On average, these outperformers reduced their costs more aggressively than competitors during the crisis, which gave them the capacity to invest in growth opportunities. They also divested nonperforming parts of their business (for example, certain formats) more systematically than their peers. Once the crisis was winding down, these companies were among the first and the most determined to make investments and acquisitions in attractive growth segments. Looking ahead, we see three strategic priorities for grocery retailers that will help them emerge stronger from the current period of disruption and uncertainty.
Strengthening private-label assortments and capabilities
A stronger private-label capability will help retailers remain attractive while consumers are trading down and during the subsequent recovery period. Our experience shows that a broader and more attractive private-label offering in the lower-priced part of the assortment shows the highest correlation with market share gains in the current market environment. To succeed, grocery retailers might want to take inspiration from the mindset and practices of leading CPG companies in the way they manage their private-label offerings. Additionally, they should consider building a design-to-win approach that revolves around key consumer needs and global trends such as value, health, and sustainability. To claim their fair share of growth during a potential recovery period in the second half of the year, retailers should also start thinking about innovations in the premium part of their assortment.
A strong private-label design capability will also help to differentiate the assortment offering.
Creating room for investments by acting boldly on profitability
To tackle cost and margin pressure effectively, grocers need to manage operational expenditure tightly. To create the necessary fact base for data-driven supplier negotiations and price setting, grocery retailers will want to examine how the prices for ingredients and other supplier costs (such as energy) are changing and seek to understand how this should be reflected in the purchase price of each product. Taking a cross-functional view of supply chain costs and looking at them end to end from supplier to store can unlock further opportunities to increase efficiency. In parallel, grocery retailers should seek to boost the productivity of capital expenditure—for example, by challenging infrastructure investments and reviewing store footprints. Another important lever to free up funds for investments in future growth is to identify and divest parts of the business (for instance, store formats, channels, or categories) that do not yield enough profit and do not support the company’s strategic objectives. Moreover, grocery retailers will want to accelerate their online ventures’ path to breakeven. For example, they could tailor the online value proposition more to online customer needs, invest in supply chain automatization, and tap into high-margin adjacent opportunities such as retail media and meal delivery.
Investing in future growth
While the two strategic priorities above represent areas of immediate focus for most grocery retailers, it is equally important to look further ahead and invest in future growth drivers such as analytics, sustainability, and e-grocery.
This content was originally published here.