M&S seeks online grocery lifeline with Ocado venture talks

To judge from the share price reaction in both companies, investors in Ocado and Marks & Spencer love the idea of the pair setting up a retail joint venture, with shares of the former rising by 11.7% and the latter by 3.24%.

And all on the back of a short statement from both companies, flushed out by a report in the Evening Standard, merely admitting that talks were taking place.

The joint venture is one of a number of possible options that were under discussion when, at the end of January, M&S and Ocado were first reported to be holding talks.

Other scenarios were said to range from M&S signing up as a partner with Ocado, in the way the online company currently has an agreement with Morrisons, to a full-blown purchase of Ocado's vans and distribution centres by M&S.

A joint venture would appear to be a halfway house between those two possibilities.

What is not clear is what any joint venture would mean for Waitrose.

Its partnership with Ocado dates back to January 2002, when the company first launched its delivery service, with Waitrose's parent, the John Lewis Partnership, owning as much as 29% of Ocado in those days.

The stake was finally sold in February 2011 and since then, Waitrose has launched its own home delivery service - although, under its existing deal with Ocado, it is still contracted to supply groceries to the latter until September 2020.

Under that agreement, Ocado must give Waitrose 18 months' notice of its intention to quit, which is why - according to the Standard - the two have been rushing to get a deal in place by 1 March.

It is not clear either, without knowing full details, precisely how this arrangement will work.

The assumption must be, though, that Ocado is looking to substitute M&S for Waitrose.

That might be fraught with risks.

For a start, Ocado currently stocks some 46,000 individual lines, or SKUs (stock keeping units) as they are known in the jargon.

Many of these are individual brands and they include some 4,000 Waitrose own-brand items.

Even that is not enough to meet the full list of products Ocado seeks to sell its customers and, for some time now, Ocado has had to fill in gaps by either sourcing directly from brand owners like Unilever or Coca-Cola or by selling its own-branded products - even if, in some cases, that has ultimately led to it competing with Waitrose's brands on its own platform.

It is unclear whether M&S-branded lines would be able to replace every Waitrose-branded line that would be lost if Ocado were to drop Waitrose entirely.

Moreover, would those customers who shop with Ocado because of its long-standing relationship with Waitrose - many customers still assume the pair have common ownership - stick with it if it dropped Waitrose entirely?

Most customers do not do their weekly food shop at M&S but use it primarily for top-ups, or for buying an individual evening meal, or for one-off 'special' purchases such as high-end picnic or party food.

It is why, every Christmas, M&S's share of the grocery market doubles - it sells an estimated one in four turkeys sold in towns where it has stores - as customers splash out more with it on festive luxuries and treats.

And would M&S want its own high-end food products to simply be just another brand available on the Ocado platform? That is why a joint venture, introducing an element of exclusivity, would make more sense.

Another big question is whether M&S will be looking to use this agreement with Ocado to move into the mass grocery market in a bigger way.

M&S has always argued that it did not need an online grocery delivery service and has not suffered by not having one.

If it were to partner with Ocado, it suggests M&S is indeed looking to be somewhere where customers do their big weekly shop, duking it out with the big four and Waitrose.

Adding the existing lines sold on Ocado's platform to M&S's own existing lines would certainly put it in a position to do that.

It would, for example, enable M&S to offer a far greater range of food and drink products than it currently does in its store network.

When he became chief executive of M&S, Stuart Rose - who is now, ironically, chairman of Ocado - always used to grumble that the company's refusal to stock other people's brands meant he could never get everything he wanted from his own stores.

He managed to change that, to an extent: it is now possible to buy a bottle of Tabasco sauce - the brand Lord Rose always said he most wanted to buy in M&S - or a can of Heinz baked beans from M&S.

But adding the full range of lines sold by Ocado to the existing lines stocked by M&S would make it a one-stop shop for grocery shoppers.

Archie Norman, the M&S chairman, enjoys a stellar reputation in the City due to his rescue and turnaround of Asda in the early 1990s.

It would not be surprising if he wants to take M&S in that direction.

For Ocado, the advantages of a deal with M&S are much more clear-cut.

Swapping it for Waitrose would remove the issue of competing with its own partner in some lines.

And M&S is possibly just about the only grocery brand, other than Fortnum & Mason or Selfridges, with even greater cachet than Waitrose among the well-heeled middle classes in London and the Home Counties who form the bulk of Ocado's customer base.

It might also provide a sales fillip to Ocado's retail division which, it has promised investors, will grow sales by between 10% and 15% during the current financial year.

And setting up the partnership via a joint venture with M&S would enable it to ring-fence its activities from those of its existing arrangements with Morrisons.

Setting up a joint venture with M&S might also add clarity in the minds of Ocado's shareholders about how the company sees its future.

It has signed a number of deals to provide 'technology solutions' under licence to big grocery retailers during the last year, including the likes of Kroger of the US, Casino of France, Sobeys of Canada, Bon Prue of Spain and ICA of Sweden.

Over time, it is possible to speculate, M&S might buy control of the joint venture and leave Ocado as a pure technology company.

The latter does not want to go down that path just yet, however, as investors remain far from convinced that these licensing deals will turn out to be as profitable in the long run as Ocado's management insist they will.

Accordingly, for now, it makes sense for Ocado to retain ownership of a profitable retail operation of its own.

Effectively selling half of its retail operations to M&S, meanwhile, would bring in the money Ocado needs - this could be as much as £900m - to roll out its technology solutions.

How M&S will come up with that money, given the debt it is already carrying on its balance sheet, is another question.

Some kind of cash call looks likely - something that would not go down well with the 330,000 or so retail investors who own M&S shares.

This putative partnership, then, raises more questions than answers.

And not just for the two would-be partners: another is how Waitrose will fare without Ocado stocking its lines.