Morrison Supermarkets is to launch an online food operation with Ocado Group to commence grocery deliveries to customers by January 2014.
"The agreement will enable Morrisons to enter the online grocery market quickly with a profitable business model," Morrisons said in a statement. "This industry leading customer proposition combines Morrisons affordable fresh food - much of it from the company's own manufacturing facilities - with Ocado's leading end-to-end technology, logistics and distribution operations."
Fulfilment will be from Ocado's recently opened Dordon Customer Fulfilment Centre (CFC) in the Midlands, with customer deliveries through a Morrisons liveried fleet.
The agreement will comprise a technology and services arrangement and a sale and leaseback of property and equipment at Dordon. The agreement also makes provision for the joint development of new CFCs as the parties may determine in future.
Morrisons will make an initial capital payment of up to £170 million to Ocado to acquire Dordon and associated mechanical handling equipment, as well as a licence and integration fee. A further £46 million will be invested to expand Dordon in order to accommodate Morrisons range, integrate with Morrisons systems and establish a network of delivery spokes. On an annual basis, Morrisons will also pay service costs and a contribution to research and development (R&D) expenditure.
In return, Ocado will receive a share of the positive EBIT of Morrisons.com.
Morrisons anticipates that its new food.com business will incur a further £25 million development costs in the year, as a result of which, its total full year new business development investment will be £65 million.
"This agreement is a significant strategic step for Morrisons," commented Morrisons chief executive Dalton Philips. "From a standing start, Morrisons will be competing in the fast growing on-line channel by the end of this year with a really compelling proposition."
According to Ocado, the agreement will allow Ocado to continue to improve its intellectual property (IP), with the fees earned under the agreement enabling greater investment in technology and R&D. It will also strengthen Ocado's balance sheet and reduce finance costs.
"We see Morrisons decision to adopt our model to drive its online launch as a further endorsement of our technological and logistical excellence," stated Ocado chief executive Tim Steiner. "This validation should support the internationalisation of our model as well as the growth of our UK business by increased market use of our operating model, enhancing capital efficiency and improving returns."
He stressed that Ocado’s customers and the current contractual agreement with Waitrose would remain unaffected by the new arrangements, adding that over time, the financial flexibility and increased investment should result in continual improvement of Ocado's proposition to its customers.
This may have been in response to comments on Monday, when the head of Waitrose revealed he would reject a deal between Ocado and Morrisons. Speaking to the Telegraph, Mark Price said: "I would never knowingly sign a contract with Ocado that agreed to them working with another retail competitor."
According to Price, if Ocado did do a deal with Morrisons, it could risk a breach of contract with Waitrose and possible legal action and demands for compensation. "If a contract is signed between Morrisons and Ocado we will want our legal team to examine it immediately to ensure there are no breaches of the contract," Price said.
"We do not think that this is a good deal for Morrison," voiced Philip Dorgan, analyst at Panmure Gordon. "In particular, signing a 25-year deal in an online world with an unprofitable, unproven operator looks likely to cause problems."
He added: "While it achieves the objective of getting online, it comes at a big cost.
"Morrisons has also chosen an unprofitable business model and rejected the only proven online food model, which is picking in store."
He reiterated his 'sell' recommendation on Morrisons.
This article was written for our sister website Interactive Investor