Instacart IPO: Will It Win The Race Against Market Saturation?

The company's journey to IPO is impressive, but the long-term upside hinges on the success of its long-term bets like ads and the enterprise platform.

Last week, Instacart filed an S-1 with the Securities and Exchange Commission (SEC) in preparation for their IPO. This is an incredible moment for the company that pioneered the online grocery delivery market.

Huge congratulations to the team on this milestone — it’s an impressive outcome from an 11-year journey. This, along with the Klavio and ARM IPOs, has created fresh hope that the tech IPO market is en route to recovery.

Interestingly, when a company announces it intends to go public, the law requires it to open up a firehose of information. One such document is Instacart’s 300+ page S-1 filing. From analyzing this document, a couple of things stand out:

• In 2022, the US grocery market was $1.1 trillion, of which ~$132B is online; of this, ~$29B ran through Instacart. In other words, Instacart already has 22% of the current total addressable market (TAM) for online grocery, pointing to a market saturation risk.

• The company lists out a long list of potential risks (which is required and therefore expected on an S-1), and many of these risks seem non-trivial — intense competition, heavy reliance on medium-size retailers who might be consolidating/getting bigger, profitability risks to name a few, etc.

While Instacart has navigated rough valuation corrections and managed to have a profitable 2022, the company still has several challenges ahead as it starts operating as a public company.

In this article, we’ll talk about where the US grocery market is, Instacart’s market saturation problem, and the long (but uncertain) bets the company is making to set itself up for success.

US Grocery Market and Instacart’s Market Saturation Problem

To understand Instacart’s market saturation problem, let’s start with understanding the US grocery market from a couple of different lenses.

One lens is looking at the overall market and what percent of it is/will be online. The total US grocery market as of 2022 is $1.1 trillion. Of this, ~12% is online (i.e., ~$132B).

Of the $132B online grocery market, Instacart ran $29B worth of transactions in 2022, i.e., they already have ~22% of the online grocery market.

Also note that the total US grocery is expected to grow modestly at ~2.3% annually, which is not surprising for a mature market. While the % of this market that moves online changes meaningfully, it is estimated to cap out at ~21–24% in the next 5–10 years.

As an example, per Instacart’s own reporting (chart below), in 2027, the online grocery market will be $1.3B * 21% online = ~$273B (about double what it is today).

Another lens to look at the market is share by retailer. About half of the market is owned by large retailers (Walmart, Costco, Kroger, Sam’s Club), about one-fourth by medium retailers (Publix, Target, Albertsons/Safeway, H-E-B, Whole Foods), and the remaining one-fourth by small local stores (convenience stores, local grocery stores, specialty grocery stores, etc.).

In other words, large retailers hold a lot of sway, followed by medium retailers.

Put these two lenses together, and you start seeing the key challenges Instacart is facing.

First, the overall grocery market is not growing by that much, and Instacart is facing intense competition. While Instacart wants to “grow the pie” and not redistribute existing value, this is much harder to do in a mature market like US grocery.

For Instacart to succeed, the company needs to preserve/expand its share of the highly competitive online grocery market AND increase the percentage of grocery delivery that happens online.

Second, Instacart needs to make itself valuable enough that large and medium retailers stick around. Large retailers (half of the grocery market) have either already invested or are starting to invest in their own technology offerings.

Grocery is also a high volume, low margin business, which has resulted in more consolidation lately (Kroger and Albertsons/Safeway announced they are merging).

As more of the medium retailers beef up to become larger, Instacart runs the risk of losing them if they choose to in-house their technology and logistics investments.

For Instacart to be successful long-term, it’s critical for them to solve these two big challenges, and the company is making long-term bets in that direction.

Instacart’s Long (but Uncertain) Game

It’s clear from the S-1 that Instacart understands these challenges and is willing to make long-term investments. We’ll look at a few of these investments, and what the outlook looks like for each.

Building Customer Loyalty to Defend Its Market

Customers often don’t have loyalty toward delivery platforms and tend to switch freely to the cheapest option. While Instacart has built features that make the user experience more delightful (e.g., showing you items you have ordered before), competitors have followed suit.

Instacart acknowledges this risk:

As the effects of the COVID-19 pandemic and its variants subside, including the cessation of government stimulus, it is increasingly important to our business and its ability to grow for consumers to perceive long-term value from Instacart versus in-store shopping or less costly alternatives, particularly for lower income consumers.

They are making investments to build loyalty — both through cheaper prices derived from operational efficiencies, and an unlimited free delivery subscription Instacart+.

Though Instacart+ has an impressive 5M members and accounts for ~57% of transaction volume, several competitors have equivalent products that do not require explicit payments.

For example, DoorDash’s DashPass is offered for free with some Chase credit cards, and Walmart+ bundles free grocery delivery along with free eCommerce shipping.

Instacart also has a similar deal with Chase credit cards today, pointing to a likely future where several subscriptions are provided to consumers for free, thereby eroding Instacart’s advantage from Instacart+.

Take it with a grain of salt since it’s one person’s experience, but the last time I ordered groceries online, I compared prices on DoorDash and Instacart (because both are more expensive than in-store). I had free subscriptions for both through credit cards.

The final amount turned out to be about the same, and I ended up ordering with DoorDash — because I use the app more often for ordering from restaurants. This points to another disadvantage Instacart has over more high-frequency/ubiquitous competitors.

Overall, I still think Instacart will continue to be a significant player and at least defend the % of the online grocery market they own, but I’m not bullish that this % will increase.

Scaling Up Advertising for New Revenue + Subsidizing Delivery

Instacart ads generated $740M in 2022 revenue. Besides creating a new revenue stream (which Instacart definitely needs given its market saturation), this descriptive chart from Instacart’s S-1 perfectly captures why advertising matters for the company:

• For every transaction, Instacart collects fees from retailers and from consumers. It then pays out shoppers who pick up/deliver groceries; in this part of the funnel, from a $110 transaction, Instacart gets to keep $7.

• There is further “cost of revenue” including but not limited to technology/infrastructure, employee salaries, etc.; of the $7, Instacart gets to keep $4 “gross profit”, i.e., a low 4% profit margin.

• Now, add advertising to this. What Instacart keeps goes up to $7 “gross profit”, i.e., advertising turns Instacart from a 4% to a 6% margin business. In other words, it increases the company’s bottom line by 50%.

• This is a very similar strategy to how Uber successfully used ads to subsidize their low-margin delivery & rides business.

While the ads revenue number is impressive, what makes this product strategically valuable is what ads in the context of Instacart can drive for advertisers. Let’s look at Uber briefly, and then come back to Instacart.

In the Uber analysis, I wrote about the differences between UberEats and Uber Rides app inventory — UberEats is high intent and in context (e.g., you are searching for restaurants and you see a restaurant ad) vs. Uber Rides which is more display ads-y (e.g., you ordered a ride, there’s a free canvas there, and Uber shows you an ad for something that could be relevant to you but not contextual).

Between the two, I was significantly more bullish on UberEats because the value proposition to an advertiser is clear — spend ads money with Uber and directly measure the transactions it drives (the link is much less defensible for Uber Rides app ads).

For the same reason, I’m very bullish about Instacart ads. Specifically, Instacart is building their ads product for consumer packaged goods (CPG) advertisers — classic examples of CPG advertisers are Procter and Gamble (makes Tide pods), Coca-Cola, Kellogg’s, AbInBev (makes Bud Light) to name a few.

Though CPG advertisers have some of the most sophisticated marketers in the industry, they have often struggled with measuring the direct effectiveness of their ads.

For example, if you are Procter & Gamble and you want to increase sales of Tide pods, you don’t go run ads on Google, Facebook, or display. Because users don’t buy directly from Procter & Gamble, they buy from distributors/retailers like Walmart and Target.

Therefore, CPG advertisers typically have to use more traditional marketing methods, like paying Walmart to show their products prominently in aisles.

Another version of this is co-op advertising dollars where a CPG brand spends ad dollars on behalf of some distributors, e.g., AbInBev spends ad dollars promoting Bud Light sales in a few specific bars.

While several top retailers have built sophisticated ad products for CPG advertisers (a new category of ad platforms called retail media networks), the two-hop problem still exists — if you are a CPG brand and you don’t sell directly to consumers, you need to rely on some sort of “estimated” measurement of how effectively your ads dollars are driving sales.

Instacart breaks that huge limitation. Their ad product lets CPG advertisers promote specific items at specific retailers in a highly contextual format, e.g., Procter & Gamble can specifically promote Tide pods when you are in the process of ordering from a Safeway near you.

And more importantly, since the actual transaction happens within the Instacart app, Instacart can deterministically (without any “estimations”) say how much product sales were driven by ad spend.

Irrespective of how mature or effective the Instacart ad product is today, the ability to provide direct response advertising to CPG advertisers and measure sales outcomes with high confidence is a big moat that very few other products have.

There are a couple of advertising-related risks though. Instacart’s order numbers are flat year over year, and if this were to decline, that would hurt their ability to scale the ads products (sub-scale advertising products have a difficult time succeeding — e.g., Twitter). Also, with Instacart’s ad product, the company risks pissing off retailers who are essentially building their own ad products.

Advertising often tends to be a zero-sum game, and if Procter and Gamble is spending directly with Instacart, that’s money not being spent on Safeway’s retail media network. Instacart could make the argument that it “grows the pie” for everyone, but I’m not confident this would land with retailers.

My guess is that it will land in a place where Instacart agrees to some revenue share model with retailers. Overall, I’m bullish that the ads business will continue to thrive as long as it can keep up order volume.

Instacart Enterprise Platform

At the beginning of the S-1, Instacart CEO Fidji Simo articulates Instacart’s vision:

Our vision is to build the technology that powers every single grocery transaction — working with the retailers that consumers know and love to invent the future of grocery together. And right now, that’s more important than ever.

Note the language there — Instacart does not say that they want to be the primary platform for every grocery transaction. They say they want to build the technology that powers it.

I have no criticism of the framing, and I think that’s a smart strategy, but I do think that the framing is a direct consequence of the market saturation problem Instacart is facing. Instacart knows that more online grocery orders cannot be their only future (or at least that there’s a ceiling on the addressable market with that approach).

A few excerpts from the S-1 support this and also shine a light on how Instacart is thinking about going beyond online grocery:

We (Instacart) believe the future of grocery won’t be about choosing between shopping online and in-store. Most of us are going to do both. So we want to create a truly omni-channel experience that brings the best of the online shopping experience to physical stores, and vice versa.

With the business of grocery changing so quickly, many retailers need a trusted partner to help them navigate this digital transformation so that they can drive success both online and in-store. If the neighborhood grocer who has been serving their community for decades can’t find an edge, they may not be able to keep up.

They are looking to address this opportunity with the Instacart enterprise platform — it’s essentially a Shopify-esqe offering but specifically for brick-and-mortar retailers, and supports a range of functionality across retailers’ life cycles. Some notable functionality includes:

• eCommerce: They provide white-label online storefronts for 550 brands (see screenshot of Sprouts’ storefront powered by Instacart).

• Fulfillment: actual delivery of orders; typically picked, packed, and delivered by Instacart shoppers, but retailers can also choose to pick and pack themselves.

• Ads: Power sponsored products and display ads on retailers’ eCommerce storefronts

With this investment, Instacart is betting that they can use their existing position as retailers’ delivery partners and expand that to be more strategic technology partners, and consequently get retailers to stick around with them long term (and not consider in-housing all of their online business).

It is a smart bet, but I think is nowhere close to a slam dunk (at least so far). Large retailers (Walmart, Kroger, etc.) control ~50% of the grocery market, and I’m skeptical that they would want to rely on Instacart’s enterprise platform as their storefront.

Large companies like to minimize external dependencies because these tend to slow down product development heavily in the long term.

Additionally, if I were running online grocery at Kroger, I would not want a distribution partner to also be my technology provider — because sooner or later, the partner is going to have a conflict of interest, and that won’t be a fun conversation to have.

Even if I had no technical competency in-house, I would much rather hire from a long list of system integrators, or contract the work to an IT company (like Infosys, Wipro) to build an in-house system.

Outsourcing tech for online grocery is likely more palatable for medium-sized retailers who are okay with strategic risk, but there have been indications that consolidation is coming (e.g., Kroger Albertsons merger), and it’s uncertain how many medium-sized retailed will continue to exist in the long term.

Not to say this bet won’t be successful — just that these are non-trivial challenges that Instacart needs to address to actually make the transition to being a dual distribution + technology partner for medium and large retailers.

Conclusion

I think Instacart’s journey so far is nothing short of impressive, and they have clearly created a market that’s here to stay. Despite all the non-trivial challenges, I am bullish that Instacart will come out of this successful.

Their ads business that caters to CPG advertisers’ direct response needs is a strong moat that can subsidize the delivery business. This, along with other operational improvements they are making, can improve their profitability and therefore at least maintain their market share of the online market (I’m skeptical about it expanding).

The key uncertainty to me is if they can make the transition to a dual distribution + technology partner role for retailers, and that might meaningfully change the trajectory of what Instacart’s long-term valuation ends up being.

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Best, Viggy.

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