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A Barron’s article last week quoted a public equity investor in Whole Foods, the iconic American grocer that Amazon is purchasing for $13.7B:
I wouldn’t be surprised if every grocery store has an emergency board meeting this weekend.
Should the stalwarts of the grocery industry, as he suggests, be shaking in their boots?
Remember: Whole Foods is a tiny player in the U.S. grocery market. With $16B in grocery revenues, it has only 2% market share and is dwarfed by larger players like Costco ($67B), Kroger ($87B), and Wal-mart ($272B). Moreover, it serves a tiny portion of the population. Its 400+ stores are predominately found in affluent neighborhoods and are viewed as a luxury by most middle class Americans.
If Amazon were only buying a grocer, few would be concerned. Shopping at Whole Foods is a wonderful experience, for those who can afford to do so, but Amazon’s plans likely go far beyond business as usual. The market clearly agrees. On the day of the deal announcement, Amazon’s stock appreciated by more than the deal value. That means Amazon is effectively getting Whole Foods for free. Said differently, the market believes future synergies are more valuable than Whole Foods is today on a standalone basis.
So what does Amazon plan to do with Whole Foods? A few ideas have been swimming around my head all week:
- Importance of offline food channels. First and foremost, this acquisition is an admission that grocery doesn’t work entirely online. I spoke to a former consultant to the grocery industry recently, who told me that many consumers she interviewed shop in store because it enables them to verify the freshness of produce. A melon on a website isn’t nearly as appealing as a melon you can hold and smell. Amazon must own retail to sell fresh food to the masses. Furthermore, the distribution model for grocery is meaningfully different those of CPGs or hardlines. Amazon is acquiring a functioning cold chain and expertise that it doesn’t currently have. Amazon will likely bring some its operational experience to bear and battle much of the waste in the current model, but it will do so by building on what is already working for Whole Foods.
- 400+ last mile distribution points. The majority of Whole Foods’ 400+ stores are leased, not owned, but that won’t stop Amazon from utilizing this prime urban real estate for other purposes. Amazon has been testing drone delivery for years now, but now it finally has a “last mile” parking spot for them (pending appropriate legislation of course). More pedestrian implementations of last mile delivery, including couriers (sorry, Instacart) and sidewalk robots, could also benefit from an urban distribution hub. I’d also expect to see more “buy online, pick up in store” options from Amazon in the future, both for food and other goods.
- Double down on private label. The 365 private label brand at Whole Foods currently accounts for only 12% of sales. Amazon is currently experimenting with its own private labels: AmazonBasics (batteries), Mama Bear (baby food), Happy Belly (cooking supplies), etc. Given the attractive margin profile of private label and Amazon’s sophisticated understanding of customer demand, I imagine it will both promote those private label brands aggressively at Whole Foods and create new product lines that work better in an offline context.
- Test bed for Amazon Go. Remember that cool video showing Amazon’s computer vision powered self-checkout technology? Whole Foods is the perfect test bed for it. The consumer will benefit greatly from this technology. Unfortunately, the vast majority of cashiers will likely lose their jobs. Today, cashier is the 5th most common job in the U.S. at approximately 3.5 million workers. This presents a big social problem that hopefully Amazon will play a role in solving.
- A more compelling Prime. The 80 million Prime subscribers spend 86% more on average than those who do not subscribe. That’s because subscribers get the value of free, fast shipping and better than advertised prices on many goods. Bezos was once inspired by Costco’s membership based model, and you have to believe that the purchase of Whole Foods feels “full circle” for him. Imagine how much greater the incentive to sign up for Prime will be when your groceries purchased at the store cost less as well. Maybe you could order online and get local delivery, if only you’re a Prime member. Bezos will certainly wield Prime as a competitive weapon in the grocery industry to increase Whole Foods’ market share today from 2% today.
While speculation is fun, let’s also not forget that M&A is hard to pull off. Few companies do it well, and Amazon has never ingested a company as large as Whole Foods. Nor has it ever purchased a retailer. Yet, given Bezos’ track record for shaking up commerce, I have little doubt that this acquisition will look smart over a 5–10 year horizon and that Amazon’s share of our wallet (and stomachs) will continue to rise.
Disclaimer: I own Amazon stock, so take the above with appropriate grain of (organic, fair trade) salt.
“Amazon and Whole Foods: Is this a grocery apocalypse?” (Link)
Amazon left Wall Street and rivals guessing about its intentions because it held no conference call after disclosing the deal on Friday. “Amazon is innovative and disruptive. It isn’t Amazon’s strategy to show its hand,” says Instinet analyst Anthony DiClemente.
His view is that Amazon will look for “identifiable ways to improve Whole Foods’ returns, build direct relationships with Whole Foods customers, and use its distribution platform for growth in other areas.” Amazon also gets the opportunity to transform Whole Foods’ 400-plus U.S. stores located mainly in affluent areas.
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