What the Amazon Whole Foods Acquisition Has in Store for Supermarkets: Digital Disruption

What the Amazon Whole Foods Acquisition Has in Store for Supermarkets: Digital Disruption

What the Amazon Whole Foods Acquisition Has in Store for Supermarkets: Digital Disruption

access_time Aug/09/2017

This summer, a group of Democrats in Congress urged the Federal Trade Commission to conduct a review of Amazon's plan to buy Whole Foods. The lawmakers asked that the review include consideration of what effect the $13.7 billion deal might have on our access to healthy foods.

Related: Amazon Is Buying Whole Foods for a Whopping $13.7 Billion -- Is It a Good Deal?

This may seem like an overreaction to a deal that Wall Street analysts say will have no significant immediate impact on Amazon's overall valuation. However, an examination of the deal within the context of Amazon's strategy starts to paint a picture of an industry on the brink of a massive disruption.

The nature of that disruption? It's clear Amazon is not merely expanding into the grocery business, but is seeking to fundamentally change the way we buy and receive our food.

Amazon's pursuit of value vacancies

If you define Amazon's market as the home delivery of products, goods and services, how does this acquisition fit the company's strategy? Simply put, by purchasing Whole Foods, Amazon is pursuing a value vacancy, or market opportunity that can be exploited through a digitally enabled business model.

Value vacancies, as defined in "Digital Vortex: How Today's Market Leaders Can Beat Disruptive Competitors at Their Own Game," are those categories in which the competition hasn't caught up to opportunity. Amazon has exploited these opportunities time and time again in publishing, apparel and sporting goods -- with well-documented success. Now, the groceries segment, too, has fallen squarely into Amazon's crosshairs.

Related: The Winners and Losers in Amazon's Whole Foods Deal

In the grocery industry, competition is lagging while the size of the opportunity is immense -- potentially $668 billion, according to some estimates. Consumers are able to go online and click once or twice to order everything from clothes to cars, but a vast majority still drive to stores, navigate crowded aisles to find items and then stand in line to pay for their food.

On the other end of the value chain, grocers -- the middle men between food producers and consumers -- must establish and service chains of stores nationwide. This system is hardly the most convenient or economical, and that makes it ripe for digital disruption.

While groceries are not new to Amazon, this particular acquisition is the company's first significant investment in the industry. In spite of Amazon Fresh, groceries is one of the last large retail sectors where Amazon does not have a significant share. At the same time, the food-delivery market represents a significant revenue opportunity.

According to a recent research by Morgan Stanley, the delivery market could reach a value of $210 billion annually in the long term, rising dramatically from around $11 billion today. A report by Whole Foods itself shows that online ordering represents less than 1 percent of the company's current revenue. This is probably true for the retail grocery sector overall, meaning that the market is still nascent and fragmented, with no established business value model.

Why Whole Foods?

The most limiting challenge to date for home delivery of groceries has been the ability to deliver perishable foods quickly. However, the short shelf life of fresh food is a competitive advantage for a leader in fast delivery. Amazon, through its logistical expertise, has been able to dramatically reduce delivery time over its competitors'. However, quicker delivery is still needed to make online food shopping a reality and one-day delivery remains an exception.

To achieve this, Amazon needs a presence closer to its customers. And Whole Foods fills that vacuum. Its hundreds of stores offer a hyper-local presence in areas with the highest density of high net worth individuals. This high-end positioning is the best fit in the industry for Amazon's pursuit of consumers with discretionary income.

What can Amazon bring to the industry?

Amazon has made its fortune by selling products at prices most competitors can't match while driving revenue through membership programs and other services. In essence, Amazon doesn't have to operate at a profit as others in the industry do. If Amazon operates the fresh groceries business at a very low margin, while driving profitability through its Prime membership and cash from other areas, many grocery chains won't be able to compete.

This model has been proven elsewhere in the grocery industry through membership-only warehouse clubs. Costco, the largest of such retailers, extends deep savings on bulk items to its members, deriving most of its revenue from annual membership fees. In fact, in 2017, membership fees accounted for 73 percent of the company's operating income.

In addition to this advantage in cost savings, Amazon can also provide customers with an unparalleled shopping experience. Those who have been to a grocery store the day before a holiday have likely felt the pain of a business competing primarily on cost rather than experience. Stores offer promotional prices to lure as many customers into the building as possible, but pay little mind to how the customer feels when inside.

Amazon will not only save the post-deal customer time; it will be able to apply its established services of automated checkout and "intelligent shopping."

Further, Amazon will maximize the spend of customers in a way brick and mortar retailers are simply unable to do. This will be possible through use of its analytics capabilities, to predict just what customers will need plus its one-click replenishment through its Dash Buttons, and its ability to suggest additional, complementary products.

Time is of the essence.

Amazon's unique model and position in the marketplace afford it many advantages in entering the grocery industry. However, the behemoth must act quickly to maximize the value it gets from the acquisition. Value vacancies like this one are notoriously fleeting. Disruptors will soon attack any profitable new market, so companies must win them and maximize revenue and profit margin while they can.

Competitive players are already experimenting and growing their revenue in this area: Instacart, Uber EATS and Google Shopping Express are all disruptive players in the market that could pose a competitive threat if they establish leadership in this segment before Amazon does.

Amazon appears to be taking this threat seriously, though, with rumblings of more acquisitions planned in the grocery industry. Supermarkets with membership business models similar to that of Prime will be able to help an Amazon-fueled Whole foods expand on a private label brand. They'll provide more brick and mortar bases from which to improve delivery times.

Related: With Its Whole Foods Purchase, Amazon Just Bought a Playground for Big Data

Although all this is just speculation right now, one thing is certain: Amazon is not nearly done with its plans to reshape how we buy food.

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