The grocery business is about an $800 billion market in the United States and about $80 billion in Canada. This is one sector of the retail market where Amazon has not achieved a significant beachhead in either country. With the deal to buy Whole Foods, the online retailer will have a small slice of the grocery market (about 1.2% in the United States) in North America, which is dominated by a handful of firms like Walmart (14.2%) and Kroger (7.2%) in the United States and Loblaw Companies, Metro Inc. and Sobeys in Canada.
Last year, the online shopping giant launched Amazon Go, an experimental grocery store with no checkout counter that’s currently open to Amazon employees in Seattle. Amazon also opened its first brick-and-mortar book store in Seattle in 2015, and has since expanded to New York City, Chicago, and Los Angeles. The company is said to be evaluating various physical retail experiments that range from futuristic Home-Depot-like stores that incorporate augmented reality to Apple-like electronics boutiques, according to The New York Times. Amazon’s acquisition gives the company 431 physical Whole Foods locations to potentially flesh out new concepts.
Amazon’s entry into the grocery market will expose the company to an incredible array of commodities and supply chain variables.
Commodities
In addition to moving a range of packaged food and non-food products (i.e. magazines, utensils, cosmetic and health care items, etc.), Amazon will now be transporting perishables and fresh produce. This is a challenging consumer category for online retailers as they:
• require temperature control (i.e. products can fall into six categories of refrigeration including keep from freezing, keep frozen, store at room temperature etc.),
• have seasonality and time definite shelf life issues,
• need specialized packaging, necessitate accurate and efficient delivery scheduling,
• involve a high number of SKUs, and
• demand rapid order processing, picking, packing, and delivery.
Transportation Modes
Buying Whole Foods supplies Amazon with a grocer that has both a brick-and-mortar network of stores and a large set of transportation suppliers. According to the United States Department of Agriculture, ninety-five percent of perishables move via over the road truckload transport while one percent are transported in intermodal containers and four percent move via boxcar. Unlike many packaged goods loads, perishables are often picked up as “live loads” and have extended pick-up and delivery intervals. Because of the range of products, deliveries can be via truckload, single or multi-stop and via LTL. The Amazon online distribution network is quite different.
Whole Foods changes the Delivery Dynamic for Amazon’s Core Business
Amazon currently has a very extensive distribution and delivery network to move its core online sales products to markets. The Whole Foods’ store infrastructure opens a new array of fresh, organic produce and specialty groceries to the Amazon customer base. A recent Stifel article suggests that the Whole Foods acquisition would provide baseload density upon which Amazon could layer conventional parcels, meaning lower last mile delivery costs. That same brick-and-mortar presence gives Amazon an immediate network of locations for in-store pickup, drop-off locations for consolidating returns, and new locations to install parcel lockers for 24-hour service and/or customers that don’t want to wait in line.
Industry experts estimate the company would have to add a dozen or more grocery warehouses, particularly if it wanted to supply Whole Food stores in addition to homes. Amazon would likely continue to rely on United Natural Foods Inc. to continue to supply Whole Foods with hard-to-source products, but would probably aim to cut costs and handle more of the distribution for conventional items. Even using Whole Foods stores to provide food for delivering to nearby urban shoppers would have specific limits, since many outlets lack the floor space to handle thousands of online orders.
Moving Inventory closer to the Consumer to increase Speed to Market
In Amazon’s relentless pursuit of customer satisfaction, date/time definite delivery have been instrumental in establishing the expectations bar. After setting the standard with 2-day Prime, its’ competitors have been struggling to play catch up; next-day, same-day, and even 1-hour delivery have become the new standards. But faster delivery is often cost-prohibitive, as existing national and super-regional parcel delivery networks were not set up for same day or even next day speed on a relatively low-cost basis. Surveys have found that consumers are usually unwilling to pay up for the extra service which means that for now, same day remains only a niche offering.
The solution that Amazon has found is to drive inventory (i.e. warehouses) closer to the consumer, thus reducing the length and cost of the last mile component. Whole Foods’ existing store infrastructure is potentially the next evolution of that model, allowing Amazon to position not just grocery and fresh foods, but also traditional e-commerce inventory at the neighborhood level. However, facilities for distributing fresh food are far more complicated than ordinary warehouses.
As highlighted above, a single facility may require multiple temperature settings to house products from ice cream to berries. Some require certification from the government bodies, and extra care must be taken to keep shelves clean and prevent pests from contaminating food. Whole Foods has over 1 million square feet of warehouse space for distribution to its markets, and a chunk of its inventory goes straight from suppliers to stores, according to Marc Wulfraat, president of MWPVL. “It’s a peanut. It’s nothing,” he said of Whole Foods’ distribution. “If Amazon wants to become a dominant grocery company in a short period of time, then there would be an investment required, and it would be big.”
Regulatory Changes are Impacting Retail Distribution
Amazon is making this move at a time when the trucking industry is transitioning to electronic logging devices (ELDs). The widespread application of these devices could alter the current paradigms for miles driven per day and for freight rates. As ELD compliance evolves, the regulatory environment may play a big role in the economics of food distribution.
Market Positioning
Lisa Eadicicco of Time magazine identified that Amazon’s Prime Now service promises to deliver certain products — ranging from paper towels to electronics — in an hour or less, which Amazon sources from 70 fulfillment centers in the U.S. With its purchase of Whole Foods and the hundreds of grocery stores it operates — which sell everything from fresh food to beer, bakery items, flowers, and pet supplies — Amazon has an opportunity to expand the products it can deliver under Prime Now.
Amazon is far from the only digital company to show interest in the grocery space with its AmazonFresh service, which is available for Prime members for $14.99 per month. Adding Whole Foods’ selection of items to its service could give the online retail giant a competitive edge against Google, whose Express Deliver service now reaches 90 percent of the U.S. Instacart, Peapod, and FreshDirect are also players in this space.
Summary
The “bricks and mortar” grocery store delivery model and the online shopping model are quite different. Whole Foods is still a relatively small player in the overall food distribution market in both Canada and the United States. It has not been performing well over the past several quarters. Moody’s has identified 22 retailers that are significant risk of bankruptcy, including some very well-known companies (i.e. Sears, Neiman Marcus). Analysts are even predicting that one-quarter of America’s malls could close within the next five years. To be successful, Amazon will need to fix Whole Foods current business as it seeks to identify the synergies from this acquisition, while capitalizing on and mastering the supply chains from these two related but different businesses.
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