Amazon’s new customer, and the economics of scale in groceries

by on June 19, 2017 at 8:10 am in Economics, Food and Drink, Web/Tech | Permalink

Ben Thompson writes:

…you can see the outline of similar efforts in logistics: Amazon is building out a delivery network with itself as the first-and-best customer; in the long run it seems obvious said logistics services will be exposed as a platform.

This, though, is what was missing from Amazon’s grocery efforts: there was no first-and-best customer. Absent that, and given all the limitations of groceries, AmazonFresh was doomed to be eternally sub-scale.

WHOLE FOODS: CUSTOMER, NOT RETAILER

This is the key to understanding the purchase of Whole Foods: to the outside it may seem that Amazon is buying a retailer. The truth, though, is that Amazon is buying a customer — the first-and-best customer that will instantly bring its grocery efforts to scale.

Today, all of the logistics that go into a Whole Foods store are for the purpose of stocking physical shelves: the entire operation is integrated. What I expect Amazon to do over the next few years is transform the Whole Foods supply chain into a service architecture based on primitives: meat, fruit, vegetables, baked goods, non-perishables (Whole Foods’ outsized reliance on store brands is something that I’m sure was very attractive to Amazon). What will make this massive investment worth it, though, is that there will be a guaranteed customer: Whole Foods Markets.

…At its core Amazon is a services provider enabled — and protected — by scale.

Here is the full piece, with many more background and points.

1 Vangel Vesovski June 19, 2017 at 9:03 am

This looks a lot like narrative trying to explain something that will eventually reveal that Bezos is not wearing any clothes than a detailed look at facts. Is Amazon going to compete with SYSCO and other food distributors? Even if it does, the high capital costs and low margins move the company away from the tech sector and raise questions about valuations. Now I could accept an argument in which a company that is overvalued is using its paper to buy up one that is a much better value but given that the transaction is cash only I do not see evidence of that.

2 MMc June 19, 2017 at 10:43 am

”””’ “…narrative trying to explain something…”

Yeah, Ben Thompson’s narrative here makes no sense at all.

How exactly does Amazon make big bucks by ‘owning’ WF as a “Customer” ?? (Amazon will sell lots of stuff to itself ?)

Maybe WF has big value as a dedicated logistics ‘supplier’, but that was not Thompson’s stated point.

Home food delivery can’t escape the big logistics problem of quickly “perishable” foods. Walk-in supermarkets will own that market for a long long time.

3 Patrick June 19, 2017 at 11:03 am

The argument is that the business Amazon wants to get into is logistics for other large companies _like_ WF. The way amazon develops a service is through building it to support a main money making venture (like keeping a shopping website from imploding during the Christmas season). And then once that core service is understood, productizing it (amazon web services) to make much more money. The argument is WF is simply the initial money making venture to develop food logistics behind before they start offering it as a product in a few years. I can’t say if it’s convincing, but it’s a nice narrative.

4 MMc June 19, 2017 at 11:59 am

… so how is WF the “customer” to Amazon in all that? Sorry, your explanation just muddies the water more.

5 Borjigid June 19, 2017 at 12:41 pm

Whole Foods will pay Amazon for logistics services. Thus WF will be a customer of Amazon’s.

Amazon will also own WF, but that won’t change the fact that WF will pay Amazon corporate in return for goods and services.

6 MMc June 19, 2017 at 4:47 pm

…so Thompson’s fixation on WF as customer is trivial corporate accounting jargon.
If Amazon owns it all, taking money from one of its pockets and putting it in another of its pockets… does not change the corporate big picture.

7 Borjigid June 19, 2017 at 6:34 pm

A delivery business benefits from returns to scale.

On the demand side, if I’m the only customer for Amazon Fresh in my neighbor, they’re going to hemorrhage money delivering to me. If everybody in my neighborhood is an Amazon Fresh customer, they’re likely to be profitable. Amazon Fresh is currently suffering from a lack of scale. Purchasing Whole Foods (and their grocery delivery business) is a quick way to gain scale.

On the supply side, if Amazon is only distributing food through delivery, it needs to very precisely estimate the amount of perishables it will sell. If it buys too many, they’ll rot. If it buys too few, customers will be upset. If they are distributing fresh food from the same stockpiles via both delivery and brick-and-mortar stores, the estimating becomes easier. So purchasing Whole Foods helps there too.

8 dan1111 June 19, 2017 at 11:35 am

“narrative trying to explain something that will eventually reveal that Bezos is not wearing any clothes”.

I find this interesting, because quite awhile ago (maybe 10-12 or more years ago) I watched a fawning documentary on Bezos and came away with the conclusion that he “is not wearing any clothes”. Amazon was not profitable and he refused to say when they would be profitable. He did quirky things like drive an old car and use a door on sawhorses as a desk. I thought he was the trendy executive of the moment who was going to come into a collision course with reality.

However, I feel that I have been proven quite wrong since then. He really was revolutionizing the business. Of course he could have been successful in the past and still fail now. But to me the post rings true as to the sort of capability that Amazon can bring to the table (and deliver successfully (no pun intended)).

9 rayward June 19, 2017 at 9:05 am

Amazon will cut WF’s costs by increasing efficiency in the supply chain, not to increase WF’s profits but to lower WF’s prices (that’s the conventional wisdom). Amazon is almost (but not quite) unique in its freedom to ignore profits and to focus instead on total revenues. Amazon can ignore profits because the absence of profits and dividends doesn’t adversely affect Amazon’s stock price; indeed, the absence of profits and dividends cuts the fundamental connection between the two. The irony of Amazon buying WF is that institutional investors in WF have been hammering WF to take action to increase profits and its stock price. Amazon has the freedom to operate much like a nonprofit or state-owned enterprise. This about that for a minute. I know, Amazon has been generating significant profits in recent years, but those profits come almost entirely from its cloud business not the retail business on which it is based. Does Amazon portend a retail future without profits? Most small business is in retail (including restaurants). How does small business prosper if it doesn’t generate profits? Think about that for a minute.

10 Dick the Barber June 19, 2017 at 9:51 am

Truth. Brick and mortar retailers cannot survive without profits. Amazon not so much.

The stock price is over $1,000 a share. What’s the PE? What the implied multiplier? Barron’s lists shows the PE “dd.”

“Blue Apron” is contemplating an IPO at $3 billion. It has never posted a profit?

11 anon June 19, 2017 at 11:26 am

Amazon just invests a lot in expanding its business. It could post huge profits if it wanted to.

12 dan1111 June 19, 2017 at 4:46 pm

+1

13 Thomas June 20, 2017 at 2:41 pm

By my back of the napkin calculations, without any investment would still be about 50% more expensive than the average S&P500 stock by PE with net earnings of about 12.3 billion dollars.

14 Thomas June 20, 2017 at 2:42 pm

That’s an expensive bet on the efficacy of those investments.

15 prior_test2 June 19, 2017 at 9:06 am

So, how will Amazon deal with Lidl, one wonders.

16 Borjigid June 19, 2017 at 12:44 pm

More product offerings. Lidl is built around limited offerings.

Also, Bezos doesn’t care about profits, just market share.

17 prior_test2 June 19, 2017 at 1:40 pm

Lidl cares about both. And the limited offerings is seen as a plus by both Aldi and Lidl. And though I have no real comment about Lidl’s logistics chain, Aldi’s is as brutally efficient as possible, in large part due to that limited offering.

I recognize that Whole Foods is an entire different category, but the point of the post seems to misunderstand that there is more than one kind of logistics chain, and that the German retail food market is brutal. Meaning that if Lidl and Aldi follow their strengths, Amazon may discover the same thing that Walmart did, after suffering major losses in Germany. It would be interesting to see how Whole Foods would do against Alnatura, a German organic retailer/wholesaler (they have their own stores, plus provide their product lines to other retailers) – Alnatura comes out of the same environment as Aldi and Lidl, after all.

18 dearieme June 19, 2017 at 9:16 am

Our experience of having deliveries from a supermarket is they they’re fine for detergents, bog rolls, and that sort of thing, and for frozen food, canned food, biscuits, wine, beer, water, and so on. For fresh food – meat, cheese, fish, fruit, veg, baking – they are hopeless. But maybe mass society doesn’t give a damn.

19 anonymous June 19, 2017 at 11:29 am

I had no issues with those items. Obviously you can’t pick them out yourself, but there’s no way around that.

20 dearieme June 19, 2017 at 1:26 pm

“Obviously you can’t pick them out yourself”: that is precisely the point. Why would you trust some pimply youth to pick them for you? Or a robot?

21 Art Deco June 19, 2017 at 2:27 pm

He’s British, you’re British. He eats swill. So do you. You’ve just taken the time to be British and offer snippy complaints while you’re chowing down on Marmite-on-toast and throwing down the scotch.

22 Art Deco June 19, 2017 at 2:29 pm

???

23 Thiago Ribeiro June 19, 2017 at 5:19 pm

Jackson is told (I myself have never heard or read the speech) to have explained how he used to spit at his boas’ customers’ orders.

24 Thiago Ribeiro June 19, 2017 at 5:19 pm

boss’

25 Hadur June 19, 2017 at 9:35 am

A friend of mine recently moved to a new apartment building, far away from a grocery store. He went onto Facebook to ask which grocery delivery service was the best.

The consensus among our mutual friends was that Amazon’s existing service was already the best. Friend went with Peapod, though, due to uncertainty over what this deal. He said he’d revisit after 6 months though.

26 Dick the Barber June 19, 2017 at 9:44 am

If Americans would desist voting for Republicans, liberals wouldn’t have to shoot Republican Congressmen.

so, they can’t go there. They might get shot.

27 Thiago Ribeiro June 19, 2017 at 9:51 am

If Americans would desist playing baseball, nothing like that would ever happen. How many lives must American obsession with boring sports cost before it is enough? There has never been an attempt at political assassination at a soccer game in Brazil.

28 Careless June 19, 2017 at 10:02 am
29 Thiago Ribeiro June 19, 2017 at 11:24 am

Thise things are incredibly rare. Rags like the Daily Mail try to blow this kind of incident out of proportion both out of sensationalism and as a ploy to hurt Brazil’s standing among the world’s nations. One cannot compare criminals skneaking around in what is little more than a ghost town and hurting random people (as sad as it surely is) with American citizens acting in broad daylight against the American leadership at the sanctum sanctorum of American power. There is a deep, grave confidence crisis facing your country, you leadership and your citizens.

30 Thiago Ribeiro June 19, 2017 at 11:24 am

Those things are incredibly rare. Rags like the Daily Mail try to blow this kind of incident out of proportion both out of sensationalism and as a ploy to hurt Brazil’s standing among the world’s nations. One cannot compare criminals skneaking around in what is little more than a ghost town and hurting random people (as sad as it surely is) with American citizens acting in broad daylight against the American leadership at the sanctum sanctorum of American power. There is a deep, grave confidence crisis facing your country, you leadership and your citizens.

31 msgkings June 19, 2017 at 12:30 pm

LOL no

32 Thiago Ribeiro June 19, 2017 at 12:38 pm

Rhere is a clear, present chasm between the American people and its leaders.

33 msgkings June 19, 2017 at 1:31 pm

LOL nope

34 Thiago Ribeiro June 19, 2017 at 2:09 pm

Yes, there is. A desperate populace has exchanged tha ballot for the bullet.

35 msgkings June 19, 2017 at 2:35 pm

LOL nah

36 Thiago Ribeiro June 19, 2017 at 5:16 pm

Yes, Americans want change and do not believe they can get it by lawful methods anymore.

37 msgkings June 19, 2017 at 5:32 pm

LOL nein

38 Thiago Ribeiro June 19, 2017 at 6:10 pm

The 1%’s grip on power can not be broken by legal means anymore.

39 msgkings June 19, 2017 at 6:15 pm

LOL não

40 Thiago Ribeiro June 19, 2017 at 6:41 pm

Sim. Americans know their leaders have betrayed them.

41 charlie June 19, 2017 at 10:18 am

Interesting take.

I wonder if Amazon has really transformed any supply chain outside of books.

They claim to be the largest retailer of clothes. Has it changed the supply chain? No question it has changed the retail experience but I don’t see many amazon-only clothes. baby diapers?

WF also had a partnership with Instacart, which did have the best delivery services. Agreed that grocery delivery may only work for boxed item.

42 Evans_KY June 19, 2017 at 10:39 am

A diabolical move by Bezos. In rural areas there is a Walmart and Kroger in every small town. They have been struggling to keep up with curbside service and expedited shipping. No fresh food delivery services here. But with an Amazon warehouse and Whole Foods within an hour drive, this deal makes my Prime membership more valuable.

Whole Foods is known for including local produce in their stores and I hope Bezos continues/expands that tradition. Community supported agriculture is very important in our area.

43 ¯\_(ツ)_/¯ June 19, 2017 at 11:17 am

This is pretty smart speculation, but I can’t really get into all this week’s Speculation vs Speculation. It’s like “if I had a million dollars” but played with Amazon scale numbers.

44 CG June 19, 2017 at 11:25 am

Oh wow Amazon is transforming the future, they’re not even investing in retail, they’re buying a supply chain and a customer, ooo they’re going to shake the foundations of how people buy goods and services.

Sorry, I just don’t buy it. Amazon, while certainly innovative, is simply a conglomerate. It’s a holding company with various loosely related business lines – online retail, AWS, hardware, prime serivces (i.e. movies/music/books), fresh, etc. They can generate economies of scale but still face fierce competition from all sides (google, apple, microsoft, even traditional retailers stepping up their e-commerce game). If anything, this latest move does not signal a nod to the future, but a nod to the past – it’s a capitulation to the traditional retail model and indicative of the staying power of bricks and mortar.

45 anonymous June 19, 2017 at 11:40 am

Well, if brick and mortar groceries can’t work, then what can? Is a future of warehouses, grocery stores, and no other retail a capitulation to the traditional retail model?

46 CG June 19, 2017 at 12:26 pm

Investors become so taken with current trends and changes that they often fail to recognize the longer term consistencies and fail to contextualize just how big industry changes need to be in order to see the kind of shift in fundamentals that you’re describing. For example, e-commerce is still less than 9% of total US retail sales (excluding restaurant sales), and note this includes as e-commerce consumer to consumer transactions, like paypyal, and auction sites like ebay. Yes it’s growing rapidly, but to suggest that this number will make up anything close to 100% is delusional. People like going out to shop, for food, clothes, everything, and that’s never going to completely go away, it’s a fundamental part of the social experience. Traditional retail has its challenges but you’re already seeing companies adapt to this with the shift a way from the indoor mall and the rise of experiential retail. I have no idea at what % will e-commerce begin to plateau, but this idea of a future where everything is done online and delivered from warehouses strikes me as pretty absurd and contrary to the continuities we’ve seen in human behavior across cultures and time.

47 anonymous June 19, 2017 at 12:39 pm

Food and clothing yes, other things not so much.

Food makes up over 10% of retail sales, clothing about 5%. Gas stations make up close to 10%- I will give you that as well. Auto sales make up about 20% of retail sales and are protected by the government, for now.

48 ¯\_(ツ)_/¯ June 19, 2017 at 12:45 pm

“Other things” includes a trip to the hardware store, when you aren’t exactly sure what you’ll need. To name just once store hard for Amazon to pick off, Home Depot.

Still, Speculation vs Speculation.

49 mpowell June 19, 2017 at 1:04 pm

I’m not saying Home Depot is going away, but there is a lot of crap from Home Depot I would rather order on Amazon Prime. Usually, it doesn’t exist. I think this may be partly a branding at low cost issue and Amazon is starting to solve this problems with their AmazonBasics branding. Another thing Home Depot has going for it is that the weight of most of its items mean that offloading transport to the customer is the better model. I think Amazon can win some of the market share, but maybe not much of the higher revenue stuff.

50 anonymous June 19, 2017 at 12:40 pm

“the continuities we’ve seen in human behavior across cultures and time.”

LOL. Yeah why wasn’t everyone buying online in the Roman Empire? That does puzzle me.

51 CG June 19, 2017 at 12:56 pm

Strawman. Humans are inherently social and will always be going to the market even with lower cost alternatives because there is value in the experience.

52 msgkings June 19, 2017 at 1:34 pm

CG is correct. It’s the same reason people still go to concerts and movies in the theater even though they can get the same music or movies online or on TV.

The composition of what people buy at the store will probably change significantly, with basics like paper towels bought almost entirely online. Most other things shopping is entertainment.

53 chuck martel June 19, 2017 at 7:22 pm

Today’s WSJ, pg. A10:

“I would be the first one to sign up for Whole Foods delivery and would probably never step foot in the store again,” said Judah Ross, 29, an entrepreneur who lives near the Whole Foods flagship store in Austin, Texas, and shops there every other week. “Whole Foods is a pleasant place but I hate going out to shop for groceries. Even though it’s so close, there’s traffic, parking and waiting in line. The convenience of delivery would outweigh any benefit of picking out the food.”

This person is a typical American whose priorities in life are comfort, convenience, entertainment and security. A trip to Whole Foods by Ross could easily involve missing a Seinfeld re-run or being forced to stand behind an unattractive person with respiratory issues in a check-out line.

54 asdfG June 19, 2017 at 2:52 pm

You are aware you can get your very only blog for free, right Art?

55 pongogogo June 19, 2017 at 3:09 pm

I think this is wrong. I think they just keep buying premium brands to make Prime membership more compelling/comprehensive and move upmarket where the margins are wider. They then leave the scraps to everyone else and just sell distribution.

Typically (at least for me) when you use prime you are price blind and don’t shop around – it’s a ludicrously sticky service.

56 Andao June 19, 2017 at 3:42 pm

WF as a customer makes sense. Bezos must have looked at AmazonFresh growth and development they’d never get enough scale to be competitive in food logistics. Now the customer pool (and purchasing power!) of the combined entity will make the whole food logistics thing more viable.

Of course there’s a lot of assumptions baked in there that could fail miserably. As other posters noted, a large number of people enjoy shopping at grocery stores and will continue to do so.

57 Zach June 19, 2017 at 5:12 pm

This AWS layer in the middle has several key characteristics:

AWS has massive fixed costs but benefits tremendously from economies of scale
The cost to build AWS was justified because the first and best customer is Amazon’s e-commerce business
AWS’s focus on “primitives” meant it could be sold as-is to developers beyond Amazon, increasing the returns to scale and, by extension, deepening AWS’ moat

How does this apply to groceries? The infrastructure here is large warehouses that ship to Whole Foods markets. The infrastructure costs are large, but not overwhelming — such warehouses already exist, after all. There are returns to scale, but they aren’t massive, and anyway Walmart already operates on a larger scale. You can offer warehousing services to other supermarkets, but that’s an already-existing, competitive business.

The difference Thompson seems to be focusing on is that Amazon can customize the warehouse operations to their own retail needs. But why is it better to own the warehouse than to rent a corner of the warehouse and customize that?

Also, is Whole Foods really a customer of the warehouses in the same way that Amazon is a customer of Amazon Web Services? For Web Services, Amazon’s needs are very similar to the needs of other customers. But a supermarket’s warehousing needs are very different from a direct-to-consumer business’. At the end of the day, the supermarket is going to have a semitrailer pulling up to the back door with palletized goods, while a consumer business has to subdivide those goods into individual packages before shipping.

The supermarket would really prefer that nothing ever gets taken off a pallet until it reaches the store. The consumer business does nothing but taking things off the pallet. Where’s the commonality?

58 Zach June 19, 2017 at 5:19 pm

The only thing I can think of is that Amazon would now sell the consumer delivery services to other direct-to-consumer grocers. But then why would you want to own Whole Foods, which doesn’t use that model?

59 chuck martel June 19, 2017 at 7:30 pm

Whole Foods has a customer base that it doesn’t necessarily share with Walmart, Aldi, or other traditional grocery chains and this base is being eroded by WF’s intimidating prices. Is Amazon purchasing WF’s business or its physical capital? Does it intend to use WF as its own physical retail outlet in its present configuration or use its facilities in a completely different manner?

60 BD June 20, 2017 at 10:41 am

Amazon will leverage Whole Food’s understanding of “prime” grocery buyers and grocery marketing to perfect the online ordering process and offer a three tiered delivery scheme. Customers will be able to choose shopping in the store, curbside pickup, or delivery. I don’t see anything but upside for Amazon. The thing they need to avoid is making too many changes to the mix of products and pissing off the prime grocery buyers. But they’re not going to start shopping at Walmart no matter what.

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