There’s a ton of excitement about Amazon’s big entry into groceries. In 2017, Amazon bought Whole Foods, and since then it’s opened a handful of new Amazon Fresh grocery stores and plans many more, along with Amazon 4-star stores featuring collections of 4- and 5-star products selected by Amazon, small cashier-less Amazon Go convenience stores, small Amazon Go grocery stores, and some physical bookstores. It is diving deep into physical retail, focused primarily on groceries.
That excitement is sadly misplaced.
Amazon has no business being in groceries at all. Take it from one who knows – Jeff Bezos. In his 2005 letter to shareholders, Jeff Bezos said this: “I often get asked, “When are you going to open physical stores?” That’s an expansion opportunity we’ve resisted. It fails all but one of the tests outlined above. The potential size of a network of physical stores is exciting. However: we don’t know how to do it with low capital and high returns; physical-world retailing is a cagey and ancient business that’s already well served; and we don’t have any ideas for how to build a physical world store experience that’s meaningfully differentiated for customers.”
Nothing much has changed since 2006. Grocery stores are high capital/low margin projects. A small store (c.30,000 square foot) costs $5-10 million to fit out. The market is well served (especially in affluent areas), and is dominated by big, experienced, and well-established competitors with efficient low-cost supply chains, making margins mostly of 1-3%. Unlike books and electronics and even apparel, there are no fat and happy bricks-and-mortar incumbents with tempting margins. So where are Amazon’s key competitive advantages? It turns out, there aren’t any:
- The online edge. Amazon’s huge competitive advantages online mean nothing in groceries. That huge catalog and the great search and recommendation system doesn’t matter much… milk and eggs is milk and eggs. In short, being great online doesn’t help.
- Amazon’s extraordinary logistics network it tuned to goods, not groceries. Amazon is adapting its Flex (Uber-for-Amazon) drivers and network for groceries, but that’s something any big chain could match.
- Amazon’s past record in groceries is poor: Amazon Fresh – its long-running grocery delivery service – has gained no traction. And Whole Foods stores are not well placed to act as a delivery hub.
Amazon has no expertise in groceries, no track record of success, and will be running uphill against bigger and more experienced competitors with much better supply chains and deep established relationships with both suppliers and customers.
But what if Amazon transforms groceries into something new, building the grocery stores of tomorrow, not today? Clearly, Amazon is betting on automation. It’s investing in the grocery business of 2031. What does that look like?
- Much more deeply online, but with the majority of sales still made in person.
- Automated in both the front of the store – where Go is leading-edge technology – and behind the scenes, where Amazon will either build or buy technologies like those developed by Ocado for automated stocking to drive down labor costs. But aside from Go, these are technologies that other stores are already adopting.
- Differentiated, via re-invention of physical stores. Without this, Amazon just owns a regular grocery business. But so far, there’s no sign of the all-singing, all-dancing, Amazon grocery story experience. Maybe it should ask Disney for help.
- Delivery-oriented. Amazon is rebuilding its Flex capability for groceries.
Amazon may cut costs with cashier-less Go stores and automated stocking, but competitors can do that as well. It’s not likely that automation will provide both a significant and a durable advantage. Amazon Go doesn’t seem likely to become a huge customer magnet, and Go stores are currently more an alternative to 7-11 than Kroger’s. Overall, it’s hard to see where Amazon builds a competitive advantage even ten years from now.
But that’s a modest problem. The trainwreck comes from huge organizational and financial challenges. A medium-sized grocery does about $550,000 in monthly sales, generating net operating income of $5-15,000. If Amazon is serious about groceries, Aldi’s is a good target/benchmark: it’s the 4th largest groceries chain, after Walmart, Albertson’s and Kroger’s, with about 5% of the US market, on about $31 billion in revenues.
To match Aldi’s, Amazon would need about 4,700 average-sized supermarkets. But this is not a digital business, with effortless scaling. It’s a physical business where every store requires that a location be acquired, staff hired, and the local community satisfied, especially as food sales are highly regulated and monitored. Standing up even 100 stores is an immense challenge; 4,700 stores would take many years. And in the meantime, Amazon would be a very small fish in a big pond filled with large hungry sharks, without the scale to extract the best prices from suppliers – the key to success in Amazon’s low-price entry strategy.
Worse still, even a successful groceries business wouldn’t move the income needle for Amazon. Let’s assume that Amazon can overcome all the disadvantages, and build a 4,700 store network. Aldi’s profits in 2019 were about 1.4% of revenues; Amazon’s stores would at that rate generate about $440 million in operating income 3% of Amazon’s operating income in 2019. That doesn’t include startup costs for store development, even without advanced automation. And that’s just the start. Running 4,700 stores is an enormous undertaking. It’s not like scaling a digital enterprise. Every store comes with dust and rats and physical problems that have to be solved every day. It’s not a turnkey operation that just keeps operating until you turn it off. It is a physical plant that deteriorates every day, and operations that requires constant maintenance.
So why is Amazon buying into groceries? Perhaps Amazon has been successful for so long that it believes it can do anything. Perhaps it’s just that groceries is a big fat $650 billion target, filled with what Amazon may see as old-fashioned companies doing business in a 20th century sort of way. Perhaps Amazon somehow sees groceries either as a gateway which may open the door for Amazon to new markets, or as a segment with strong synergies to its existing retail business (it is after all 5% of household spending in the US). Perhaps all those stores can be mini-fulfillment hubs, in suburbs where Amazon might find it hard to put a warehouse. Perhaps.
What’s clear is that groceries – ironically the most mundane and mature of industries – is the first real test of Amazon’s self-belief and also perhaps of its oft-stated acceptance of big failures. Almost 2,500 years ago the ancient Greeks developed the concept of hubris, excessive self-confidence that draws down the wrath of the gods. Amazon may be about to A more modern take would look to the endless wars fought by the US, draining confidence and resources to no great benefit. Perhaps groceries will be Amazon’s Afghanistan, if not it’s Vietnam.