Groceries: Amazon’s Afghanistan?

In 2017, Amazon bought Whole Foods. Since then, it’s opened a handful of new Amazon Fresh grocery stores and plans many more, along with Amazon 4-star stores, small cashier-less Amazon Go convenience stores, small Amazon Go grocery stores, and a few physical bookstores. It’s diving deep into physical retail, focused primarily on groceries.

Plenty of excitement, then. But sadly misplaced.

Amazon has no business being in groceries at all. Take it from one who knows. 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.”

So have things changed since 2006? Not really. Grocery stores are high capital/low margin projects. Unlike books and electronics and even apparel, there are no fat and happy bricks-and-mortar incumbents with tempting margins. On the contrary; the groceries pool is filled with great white sharks. So where are Amazon’s competitive advantages? There aren’t any:

  • Amazon’s huge competitive advantages online mean nothing in groceries. That enormous catalog and the great search and recommendation system doesn’t matter much… milk and eggs is milk and eggs.
  • Amazon’s extraordinary logistics network is tuned to goods, not groceries. Doorstep delivery costs make free delivery unsustainable, Amazon has no competitive advantages here anyway, and Whole Foods stores are not well placed to act as delivery hubs.
  • Amazon’s past record in groceries is poor: Amazon Fresh – its long-running grocery delivery service – has gained no traction. And Whole foods at best breaks even.

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 with deep established relationships with both suppliers and customers.

But what if Amazon builds the grocery stores of tomorrow, not today? Maybe Amazon is betting on the grocery business of 2031, not 2021. That means automation behind the store, through automated stocking systems like Ocado’s; automation within the store, through cashier-less tech like Amazon Go; and delivery to the home, likely through more AVs such as the Scout that Amazon is testing now in Tennessee. Automation will cut costs, perhaps significantly. However, it’s being heavily pursued by other grocery chains as well, so won’t provide Amazon with a significant or durable advantage.

Still, the real train-wreck comes from huge organizational and financial challenges. A medium-sized grocery does about $554,000 in weekly sales ($28 million annually).To match the scale of Aldi’s – the 4th largest US groceries chain with about $31 billion in revenues, Amazon would need about 4,500 average-sized supermarkets. But this not digital, with effortless scaling. It’s a physical business where every store needs a location, staff, local buy-in, and regulatory approvals. Every individual store is a challenge.

Assume that somehow Amazon sprinkles magic dust and builds a network of 4,700 supermarkets in the next few years. Running them is an enormous undertaking. Each store comes with dust and rats and physical problems to be solved every day. And there’s no evidence that Amazon has a secret formula: Whole Foods is break even at best.

Leaving the standup and operational problems aside, if somehow Amazon became as successful as Aldi, that still wouldn’t move the needle. Aldi’s 2019 profits were about 1.4% of revenues, or about $430 million. That’s barely 3% of Amazon’s operating income.

Amazon may have other reasons for getting into groceries. Maybe it just wants to prove and then license technologies. But Bezos is still right. Groceries is a high cost/low margin business with well-established competitors, where Amazon has no sustainable competitive advantages. It also requires huge startup costs and offers low returns. That’s why groceries could become a quagmire for Amazon: a huge long-term financial and energy drain, with low and uncertain returns. Perhaps Bezos should re-read that letter.

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