Thursday, June 22, 2017

The Future of Physical Retail in the Age of Online

Mike Berne, Principal of MJB Consulting, is a friend and frequent collaborator. We are pleased to share his insights on the Amazon purchase of Whole Foods. While some have come out against this merger he argues that perhaps there is less to be concerned about than we think. In September,MJB and LOA will be leading an ICSC sponsored pre-conference workshop at the IDA Annual Conference in Winnipeg.  

Still digesting this acquisition, trying to get my head around it.  

My first impression is that everyone is overreacting, as per usual.  It might have been different if they had acquired Kroger or Albertsons, but at 460 stores, Whole Foods is still a niche player in the grand scheme of things — yes, it is very prominent in the uber-educated markets where media elites tend to live (partly explaining the overreaction in the press and among analysts), but there is little overlap with “Flyover Country” between the WF shopper and the Kroger/Walmart/Aldi shopper, and businesses on the scale of Amazon need both, frankly.  

That said, the purchase of Whole Foods makes sense given that there is quite a bit more overlap between Whole Foods and Amazon Prime.  The acquisition of 460 brick-and-mortar stores essentially provides Amazon with 460 new fulfillment centers that they did not have to build themselves and that sit much closer to the dense cities where their Prime members are concentrated.  In other words, these 460 fulfillment centers help to solve the so-called “last-mile” problem and can theoretically improve their margins on food delivery. 

Many of the articles appearing in the last few days manifest little to no doubt that Amazon will be able to conquer the grocery space in short order but the reality is that Amazon (and others) have been trying to do this for years now, and has mostly failed at it.  The market share for online grocery in this country is still negligible and it is not at all clear that Americans will ever follow the U.K. example.  (Yes, there is Fresh Direct, but that is an anomaly, focused as it is on the extremely dense NYC metro).  

These articles also make scant reference to the fact that Amazon has yet to establish a money-making business model for e-commerce more generally.  Over the course of two decades, the company has generated profit of roughly $5.7B — over two decades!  By comparison, Walmart generated profit of some $14M last year alone!  This is primarily because the cost of shipping and returns remains a killer, even at Amazon’s scale!  Buried within all of the hyperbole is the inconvenient truth that pure play e-commerce is simply not sustainable, and that it is only by diversifying into bricks-and-mortar that Amazon and other smaller e-tailers will be able to thrive in the long term.

So yes, free shipping and returns are great, drones are cool, and cashier-less grocery stores would be wonderful.  But as they say, segments on 60 Minutes don’t pay the bills. And I wonder how much patience investors would have had in Amazon if the company had not happened upon the much more highly-profitable cloud computing business.  

In sum, then, if this acquisition helps Amazon to lower its supply-chain costs and thereby derive some profit from selling groceries, then yeah, it will be a winner for them.  But I think the company is past the point where merely growing (taking) market share will do the trick.  It is time for results.

Authored by Mike Berne, MJB Consulting

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