Learning Outcomes
After reading this case, students should be able to:
-Articulate the reasons why Whole Foods Market (WFM) was bought by Amazon.
-Evaluate whether this decision was wise, given several industry factors.
-Explain why Amazon is interested in grocery delivery.
-Identify possible outcomes of the deal and why they are likely.
-Gain a broader understanding of the grocery industry in the context of online shopping.
Introduction
On June 16, 2017, Amazon bought WFM for $13.7 billion, at $42 per share in an all cash transaction (Chan, 2017). Amazon announced they would allow WFM to operate under its own brand and WFM’s Chief Executive Officer John Mackey would keep his position. Speculation immediately ensued as to what the online retail giant would do with the brick and mortar WFM.
Why WFM?
Founded in Texas in 1980, WFM was conceived when its founders realized that natural food shopping was ready for the supermarket format. WFM grew through a series of mergers and acquisitions of small natural food stores, such as Bread of Life and Nature’s Heartland. WFM grew to its current 450 plus stores today across the US, UK, and Canada. As of 2017, they have stores in all states except for the following: Vermont; West Virginia; South and North Dakota; Montana; Alaska; and Hawaii. This was ideal for Amazon since WFM covers a large geographic footprint around the United States.
WFM sells organic, natural, and ethically sourced products from around the world. It specializes in hard to find niche products, specifically in the health food category. WFM has their own private label called 365. The typical consumer at WFM is middle to upper class and many of the WFM products are high priced due to their organic and hard to find nature. Thus, the majority of WFM locations are in affluent urban and suburban areas. WFM currently only has 1.2% share of the grocery market (Meyer, 2017).
Amazon was able to buy WFM in large part due to recent declines in sales and share price. Due to its prices, WFM gained notoriety as “Whole Paycheck.” Their revenue growth has been steadily decreasing each year since 2012 (Thompson, 2017). WFM, at its inception, originally fulfilled a niche for organic products. However, as more consumers desired healthier options, many mainstream regional stores have started to add organic and health food sections, often at lower prices than WFM. This created a problem for WFM, which has prided itself on its ethically and sustainably sourced products, traits that typically lead to higher prices. As other competitors enter the market, they are not nearly as transparent as WFM is in terms of their supply chain, thus offering products at cheaper prices. Another reason to buy WFM was a strong consumer base that matched Amazon’s target market: middle to upper class and educated. WFM’s brand image of an affluent, upscale market fits in with Amazon’s goal of integrating their brand into the lifestyle of this consumer segment. The educated middle to upper class is increasingly time impoverished and quality and convenience oriented. The WFM image is consistent with this, thus making it an appealing choice. This consumer base gives WFM the edge over other, cheaper grocery chains. Comparatively, WFM is also larger than other chains such as Wegmans. In addition, since WFM is an upscale brand, it gave Amazon the potential to bring in new, price conscious consumers by moving the chain more down market by maintaining quality but decreasing cost.
The Acquisition
According to the regulatory filing on the acquisition, WFM had hoped to receive a bit more money. WFM initially sought $45 per share, compared to the $42 Amazon agreed to, calling that its best and final offer. Amazon initially offered $41 in May. The filing also explained that if any details leaked to the public, Amazon would walk away. There were other competitors as well: four private equity firms; and two industry competitors. Initially not named, one industry competitor was revealed to be Albertsons, a regional grocery store. Albertsons proposed a merger of equals that valued the share price at $35 to $40 (O’Donnell and Hirsch, 2017). Amazon also took a strong stance on a no bidding war, forbidding WFM from soliciting any other bids. Amazon did not want to compete in a broader sale process.
Grocery Industry
Currently, the grocery industry in the United States has been mainly tied to brick and mortar stores with little online expansion. Kroger is the largest grocery-only chain in the nation with 7% of the grocery market, yet does not reach each state, specifically the east coast (Meyer, 2017). The number one grocer in the nation is Walmart with 14% of the grocery market. The retailer offers deep discounts on items and has huge superstores with office supplies, clothes, hardware, and home appliances in addition to food (Meyer, 2017). Discount chains, such as the European Aldi’s and Lidl, are gaining in popularity, leading to competition. Grocers operate on razor thin margins in order to compete with each other.
An overarching trend seen in the grocery industry is specialization. Filling a niche has never been more important. Successful chains like WFM and Wegmans fulfill a need for a higher end market while Aldi and Lidl offer bargain prices on private-label brands. WFM, as mentioned before, fulfills a very high-end market, which makes it valuable. High end consumers tend to desire knowledgeable staff members, excellent service, and a wide variety of products. WFM has all of those traits. Chains the most comparable to WFM are Trader Joe’s, Wegmans, and Target. These three chains typically attract the upper income consumer segment and Wegmans and Trader Joe’s likewise specialize in hard to find, natural products.
The industry itself has been sluggish to adapt to online shopping; currently just 23% of households buy food online (The Nieslen Company and The Food Marketing Institute, 2017). In part, this is because consumers have a preference to pick out perishables such as meat and produce themselves. Convenience also plays a role since some items, such as aspirin or milk, may require quick turnaround for the consumer. This creates a barrier to online shopping, with many consumers not feeling in control of their purchases. Added labor cost is also a hurdle to online grocery shopping. With brick and mortar, the customer acts as the assembler (picking out their products) and as the deliverer to their home. In an online model, these two jobs must be added, thus adding to cost. In an industry that already operates on tight margins, the online model is costly. The supply chain for perishables is also complicated and requires careful logistics for numerous temperatures, US Food and Drug Administration regulations, pest control, and spoiling: just to get them from source to store. The implementation of online shopping for perishables to homes across the nation would require absolute mastery of the “cold” chain, an expensive and complicated endeavor. This has left many grocers looking to third party delivery services such as Instacart and FreshDirect. None of these delivery companies has made a national impact on the level Amazon is poised to make. The stakes are high considering that there is a large potential growth in the online grocery shopping sector: 60% of Millennials and 55% of Generation Z are willing to use online grocery shopping in the future (The Nielsen Company, 2015). Whichever company offers the smoothest transition from in person shopping to online shopping at the best price will ultimately shape and control the beginning of the online grocery era. What will predict who gets the food delivery right is the correct balance of cost, convenience, and assortment.
Amazon’s Interest and Competition
In 2007, Amazon launched its own grocery delivery business, AmazonFresh. However, Amazon has not seemed to corner this service as easily as it overtook the distribution of books and media. They currently offer some specialties, such as “single cow burgers” (Wagyu beef burgers from grass fed cattle raised in California) [Luden, 2017]. Amazon also partners with local food retailers to offer their products online in a service called Local Market. Amazon takes care of the shipping and logistics for the business. However, these specialties have not been enough to tip a significant portion of the American public into using AmazonFresh repeatedly and for more items.
Amazon has seemingly bet that grocery delivery is the wave of the future by purchasing WFM. Currently, Amazon does not have enough AmazonFresh sales to justify the infrastructure investment it would require to further streamline their supply chain (Thompson, 2017). One might argue that the grocery industry operates on too small of margins for grocery delivery to be profitable. However, that could be said of the online retailing industry as well. Amazon has always been good at trimming down supply costs and streamlining logistics, with a strategy of market share first, profits later (Nusca and Rapp, 2017). The company is known for offering a wide breadth of services but turning a very shallow profit. Amazon’s investors do not mind and rather encourage this behavior. However, Amazon is racing against time and other companies, such as Walmart and third-party delivery services, to master grocery delivery service.
Competition
Major grocery delivery competitors include Peapod (a division of Ahold), FreshDirect, and Instacart. Instacart is interesting because in February 2016, it signed a five-year contract with WFM to become the exclusive delivery partner for the grocer’s perishables business (Del Rey, 2016). Instacart continues to be used by other major companies such as Costco, BJ’s, Publix, Wegmans, and many more. Instacart poses a potential threat to Amazon, having already operated for five successful years and scoring contracts with major companies as their preferred delivery service.
Another major competitor Amazon faces is Walmart. Walmart, in some ways, has acted as a brick and mortar Amazon, aspiring to be an omnichannel store. Omnichannel stores combine in store purchasing and orders from online in one distribution center. Walmart sells thousands of products, mostly at a cheaper price than other stores. Amazon does the same thing online. It would only make sense that, as the lines between online and brick and mortar become blurred, the two titans would meet. Walmart has launched its own online site, a direct attack on Amazon. It also acquired Jet.com, an online retailer, on August 8, 2016. Jet helped Walmart report a higher fourth quarter sales growth in February 2017, 29% compared to Amazon’s 22% (Heller, 2017). While Walmart may not turn the same kind of online sales, 13.7 billion compared to Amazon’s 107 billion in 2015, it is still competitive with Amazon (Heller, 2017). Amazon’s acquisition of WFM is a significant challenge to Walmart, as 56% of Walmart sales come from groceries (Wharton, 2017). Walmart has fought back by partnering with Google voice recognition to offer streamlined voice ordering, announced in August 2017. In a blow to Alexa, Amazon’s digital assistant, Walmart customers will be able to utilize Google Express to place orders and receive recommendations. It seems as though the two retailers are trying to emulate one another and are trading hits in a grocery war. Walmart is not the only competitor dealing with the repercussions of the Amazon/WFM merger, as Kroger, Costco, and Dollar General stocks all fell more than 6% within the hour when the deal was announced.
Target is also a competitor Amazon will face. Target is considered a more upscale alternative superstore to Walmart, having just introduced a fresh grocery section in 2009. Target arguably has a portion of WFM’s consumers shopping there for the home goods that WFM does not offer. Target offers exclusive designer collaborations and is in the process of revamping their clothing lines, with the potential to draw in even more consumers. With Amazon behind it, WFM may even be able to offer more home goods than ever and take back some of their consumer base.
Potential Outcomes
Amazon could take many different routes with its acquisition. The company is notorious for staying ahead of competition and the industry by thinking of the big picture and small picture simultaneously. No matter the route, the acquisition is a bet that the grocery industry and online retail must meet at some point. Amazon is vying to be the first to make it work. Before Amazon can begin to trail blaze into this new era, they must fix what is broken at WFM.
As Amazon begins to study WFM, especially the grocer’s high costs, there is no doubt it will begin to work its signature magic: streamlined, automated logistics. Amazon made a mark in the online industry and throughout America with its mammoth warehouses and distribution centers, trailblazing with automation (Thompson, 2017). WFM’s prices have fallen and its revenue will rise as Amazon implements automation in the warehouses. The day the deal closed on August 28, 2017, Amazon cut prices in WFM, sending shockwaves to competitors. Trader Joe’s was hit the most as the closest competitor, losing 10% of regular customers between August 8 and September 3. However, these price reductions did not attract new consumers from outside WFM’s target market of upper income people, nor did they encourage consumers to drive further distances to WFM (Baertlein, 2017). Price cuts are the first step but not the whole journey for Amazon. It will need to expand to other demographics and drive more people to WFM. As consumers see WFM become more affordable, other retailers will have to work harder to keep consumers in their stores. The future could bring a new grocery war as retailers like Kroger, Trader Joe’s, and Target announce lower prices to compete with WFM.
There are currently eleven WFM distribution centers along with seafood processing plants, kitchens and bakeries that supply premade food. Amazon will have to adapt to a new world of perishables. The company has perfected automation for hard, sturdy products like books and toys, but not for easily spoiled items like popsicles and produce (Soper and Sherman, 2017). Rumors of Amazon potentially putting robots in stocking jobs on the store floor and eventually eliminating cashiers have leaked. However, Amazon has not publicly addressed these rumors. In order for Amazon to push forward with any endeavor, WFM must turn enough of a profit to make it worthwhile, or it will be doomed to face the same outcome as AmazonFresh. Even though Amazon is comfortable operating at a loss in order to gain market share, a company can only do so for a short period of time. In the meantime, the WFM acquisition has already pushed the rest of the grocery industry into a period of cost cutting and rapid innovation.
Perhaps one of the most likely outcomes is Prime membership exclusives in WFM and with Amazon online. It is unlikely that Amazon will adopt a BJ’s or Costco model of membership, as WFM has not operated on a membership model in the past. Offering Prime exclusive deals may also mean more memberships in the Amazon ecosystem. WFM may begin to offer grocery pickup, as many other grocery stores have adopted this service. However, Amazon would have to add space to WFM stores, as many outlets are not capable of handling thousands of online orders in addition to regular in-store purchases. This would require the expansion of current outlets and/or building of new ones and the hiring of more workers. In addition, the danger of pushing online orders through a physically incapable WFM would be a fall in quality for in-store consumers. That said, a variety of WFM’s branded products are already available through AmazonFresh and early reports suggest high sales.
Grocery delivery straight to the home is also a logical step for Amazon. After all, delivery is where Amazon excels. As mentioned above, AmazonFresh is a service that sends groceries and has been sluggish to gain traction due to complications with the cold chain. Amazon seems to have realized the need for an existing warehouse and distribution network, precipitating the WFM acquisition. However, as WFM currently stands, Amazon will need to develop and expand WFM to meet Amazon standards of efficiency and strength. Currently, WFM has a very small network of distribution warehouses, 1 million square feet, and AmazonFresh has around 3 million: a mere tenth of what Walmart possesses (Dastin, 2017). Industry experts estimate around a dozen or more grocery specific warehouses would be required to accommodate WFM’s expansion to an online delivery format. Amazon will need to pour additional money into distribution networks before it can even begin to go after additional grocery delivery market share.
In addition to home grocery delivery, Amazon is keenly interested in meal preparation kits. The company currently sells meal kits on AmazonFresh. However, recent actions by Amazon suggest that it is looking to start promoting them more aggressively. On July 6, 2017, Amazon registered for a trademark on “We do the prep. You be the chef.” This kind of service is currently offered by companies such as Blue Apron, a meal preparation service that delivers meals to consumers’ doors, but the consumer must assemble and cook the meal. Amazon’s trademark application indicates it is interested in services similar to Blue Apron. The date is also relevant, filed just days after Blue Apron had a rocky initial public offering, showcasing Amazon’s fierce competitive nature. Even with Blue Apron’s rocky start, its public filing predicts that the meal order market is projected to grow fifteen times faster than the restaurant business (Thompson, 2017). It is entirely possible that Amazon could be developing new meal service kits that use WFM’s products. Amazon will need to focus on drawing customers from Blue Apron and streamlining their process if they choose this route to gain more market share.
The idea of a superstore, as seen with Target and especially Walmart, might be tempting to Amazon as the idea of an omnichannel becomes more real. Omnichannel stores will feature in-store purchasing as well as the ability to pick-up online purchases. However, a large part of what makes WFM popular is its organic, natural branding. A large superstore bearing the WFM name would most likely require products that are congruent with the WFM image. Think organic domestic cotton clothes and natural lawn care. This could prove difficult and costly to stock. Another option could be to create a half and half store: one half WFM grocery and the other half a Walmart-esque supermarket; however, this would require intense remodeling of current WFM and/or building of brand new stores.
Early in 2017, Amazon showed what kind of grocery store it would like to open with its launch of Amazon Go in a store in downtown Seattle, Washington (https://www.youtube.com/watch? v=NrmMk1Myrxc). Amazon Go involves an app that is scanned upon entry into the store. The app recognizes when the consumer takes something off the shelf and places it in a basket. Amazon bills automatically to the consumer account when the consumer walks out of the store. Amazon’s internal plans show that it could build 2000 of these stores in the next decade, but it remains unclear if these stores will incorporate WFM’s products or if WFM will be slowly converted to the cashless style (Leswing, 2017). This could be problematic, as WFM stores would either need to be refitted or new ones built. Amazon may even halt further development on Amazon Go until it decides how to improve WFM.
Technology is a strong suit of Amazon’s. As mentioned above, the company will most likely implement automation into WFM’s warehouses, thus leading to increased efficiency and reduced cost. Amazon’s digital assistant persona, Alexa, from the Amazon Echo, will likely play a role in the future. Currently, Alexa can place orders for consumers through Amazon, and works very smoothly with Prime. In the future consumers can expect for Alexa to be more in tune with WFM. Whether it be ordering WFM products from Amazon, getting products delivered, or having items ready for pickup at WFM, Alexa will certainly play a part. Another tool to be paired with Alexa is the Amazon Dash Wand, a small handheld scanner that connects to Alexa and specifically AmazonFresh, the grocery delivery service. The Amazon Dash Wand is meant for consumers to scan products and have Alexa reorder them, lookup recipes based on products, and convert units (Patel, 2017). It is clear that the Amazon Dash Wand is marketed for groceries, along with the fact it automatically puts orders in AmazonFresh, not regular Amazon. In the future, the Amazon Dash Wand might be used for scanning groceries that can be picked up or delivered at/from WFM. Again, any implementation of digital orders through WFM would require intense remodeling/building of new warehouses and outlets.
Anti-Trust Laws
In July of 2017, Representative David Cicilline, D-R.I. wrote to a Judiciary Committee chairman and a chairman of the Subcommittee on Regulatory Reform, Commercial and Antitrust Law, asking for the WFM Amazon deal to be considered for anti-trust violations (Meyer,2017). Cicilline claims that the acquisition will affect the future of the grocery industry and food delivery. Cicilline draws concern over Amazon’s size and power, specifically workers being replaced by Amazon technology (Cicilline, 2017).
Amazon’s tendency to snap up as many different services and industries as possible is problematic in anti-trust terms. In its days as an online bookstore Amazon was infamous for “stalking” smaller publishers, behavior that has transferred to its current business model. There is grave concern for companies in the industries Amazon has launched into, especially smaller companies. A major concern is the lack of competition, since Amazon is the only company that offers its current combination of services at its current scale. A second concern is predatory pricing, as Amazon can price products at a loss and eat the costs. The problem is not that the company corners one market, but that it can undercut many different markets. Amazon has a knack for identifying early trends, and has already illustrated an interest in emerging markets. Since early trends are usually adopted more quickly by small companies, Amazon can easily push them out or simply buy them out (see Zappos and Diapers.com). As Amazon expands it will only get harder for the company to fight off anti-trust laws and accusations of illegal monopolization.
Discussion Questions
- WFM is renowned for its product mix of healthy and organic products. Should Amazon change this mix in order to maximize profit? (I already did this question)
- What are the benefits of Amazon’s market share first, profits later model? What are the drawbacks? In light of these factors, did it make a wise decision to acquire WFM when it did?
- What dilemma did Amazon encounter with its distribution of AmazonFresh? In light of this dilemma, what will need to happen before Amazon can pursue expansion with WFM?
- What are the widespread economic consequences of this acquisition?
