On Friday Amazon announced it’s to buy the grocer Whole Foods for $13.4bn.
This is an unusual deal for Amazon. It’s the company’s biggest ever acquisition by a factor of twenty.
But it has no choice! If Amazon wants to sell food, there’s no cheap way to get started.
That’s because groceries are totally different from Amazon’s other businesses. As I wrote yesterday , Amazon’s regular playbook won’t work when it comes to selling food:
“Amazon’s business model has a weakness. It works well for everything except the most important product category of the lot – the category that accounts for 20% of all consumer spending – food.
Amazon uses a relatively small number of giant fulfilment centres (12 in the UK). They’re big and super-efficient, and they can serve the whole country in a day or two.
Now that’s great for “everything else”, but it’s useless for selling food. Because food is perishable.
Because food is perishable, 12 giant fulfilment centres wont do. Grocers like Tesco have to be close to their customers. They need lots of small distribution centres and hundreds of individual shops, with fridges in each of them. Tesco has 28 distribution centres in the UK, and around 3,300 shops.
In other words, Amazon’s big advantage over its competitors – its super-efficient distribution network – is nullified when it comes to fresh food.
So for the first time in ten years, Amazon is in a fair fight. It won’t have the lowest prices by default. It’s going to have to find another way to win.
And that is why Amazon bought the US Grocer Whole Foods for $13.4bn on Friday. According to Redbush Securities, the deal gives Amazon “440 refrigerated warehouses within 10 miles of probably 80% of the [US] population.”
So to summarise, Amazon has taken over the world by having a huge, efficient distribution network. The distribution network has allowed it to crash into new markets left, right and centre, and undercut competitors on price. That’s the Amazon playbook.
But when it comes to groceries, the playbook doesn’t work. Amazon’s distribution network is set up all wrong for groceries. It’s too far from customers. Buying Whole Food helps fix that problem.
But if Amazon can’t win at groceries by automatically having the lowest prices… how will it win?
Is there any reason to think it’ll do a better job than the other grocers?
That’s the question I want to explore today.
The middleman plan
I keep coming back to two ideas: Amazon as a network of companies; and Amazon as a middleman. That’s the way I make sense of Amazon. And that’s the way I’m making sense of this Whole Foods deal.
You see Amazon isn’t one giant business, selling every product and service under the sun. It’s a network of companies. Its IT division sells IT to the rest of Amazon and to other companies. Its warehouses sell warehouses to Amazon and to third-party resellers. Likewise with customer service, shipping, the Kindle, and Amazon’s voice recognition software. Everything is for sale at Amazon.
The beauty of this strategy is this: after Amazon makes a huge upfront investment in IT/warehouses/cargo/voice recognition, other companies help pay it off. That’s how Amazon gets to be so big and efficient. It makes bigger investments than anyone. And then it uses other companies to help pay for them.
The end result is that Amazon owns all the infrastructure for commerce. Everybody has to pay Amazon a cut for the use of their IT systems, shipping, voice recognition, or whatever else.
So Amazon ends up not as a competitor, but as a middleman. That’s the sweet spot for Amazon. It takes a couple of percent off of everyone’s business; competitor to noone.
The thin end
So how does the Whole Foods deal fit into this framework?
Well if we assume that Amazon wants to be a middleman, not a grocer…
And if we assume it follows its usual playbook, where it makes big investments in infrastructure and then opens it up to other companies…
Then we can start to see the outline of how Amazon’s groceries business might look in ten years’ time.
By that logic, the Whole Foods deal is just the beginning of a much bigger investment by Amazon. By that logic, Amazon is going to build out a giant food distribution network, with shipping and refrigerated warehouses and the rest of it.
It’s basically going to build the world’s biggest wholesale food market. The wholesale food market will supply supermarkets like Whole Foods; home delivery customers on Amazon Prime; and anyone else who wants to buy from it.
By that logic Whole Foods is just the thin end of the wedge. Right now Amazon is very, very far away from owning the world’s biggest wholesale food market. As of this week it has 440 refrigerated warehouses. That’s a start. But Whole Foods is relatively tiny; it only has 1.7% of the US groceries market. There are many years, and tens of billions, of investments still ahead.
The moment of truth
I said on Friday that the only company Amazon fears is Walmart. I said that “Amazon has to become Walmart faster than Walmart can become Amazon”.
That’s because, when it comes to online retailing, “there can only be one”. The company which sells you food online will probably sell you everything else too. Bezos needs to be sure that company is Amazon.
I reckon he’s been plotting for this moment for ten years… patiently building his war chest… stealing top talent from Walmart.
The push into groceries will be the hardest thing Amazon has ever had to do. This is Amazon’s D-Day.