Amazon Bets Big on Brick & Mortar Buying Whole Foods' 450+ Grocery Stores
Amazon’s biggest acquisition—14X the size of its next largest acquisition and the biggest deal in grocery history—nets a premier brand, a supremely well-located site portfolio... and a plan to nearly triple in size.
Another Amazonian earthquake has rocked the foundations of the retail world after last Friday morning’s announcement that Amazon was acquiring premium grocer Whole Foods. On the news, every publicly traded grocer and retailer in the grocery business saw their stock plummet—several were down double digits. Wall St. perceived the news as a disruptive event of the first order.
Suddenly, the monster whose indomitable clicks crushed brick and mortar after brick and mortar is pivoting with historic force into a substantial physical footprint. The $13.7 billion trophy deal to buy Whole Foods nets Amazon 456 stores, 91,000 employees and a brand leader. It’s experiential formats and service orientation are millienial approved and help Whole Foods generate the most revenue per square foot of any other grocer.
So, Amazon isn’t just experimenting with brick and mortar anymore, it’s picked up a best-in-breed brand to blaze into the grocery business and physical retailing.
It's also moving to corner yet another huge category. Grocers are doing more than a half trillion dollars of business in the U.S. every year. If you add in convenience, specialty foods and a few other categories, Amazon is entering a nearly 1 trillion dollar annual market. Even better, food is growing faster than the rest of the economy. Last month, grocery store sales were up 3.3%, actually outpacing foodservice, restaurant, and drinking places—which has been red hot and leading the recovery—for the first time since April 2014.
In the recent past, the grocery business has proven extra-resilient to the power of e-commerce. Foodstuffs are items that people find important enough to handle in person prior to purchase. That’s changing now. We used to never trust strangers on the internet. Now we trust an algorithm to match us with a driver who will drive safely for us in a new e-transactional normal. And consumers are trusting other people to handle and select their groceries, too. Numerous large scale and local grocery delivery and concierge services—such as Peapod, HelloFresh and Blue Apron—have sprung up in the post internet world. It probably just got a lot harder for them all to compete in the future.
Grocery also requires a lot of handling by grocers to keep store shelves stocked—because, unlike a lot of other retailers, groceries are selling perishable items and other food skus that are highly regulated and require special care, attention and maintenance. So, grocery has always been a tough business. It has high labor needs/costs. Grocery labor is often uniniozed. Worse, it has always had low margins. Waste and spoilage are constant threats that can always eat up those thin margins. Inventory management can make or break every day. It’s an intensely promotional environment and often groceries are giving away big volume or en vogue items to draw customers into the stores to purchase other goods with better margins—much the way retail gas stations make nothing on gasoline.
Traditionally beyond the grocer’s control is the cost of the goods they sell. Large buyers in modern times, especially Walmart—which got into the grocery business in the 1980’s and is now the largest grocer the U.S.—have been able to buy in volume, pressure suppliers and influence the supply chain. But the bigger forces of commodity inflation and deflation are beyond even Wal-Mart’s control.
Crop failures are beyond Amazon’s control too, for now. But it has a great track record for lowering prices for consumers. In every other space it’s entered, Amazon has become a huge deflationary force. It pushes down prices in a war for market share and pushes the competition out of business. Early on it was books, then electronics, and more recently apparel.
Achieving scale first has always been the principal element of Amazon’s strategy to beat its competition. Profits come later. As Jeff Bezos famously told Fortune in 1996: "If we're profitable within the next two years, it'll be by accident.” Twenty years later, Amazon’s success was evidently no accident. Although investors in Amazon regularly complained about profits along the way. After "winning" category after category, some investors wondered why Amazon kept reinvesting. Amazon is now actually the biggest investor in R&D, so after rocket ships maybe Jeff Bezos will get into climate and geo-engineering to prevent crop failures once and for all.
It’s unlikely too many investors will complain about Amazon’s historic investment in Whole Foods. The mega-deal quickly nets the company 450+ stores and the DNA of a company that’s been one of the few to moderately disrupt the grocery segment in a long time (although other grocers caught up, especially Kroger, which slowed Whole Foods expansion plans… more on that below). So, while Amazon has been experimenting with physical stores quite seriously in recent years, with Amazon Fresh and Amazon Go concepts, it would have taken time to build out a large and high quality network of real estate assets.
Whole Foods, also known as “Whole Paycheck,” is also generally located in strong markets and in prime locations within those markets. Location in the grocery business can be everything. Even a crappy corner store can typically compete because the convenience it offers is a utility too high for the rational, time-maximizing consumer—especially on everyday items. Sometimes a millennial will drive 300 miles for Pizza, but nobody really goes across town for bread, bubble gum, milk or paper towels.
On Friday Amazon stormed the beaches of some of retail's most fertile ground. It's 450+ new stores are supremely well-sited locations, establishing a physical bulkhead within three miles of 1/3 U.S. households with annual income of more than $100,000 with a single deal. More than 12 months ago, Amazon had already built out same-day delivery to more than 75 million Americans:
Amazon also picked up the workforce to staff it all. An obvious, but not insignficant fact. In its surge of distribution and warehouse facilities in recent years, Amazon learned many lessons about the availability of workers and related workforce issues, as the workforce specialists at Manheim Solutions can attest. To scale up a high quality, millennial-approved customer experience with a brand new workforce might be mission impossible—even for the likes of Jeff Bezos. And now, in the labor scarce environment of 2017, to replicate the workforce and culture Whole Foods already has built would be even more difficult. High quality employees already want to work at Whole Foods, which helps contribute to the quality of the overall experience. And that’s an asset with its own value.
Ditto its relationships with local and high quality suppliers.
From this base, it will be much easier for Amazon to build. In fact, that was already the plan at Whole Foods until earlier this year, when it closed 9 stores and announced it was abandoning its goal to open 1,200+ stores. "We're going to continue to grow, but I think we're going to be a more disciplined growth company than we have been in the past," John Mackey, co-founder and CEO of Whole Foods, told analysts on the company's first-quarter earnings call. Mackey said it was necessary to "result in a healthier bottom line, increased cash flow and higher returns." Whole Foods would still open more new stores, and Mackey remained "optimistic about the future growth potential for our 365 format but we want to see how this next round of stores perform before getting more aggressive."
On their own, investors and Wall St. analysts had pressured Whole Foods co-founders to perform. With food prices dropping and larger competitors, like Kroger’s 3,000 stores, catching up to its innovations, it became a tough competitive environment. Forced to choose, Whole Foods began to ease up on investing and focus on profit instead of growth.
This is probably not what Jeff Bezos has in mind. With Amazon, Whole Foods—whose management will stay in place and headquarters in Austin, Texas—will have no financial wants. They can go right back to plan. “Millions of people love Whole Foods Market because they offer the best natural and organic foods, and they make it fun to eat healthy,” Jeff Bezos said in a statement. “Whole Foods Market has been satisfying, delighting and nourishing customers for nearly four decades – they’re doing an amazing job and we want that to continue.”
Amazon can easily pick up the blueprint to grow Whole Foods stores by at least 3X. Backed by the financial resources of the Amazon mothership, now they can return to the heyday of rapid Whole Foods expansion. And now they also have the smaller store formats that Mackey and his team have innovated most recently.
Built on the back of the already massive and still growing Amazon logistics network, the possibilities are promising to say the least. Most every analyst seems to love the deal as a perfect marriage. John Mackey, the CEO of Whole Foods, also repeatedly used the "marriage" metaphor breaking the news to employees. Gushing in a townhall, making comparisons to speed dating and drawing laughs from employees, Mackey said the deal was literally a dream come true. Many of Amazon’s strengths are Whole Foods weakness and vice versa. If they play strength on strength, Amazon will help Whole Foods inject more efficiency into a its supply chain, upgrade its point of sale technology and leverage myriad synergies between the online and offline environments.
And in Whole Foods, Amazon gets some big things it didn’t have didn’t have and are hard to replicate: a top grocery brand, great store formats, high quality in-store experience and workforce culture. And don't forget truly excellent locations. And a huge growth opportunity in which it can leverage its core competencies in logistics, supply chain and retailing.
Amazon obviously feels like the time is right to become a true hybrid monster, part e-commerce beast, part brick and mortar beauty. If Amazon can incorporate the lessons it’s learned experimenting with Amazon Fresh, the Amazonian Whole Foods can scale up the grocery store of the 21st century. Although Amazon has already stated it’s not looking to overdo it, or change for change’s sake. It won’t take out checkout tills, sack checkout staff or replace them with computers or robots. Not yet anyway.
Under the original plan and conventional playbook, Whole Foods could add another 750 stores from here. By the map of Whole Foods stores above, there’s a long way to go. And there are still plenty of neighborhoods will no grocery stores at all, so called food deserts, where purchasing fresh produce requires some form of transit—which is literally a killer for the working poor, elderly and disabled.
Some markets are already well covered by Whole Foods stores, e.g. Boston, but there may still be room for future infill of the ultra-small formats, drop boxes and kiosks that will figure in the near future of ultra density. An Amazon drone may not be able to fly up to your patio with a delicious delivery basked of Whole Foods prepared foods, or down your hallway, but it might be able to deliver to strategically located kiosks at your building’s entrance.
The synergies between its customer data, predictive analytics and Whole Foods’ customer database is immense. Already 64% of US households subscribe to its loyalty program, Amazon Prime, an innovation so powerful, it broke the holiday shopping season when it was introduced in 2013.
Expect Amazon to undercut everybody for a long time. Consumers will benefit tremendously, but the competition will be intense.
Together, Amazon and Whole Foods can now promise and deliver on a seemingly impossible value proposition: the highest quality foodstuffs at the lowest price. Amazon can give away cage-free, organic chicken eggs from Whole Foods with Prime membership. Or subsidize any item(s) it wants to drive the overall sales of the greater Amazon ecosystem. In the low-margin grocery game, Amazon can afford to define victory very differently.
In the end, the oil majors divested their retail gas stations. Like food, you just don’t make a lot of money selling gasoline "downstream." One day, companies like BP, woke up and asked themselves why they were maintaining massive real estate portfolios that could really only make money selling higher margin convenience items inside the store. In many markets, most gas stations made their money selling cigarettes and hotdogs—and BP didn’t want to be operating downstream with massive physical footprints just to be in the hot dog business.
Amazon is now definitely in the hot dog business. It’s in the business of selling everything. Amazon might not care so much about turning a profit at Whole Foods, because they want all the other things that a brick and mortar portfolio delivers. Just by using Whole Foods curb fronts as takeaway pickups or its rooftops as micro heliports for drone deliveries, Amazon has unique opportunities to capture synergies from an acquisition of Whole Foods.
It can use cheap groceries to pull consumers into the Amazon ecosystem, the way gas stations used to sell milk at a loss to get drivers to stop. Soon, when you ask Alexa to order a movie with your Amazon Prime, she will ask you if you’d like to order the same pizzas you got from Whole Foods last time. She might even remind you that your paper towels, parmesan cheese and ranch dressing are low too and ask if it’s OK to include in your order (because those items just happen to fit in the drone, naturally).
There are lots of possibilities for the future. Amazon could be agnostic about Whole Foods profits for much longer than analysts anticipate. Beyond the point it has realigned the space and overcome its grocery competitors.
Bottom line: the grocery business is about to get very interesting. Another Amazonian real estate wave of expansion will sweep through the grocery category in a cycle similar to the move it made in warehouse space. And in many markets, there are plenty of buildings Whole Foods can fit into. There are all kinds of big box stores sitting around. And if they reach for more adaptive reuse opportunities, Whole Foods could breath new life into the stock of interesting legacy sites with unique feature and architecture. Amazon has shown it's not afraid of brownfields. Neither is Whole Foods, which received a $12.9 million tax credit for building on New York's polluted Gowanus canal.
If history repeats, Amazon’s gain will be create a lot of pain for its competition. The instant reaction was for every other grocery stocks to sell off massively. Supervalu, Kroger, Target, Dollar General (which has moved into food), Costco and Walmart were all down. Will they trim stores? How many? Will they exit markets the way Safeway pulled its Dominick's stores from Chicago?
What does it mean for Wal-Mart and Target? Will Target exit the grocery business? Will small grocers be acquired? Using history as a guide: expect an even bigger price war. And judging by Amazon’s history, it will be an endless price war.
Who can compete with Amazon? Few have been able to so far. Walmart is one, and this opens an entirely new front in the ongoing war between these two retailing superpowers. Two other Europeans groceries, Aldi and Lidl, have recently announced major plans to expand in the U.S. They may consider revising those now.
It’s hard to gauge the balance of this large-sized disruption against the promise of new demand for stores from the Amazonian Whole Foods. Certainly, many idle greyfield properties will be absorbed by a Whole Foods expansion of 750 to 1,000 additional stores. But will even more grocery store closures happen at the same time, or be soon to follow?
Grocery stores have been a go-to anchor for new, mixed use developments. Will another Amazon wave of disruption and deflation be a net positive or negative for commercial real estate? Can an Amazonian Whole Foods build-out trigger a quality-of-place arms race that ushers in a race to the top? Or will mass grocery store closings take out the last remaining anchors of struggling commercial properties, compound with overall retail weakness, and cause an extinction level event?
We’ll answer these questions in the next installment of our ongoing greyfield series.
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