Investing,  Thoughts

Amazon’s taking over the world and the much talked about death of retail

Amazon’s purchase of Whole Foods Market was the headline this Friday and it sent a whole sector of retail into a tailspin as the thought of competing with Amazon had investors worried about the future of the grocery space.

It’s true that Amazon and online shopping in general has had quite an effect on retail as can be seen by the many store closures in the past two years. Companies like Sears, Macy’s, J.C. Penney and many others are closing hundreds of stores this year and will likely continue to do so in the next few years.

There are two reasons for this destruction in retail. The main reason is that more and more shopping has moved online. The e-commerce share of the overall pie has more than doubled in the past decade.

Do note that the number represented in the graph below includes certain things normally not bought online like gas, cars and the number excluding those items is nearer to 15% and continuing to grow.

ecommerce, online sales,e-commerce

Amazon has been the main beneficiary of this movement as evidenced by their stock performance and brick & mortar retailers have struggled to keep up. They’ve only recently started to invest heavily in the online sector but the moat that Amazon has built in that area may be hard to beat this late in the game. In fact Amazon makes up nearly half of the overall e-commerce which is impressive considering the # of online retailers that are out there. 

The second issue with U.S. retail is that the sector has simply grown too much and now contains far more square footage of space than needed for the current spending habits. The U.S has almost 23 sq feet of retail space per person. That compares really poorly with other countries with the two second largest standing at 16 sq ft(Canada) and 11 sq ft(Australia) respectively. The vast majority of countries in Europe are well below 15 sq ft per person as well which shows there’s plenty of room for contraction in the sector.

Yes, the U.S. is more wealthy than most countries and historically has had the highest retail consumption as well but I believe that spending and shopping habits are changing and hitting the retail sector hard in the short term.

The truth is that it’s not just the Amazon effect that’s driving this struggled in retail but also changing customer tastes that lean towards less purchases and more experiences. When they do shop, younger people prefer a smaller store footprint and are less likely(or less able) to buy expensive high margin items.

It’s also true that it’s much easier to buy most things online and the advent of free and dependable two-day shipping has made a trip to the store unnecessary for many things. That’s why we see more and move movement online for things such as electronics, clothing, supplements, and others and traditional retailers have struggled to keep up with Amazon in that transition.

It’s true that people still like to go to shopping malls and stores but now they’re also more like to use them as a show room as it’s much easier now to get on your smart phone and check if you can find it cheaper online.

Last winter, I purchased a North Face jacket after trying it on in the mall but ended up buying it online because it was on sale and 30% cheaper. I’ve heard people make the argument that clothing is hard to shop for online and I was on board for a while but then I started shopping online for most of my clothing and found it to be a great experience. It’s easy to return things if they don’t fit and most of the time, once you buy an item from a certain company once, you get an idea of their sizes and I no longer have to return things too many times. It took me a few years to transition but I pretty much exclusively shop online for a lot of things especially since stores don’t often carry my size(I’m skinny tall).

That’s not to say that people don’t love going to stores anymore and that 100% of the shoppers will eventually move online for everything. There will always be people who prefer to go to the store for one reason or another and there will always be a market for retail space especially if the store formats begin to change to match the changing tastes of the customer. I’m not as bearish on retail as a lot of people out there but do believe that something needs to change and that will lead to short term pain for many retail investors until we hit a new normal.

I don’t think we need as much retail space as we have now and that’s already evidenced by the number of store closures we’ve seen and will likely continue to see in the near term.

On the other hand, there are still certain areas of the retail sector where the online experience has been lacking despite the best efforts of some online retailers and silicon valley start-ups to make it work. In these areas change has been slower to come and closures have been less frequent if not moving in the opposite direction. If you haven’t guess, I’m talking about the grocery store sector.

Grocery shopping online is still less than 5% of overall spend there and has been slow to grow and I think the reason for that is obvious. If I buy a pair of pants or a bottle of vitamins online, I pretty much know exactly what I’m getting but it’s different with food.

I want to be able to pick the exact ripeness of the pineapple I’m getting and I want to get an Avocado that I know will be ripe in four days when I want to make guacamole. I’m not sure how I can get that experience online right now and I’m not sure I’ll be able to do it ever.

Sure, I can buy cereal online or random canned items that won’t expire for years but if I can’t get everything and have to go to the store anyway for my produce and fruit then why not just buy it all at the store?

I think most people feel the same way and that’s why concepts like Amazon Fresh or Peapod or Instacart haven’t gained a ton of traction. There certainly is a market for online grocery shopping and I do expect it to grow slowly but there are still a majority of people who want to do their shopping themselves. I can see that 15% e-commerce share eventually becoming a majority for most areas of retail I’ve talked about but I just can’t see it for groceries, at least not anytime soon.

It seems like Amazon agrees and that’s why they purchased Whole Foods Market.

I’ve seen a lot said about this being an expansion plan for their Amazon Fresh product and that the WFM locations would function as quasi distribution centers and allow for easy entry into new markets and while that can certainly work and wouldn’t be surprising, I’m not so sure that’s the direct plan.

The problem I see there is that the whole foods stores aren’t massive in size compared to some of their competitors and are often located in areas where parking is already a struggle with just the super market clientele which makes them less ideal hubs for distribution center if they want them to remain storefronts.

I think they have another plan for the stores.

The reason Amazon succeeds is because they take something that’s annoying and they make it convenient. A few months ago Amazon posted a video about their Amazon Go technology(Link here if you haven’t seen it). It’s essentially a tech that allows shoppers to enter the store, grab anything they want off the shelves and leave without having to deal with the hassle of check out lines. It’s a way to take the grocery shopping experience, keep the in-store benefits but remove a lot of the in-store annoyances.

It’s totally the Amazon way of doing things and I think that’s their plan for Whole Foods Market. In fact, if you look at the design of the store in that ad, it’s a pretty similar aesthetic to the Whole Foods I’ve been to in recent years so it’s clear that they were targeting a similar shopper with that ad.

Amazon had two paths to make that technology usable. Either build up their own network of grocery stores or buy an established name with a high quality brand name, best in class margins, and with locations in prime, high income areas. I guess they chose the latter. It makes sense, they get 400+ locations in awesome locations with liquor licenses, built in eateries and can immediately use their expertise in technology, data analytics and logistics to not only improve margins but also improve prices and be more competitive at the same time. It’s a brilliant move if that’s their end goal.

It’s clear that Amazon and the expansion of e-commerce in general combined with changes in spending habits has had a negative impact on brick & mortar retailers so it’s not surprising that their entry into the grocery game sent shock waves through the industry.

Kroger was down 9%(after being down 18% due to soft guidance), Target was down 5%, Costco was down 7%, Walmart was down 4.6% and more than a dozen other stores had similar moves.

Investors are obviously spooked about the Amazon effect on grocery stores because of their fear of e-commerce but I think they should be more spooked about Amazon’s entry into brick & mortal retail. The talk up to now was how will brick and mortar retail catch up to Amazon online and the question now becomes, how well will brick and mortal retail compete with Amazon in the brick and mortar space.

I’ve talked earlier about the excessive retail space in the U.S. and grocery stores aren’t an exception to that rule. All retail stores but grocery stores especially function on razor thin margins. The industry has a median net margin below 2% and grocery stores are often below that. That means that in order to meet the demands of investors for ever growing earnings, they must often expand via acquisition or building new stores.

The problem with expansion is that we’re reaching a saturation point already and the industry is starting to see additional entrants into the market, not just in the form of Amazon, but also in the form of foreign stores like Aldi, Lidl andTrader Joe’s(my preferred shopping grounds), all of which are planning to expand.

There’s a reason a well managed company like Kroger was down nearly 30% in two days and it’s not just the Amazon effect. It’s the continued belief that retail is far too saturated in all areas and that growth in the next few years will be harder and harder to come by which isn’t what you want to see as an investor. Retail companies can no longer simply add new stores to boost revenue, they have to compete by having the best price AND the best experience.

Amazon’s purchase of WFM shows that they don’t think brick & mortal retail is dead at all, it can just be improved and I think that worries investors as it should. If Amazon can use their technology, their expertise in logistics and data analytics and anything else they have up their sleeve to improve the store going experience, reduce prices AND boost net margins then other companies should be worried.

Kroger already showed that pricing pressure can have a big impact on stock price by reducing their earnings before the Amazon announcement came out and that pricing pressure is only to increase with the entrants into the markets.

It’s not just grocers that should be worried. If Amazon can show that they can be successful in the grocery space then why not transition that to other brick & mortar areas as well. I believe there’s still money to be made in all areas of retail but there will be some casualties in the near term.

Online shopping is the future but I don’t believe that the store going experience is going to be gone forever anytime soon. It will change, evolve and become more efficient and more focused on experiences than the actual shopping but it will still be there to entice shoppers and advertise products. More and more companies will focus on the online aspect of their business but retain the storefronts to drive interest and sales. The storefront as we know it will likely shrink in size and the overall retail footprint in the U.S. will be smaller as well but retail will survive, change and continue to grow in the new format. That’s my belief and that’s why I’m not quite so bearish on retail(and indirectly REITs, many of which are focused on retail) as some others.

That being said, I believe there are dozens upon dozens of companies that exist today that likely won’t survive this change and Amazon’s entry into the brick & mortar space makes the competition all the more interesting.

I think the sector wide drop in stock price for some of these companies is warranted as poorly managed companies will fall by the wayside and disappear but well managed companies should survive and eventually thrive even if there is short term pain.

I was originally planning to analyze a few of the bigger companies that dropped quite a bit today and see if they’re worth a buy but this post has gone on for far too long so I’ll do that another time.

Personally, I have no investments in retail at this point(beyond my index funds, ETFs and REITs) but am somewhat interested in Amazon right now since I really like this move by them. I also think some of stocks that fell today may be valued attractively from a long-term viewpoint and will be taking a closer look at them.

WFM is actually trading above the offer price today which means the market believes it is possible that someone else makes an offer. It’s quite possible that a bidding war breaks out and Amazon doesn’t end up making a big entry into the brick and mortar space. Still, this shows their intention to do so and it sure is an interesting time for retail companies right now and an exciting time to be a consumer(but not an investor in some retail companies).

I’m quite eager to see what retail looks like in 2025 because I think it’ll be a lot different(and possibly cooler) than today.

Disclosure : I shop at Amazon and Trader Joe’s. I visited Kroger’s when I traveled to Tennessee and was not too impressed by the one store I visited. I live near a Target and a Walmart and a Costco. I went to Target once a year or so ago to look for tick prevention drops for my dog but they were behind a locked case and I couldn’t find anyone to open them for me so I go annoyed and bought the item online(not at Target). I have an amazon affiliate account that I may at one point link to on this blog if it’s relevant to whatever I’m discussing. I write silly disclosures. I have no plans to purchase any of the securities discussed in this post in the next week nor do I own any shares of these stocks aside from whatever is in my ETFs and index/mutual funds.


  • seekingreturns

    Interesting take and I don’t disagree. Yet I can’t get my head around the “younger people prefer a smaller store footprint and are less likely(or less able) to buy expensive high margin items” statement. With Whole Foods nickname being “Whole Paycheck”, the acquisition appears to be at odds with AMZN’s reputation for cost control (and your above observation). Also, while WFM operates in an (expanding) niche environment they do not (yet) provide all the SKUs of a KR or WMT nor do I think they want to (in their current operating model).

    My take is AMZN will mesh WFM with Amazon Fresh using WFM stores as an expanded proof of concept with technology integration. If/when successful, I would expect a wider push. I suspect it’s easier for a WMT to integrate a Jet than it is for an AMZN to do the reverse. If they do proceed, I suspect a KR or Albertson’s will be next on their shopping list – with WMT and AMZN slugging it out at the end.

    • timeinthemarket

      I do think Amazon needs to work their magic and reduce prices at WFM for this to be as effective as I say it might be. Their knowledge of cost containment and the potential for the Amazon GO technology can help achieve that.

      I’ve always thought the key demo(in terms of $$ spent) for Whole Foods was that 30-50 year range and I believe that’s the demo Amazon is going after. Most sub 30 people already know and use Amazon regularly and they’re the most likely to try new stuff online because that’s what they know. People above that range already have habits and those are harder to break so getting into the pockets of those people in a bigger way is key.

      A good deal of this is personal opinion as a lot of this data isn’t readily available. I know that when I go to whole foods, it’s for one or two specialty items and I do more of my shopping online or at smaller stores. I know that my local Trader Joe’s is packed with people in my age range but whenever I go to Whole Foods, it’s mostly people above my age range.

      I think there’s something to be said for niche stores. People like small brands, they like feeling like they’re trying something new or something that’s not owned by a massive mega corp(even if it is all going into Amazon’s pocket). I don’t think Amazon is going to change the SKU model too much. We’ve seen a lot of SKU optimization in recent years for all sorts of business models as poor performing brands are closed up or sold(Look at companies like P&G for examples, not only grocery stores). There’s something to be said around just having a few GOOD brands instead of a ton of mediocre stuff. It makes shopping easier and that’s what Amazon is going for across the board – making shopping easier. Places like Trader’s Joe’s do this and Whole Foods is closer to that(their 365 stores too) than the big mega stores.

      Also, somehow Amazon has curated this idea that they’re a COOL company that does things right and Whole Foods kinda has thing working for it as well so I see that as a fit as well.

      I read a topic the other day about Walmart buying Bonobos(online clothing retailer) and there were plenty of people saying they wouldn’t buy Bonobos anymore cause it’s Walmart but somehow they don’t seem to have the same feeling about Amazon.

  • Grant

    I agree with the Amazon go. That was my first thought when I heard that news.

    I love Amazon and I love that the keep growing and pushing the envelope. People have this fear of Amazon “taking over” but I don’t feel that way. Just in my lifetime, I remember when people use to talk about Sears as being this unstoppable force that was pushing everyone out of business and it wasn’t fair. Now Sears barely exists.

    Not saying this will happen to Amazon but the second they stopping pushing forward someone will pass them. Consumers are very much of “what have you done for me lately” crowd.

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