A weekly newsletter, mostly about Amazon
January 10 , 2021
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In 2017, Amazon bought Whole Foods. Since then, it’s opened a handful of new Amazon Fresh grocery stores and plans many more, along with Amazon 4-star stores, lots of cashier-less Amazon Go convenience stores, small Amazon Go grocery stores, and a few physical bookstores. Plus it’s looking to license both the Go technology and new Dash cashierless grocery carts. It’s diving deep into physical retail, focused primarily on groceries, with much of this coming in the last year or so.
Plenty of excitement, then. But sadly misplaced.
Amazon has no business being in groceries at all. Take it from one who knows. In his 2005 letter to shareholders, Jeff Bezos said this: “I often get asked, “When are you going to open physical stores?” That’s an expansion opportunity we’ve resisted. It fails all but one of the tests outlined above. The potential size of a network of physical stores is exciting. However: we don’t know how to do it with low capital and high returns; physical-world retailing is a cagey and ancient business that’s already well served; and we don’t have any ideas for how to build a physical world store experience that’s meaningfully differentiated for customers.”
Have things changed since 2006? Not really. Grocery stores are high capital/low margin projects. Unlike books and electronics and even apparel, there are no fat and happy bricks-and-mortar incumbents with tempting margins. On the contrary; the groceries pool is filled with hungry and highly efficient sharks. So where are Amazon’s competitive advantages?
In many industries, Amazon's huge scale and online capabilities could create real leverage. But in groceries, this is a case of the Emperor’s new clothes: None of those supposed advantages amount to much:
Amazon’s huge competitive advantages online mean nothing in groceries. That enormous catalog and the great search and recommendation system doesn’t matter much… milk and eggs is milk and eggs.
Amazon’s extraordinary logistics network is tuned to goods, not groceries. The cost of doorstep delivery in the low-margin groceries business makes free grocery delivery unsustainable in even the medium term. Worse, Amazon has no competitive advantages here anyway (just like its competitors, it’s struggling to stand up local delivery). Whole Foods stores are not well placed to act as delivery hubs.
Amazon’s past record in groceries is poor: Amazon Fresh – its long-running grocery delivery service – has gained no traction. And Whole Foods at best breaks even, three years into the Amazon era there.
There’s no differentiator. Whole Foods stores have has barely changed (and mostly for the worse). Amazon’s new supermarkets are much like others, with some fancy tech for cashier-less checkout. That won’t make a decisive difference. So there is no all-singing all-dancing grocery story on the horizon for Amazon. In fact, Amazon plans initially, it seems, to compete on price.
So Amazon has no expertise in groceries, no track record of success, no differentiation, and will be running steeply uphill against bigger and more experienced competitors with much better supply chains, which have deep established relationships with both suppliers and customers.
But what if Amazon builds the grocery stores of tomorrow, not today? Maybe Amazon is betting on the grocery business of 2031, not that of 2021. That future will likely rest on automation and delivery: behind the store, through automated stocking systems like Ocado’s; within the store, through cashier-less tech like Amazon Go; and in delivery, possibly through drones like the Scout Amazon is now testing in Tennessee. Automation will cut costs, perhaps significantly. But all these technologies (except maybe drones) are high priorities for other grocery chains as well. They can all read the tea-leaves. And drones will work only for highly specialized delivery cases – you won’t see one on your porch any time soon. So all this automation won’t provide Amazon with a significant and durable competitive advantage in groceries.
Still, the real train-wreck comes from huge organizational and financial challenges. To match the scale of Aldi’s – the 4th largest US groceries chain with about $31 billion in revenues, Amazon would need about 1,600 supermarkets (Aldi plans to have 2,500 by the end of 2022). But this not a digital product, with effortless scaling. It’s a physical business where every store needs a location, staff, local buy-in, and regulatory approvals. Every individual store is a challenge. Standing up even 300 new stores a year would be remarkable, even for a startup with Amazon's resources.
Assume that somehow Amazon sprinkles magic dust and builds a network of 1,600 supermarkets in the next few years. Running them is an enormous undertaking. Each store comes with dust and rats and physical problems to be solved every day. and staff. And customers. And supply chains – especially for fresh food. None of this is impossible, but there is also no evidence that Amazon has a secret formula for doing this significantly better: Whole Foods is proof of that.
Stretch your credulity to breaking point. Leave the startup and the operational problems aside. Aldi’s 2019 profits were about 1.4% of revenues, or about $430 million. Amazon is initially seeking market share through lower prices, so its margin would probably be lower. But even if Amazon somehow matched Aldi’s profitability, that would barely equal 3% of Amazon’s operating income as of 2019. By 2025, when the store network might be operational, even $500 million in operating income from groceries would likely be at best 2% of Amazon's total operating income. Groceries simply doesn't move the needle for Amazon. And that’s the best case.
The worst case looks just awful. Amazon will be committed to heavy startup costs and long-term leases on hundreds of properties with few if any other uses. Those properties may be cheaper now because of the retail apocalypse, but they are still expensive. So Amazon will likely lose money in the highly competitive grocery business, possibly for a long period of time. And if it goes all-on on free deliveries, it will likely lose a lot of money.
Worse still, groceries will be a huge resource sink for senior executives’ time, financial and technical resources, and energy. This isn’t something that one of Amazon’s famous two-pizza teams can knock together in an afternoon. It’s more like planning the Normandy invasion. Those resources will all be sucked away from other projects that are likely a much better fit at Amazon.
Amazon probably has other, nonfinancial reasons for getting into groceries. Maybe it just wants to prove and then license its Go technology - but it doesn’t need 1,600 stores for that. Maybe it’s concerned that the winning chains in groceries will be better positioned to challenge Amazon in ecommerce more generally. Amazon does think long term, and a dominant grocery business would have more frequent access to customers, and maybe better customer trust as well. That could become a threat. Or maybe it simply wants to ensure that it completely embraces the customer’s wallet, leaving no stone unturned. Maybe.
But basically, Bezos was right in 2005 and he’s still right today. Groceries is a high cost\low margin business with well-established competitors, where Amazon has no sustainable competitive advantages and no differentiator. It requires huge startup costs and offers low returns. So if we are using military analogies, pushing forward on groceries is much more likely to turn into Amazon’s Vietnam than a rerun of D-Day. Perhaps Bezos should re-read that letter.
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Amazon buys podcast host Wondery for about $300m. About 125m people listen to podcasts in the US every month, but aside from a few big hits like the NYTimes’ The Daily, most still have only a small audience and don’t make much money. Apple recently bought a couple of podcast hosts, Spotify – including exclusive celebrity signings like MeaghanMarkle and Prince Harry as well as top-rated Joe Rogan – while Sirius XM (which owns Pandora) bough Stitcher and Simplecast.
My take: Amazon's move is pretty smart. Aside from putting down a marker during the land grab, podcasts are a potentially important way to provide more high value content for Amazon’s smart speakers, which could help drive actual utilization of Alexa beyond news and music. That opens another lane for monetizing Alexa by eating into the advertising base for radio (about $13 billion in 2019, though declining). Amazon's powerful data capabilities will make ads more targeted and hence more valuable, and revenues from ads will help the bottom line, as Amazon loses money overall on devices like the Echo, and hasn’t yet found good ways to recoup through subscriptions (voice ordering for goods or groceries is still in its infancy). Spencer Soper has a smart take on the advertising angle here.
Green logistics in London. Amazon recently won rights to build a green Last Mile Logistic Hub in London. Built in part of an existing car park, Amazon will use bikes and pedestrians for parcel delivery within a 2km radius. The hub serves only Amazon's network, not third parties. It is expected to take up to 85 vehicles off the roads each day, putting fewer vehicle journeys by 23,000 annually. More such hubs are planned.
My take: this could be a pilot to be deployed later during the massive build-out of suburban and urban delivery hubs that Amazon has announced (1,000-1,500 new hubs). Those hubs are situated closer to the final customer, cutting last mile costs. By making them green, Amazon may be cutting those costs further in built up areas in the inner suburbs and cities, while burnishing its green credentials – which is obviously a current strategic focus. It might also help with growing consumer resistance to Amazon’s endless expansion: it’s harder to block a new hub when it means fewer cars and more foot and bike traffic instead.
Big money for affordable housing. Amazon has committed $2 billion for 20,000 units of affordable housing in three locations: Seattle WA, Arlington VA, and Nashville TN. These are all areas with a big and growing Amazon presence and a serious housing crunch. In Arlington, a package of $389.1 million in below-rate loans and grants supports 1,300 units. This targets households making 30%–80% of the area’s average income, which in Arlington means a household of four making less than about $80,000 annually. That in turn is based on the Federal definition of affordable housing. The Arlington project has some interesting features, for example phasing in affordability over 5 years as apartments become vacant, and a 99 year lease on the building.
My take: Another example of how Amazon implements its expanding social mission. The project also helps Amazon offer a very bright PR spin, with a huge headline number and few details on repayment terms and actual interest rates. The Arlington initiative is 89% loans, topped by grants (which are of course tax deductible for Amazon). As with the green hub above, this crosses over into Amazon's commercial interests – creating housing that could be occupied by their salariat, near work, at affordable prices. Still, that’s a good thing! Commercial interest reinforces social actions, and make them more sustainable.
Expanding air freight. Amazonbought 7 second hand 767s from Delta (coming in 2022) and 4 from WestJet (coming this year), ramping up the Amazon Air fleet in preparation for the launch of its $1.5 billion new air hub near Cincinnati later this year. These are the first planes Amazon has bought – the rest are leased or hired via contractors like Atlas Air. Experts price the deal at about $150 million, since aircraft prices fell 15% after COVID.
My take: Maybe Amazon taking an opportunist moment to acquire assets on the cheap. There’s no sign that its strategic alignment with its contractors has changed; indeed they may well be contracted to operate the new planes after they come on board (though their fees will of course be lower). Nor does this mean that Amazon's flight patterns will change – they are currently quite different from FedEx’s for example.
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Haven closes down. The healthcare joint venture between Amazon, JP Morgan, and Berkshire Hathaway announced it is shutting down. Critics have been quick to call it a failure, but I’m not so sure. I’ll discuss this and more in an upcoming piece on Amazon and healthcare.
Amazon and banking? A new Federal Deposit Insurance Corporation (FDIC) rule will allow non-banks to accept deposits and engage in other limited banking activities. They must maintain significantly higher capital than other insured banks, and accept FDIC audits and other standards. Will Amazon take the bait?
Amazon is looking for contractors to deliver its planned 3,236 comms satellites into low earth orbit for its global broadband Project Kuiper. Perhaps Bezos should give Elon Musk a call.
International – India. Amazon is migrating its Prime Now 2-hour deliver app into Amazon Fresh, its online grocery within the main Amazon app (much like Whole Foods is in the US). Seems likely this kind of rationalization will occur across Amazon globally as time and resources permit.
Prime Pantry is no more. Amazon quietly closed it this month. This is a way to rationalize confusing and overlapping services. Most items have been folded into the main Amazon site.
International – India. Amazon launched a new shopping app, which is not unusual. Except this will include money transfer capabilities and access to the Unified Payments Interface developed by the National Payments Corporation. See banking, above?
Amazon launches Made for You, custom T-shorts for $25. Pretty clearly a test to see if made to measure at low prices will be a coming thing, especially given the growing dominance of leisure wear within apparel.
Amazon overtook Facebook to become the second most effective tracker for US websites, though it’s still way behind Google. Combined with Amazon’s proprietary data, that’s…. worrying?
Amazon shifts on digital lending by libraries. Amazon has never allowed libraries to lend ebooks, but that may be changing. It's in discussions with a Digital Public Library of America. And not before time! There’s a petition to Congress on this, and I wrote to Jeff Bezos myself last year – maybe he finally read my email!
Main article\Short takes\Bullets\Data bytes
211,000 – tonnes of plastic used by Amazon to package seven billion items worldwide last year. Times of London
100 – electric Mercedes vans delivered in London – the first of 1,800 on order. Kilburn Times
50% – growth in third party Marketplace sales in 2020 holiday season. Amazon.
$1 billion – AWS credits provided to startups in 2020. Amazon
75,000 – additional drivers hired by Delivery Service Partners in 2020. Amazon
Amazon Rising is a newsletter mostly about Amazon, published by Robin Gaster. It’s delivered weekly on Sundays. On my website you’ll find more about me, more on by book Behemoth, Amazon Rising: Power and Seduction in the Age of Amazon, my blog, and some additional materials such as an extended bibliography.