September, 2015

Opinion

Thinking Afresh In The Amazon Age

It was back at the City Food Lecture in 2014 that Doug Gurr, then Global VP at Amazon UK and now President at Amazon China, implied that Amazon would be bringing its grocery delivery service to the United Kingdom:

Amazon in the USA has gradually developed a successful online fresh produce business. It took seven years of evolving the process in one city – Seattle – before the company was ready to roll the model out across the country.

When asked whether UK growers and suppliers into this market might soon be able to sell into a similar model, he intimated that it could happen:

“I don’t have the answer for you in the UK today. Ours is predominantly an ambient route to market. We wanted to get the fresh supply chain absolutely right in the US before rolling it out, even outside of one city. History would suggest though that once we have typically rolled something out across the US, it is followed by international expansion.”

Now, as Andrea Felsted has reported in the Financial Times, in a piece titled UK grocers brace for launch of Amazon food delivery service, the thought is that Amazon Fresh will reach the UK sooner rather than later. Amazon has leased an old Tesco warehouse and has, in general, been building up its logistics capabilities in the UK and, especially, in London.

This is a matter of great concern to UK retail executives, and it should be. And not just for the obvious reason.

Yes, of course, a major company opening an online presence is basically an oligopoly-buster. It would take years for a retailer to open a critical mass of large size stores. One reason Aldi and Lidl are such a formidable threat is they don’t need these large sites; they can grow in small sites that are more readily available. Online retailers don’t require any sites at all! So the threat is existential – an attack on all the customers that a bricks-and-mortar retailer serves rather than a slow retail rollout of bricks-and-mortar stores.

The real challenge that Amazon will pose, though, is the difference in motivation for Amazon to do this as opposed to a traditional food retailer or even an online food retailer such as Ocado.

Many years ago, when Wal-Mart began its rollout across America, the fear among grocery retailers was that Wal-Mart was unbeatable, not because it was a great merchant or had efficient supply chains. The fear was that it would be a fierce competitor because its priority was to make money on things other than food. The fear was that Wal-Mart would be focused simply on offering food and, especially, fresh foods in order to increase the frequency of visits to its high margin general merchandise stores.

In other words, if consumers visited general merchandise stores, say, once a month, but visited grocery stores twice a week, if Wal-Mart could just attract consumers into its supercenters two or three times a month, even if it broke even on food, if consumers would purchase a high-margin toy or towel or other item on each trip, the expansion into food would be a winner for Wal-Mart, regardless of whether Wal-Mart ever made a penny on food. 

As it happens, the theory never really got a test… it quickly turned out that Wal-Mart was so successful in food that it could not be indifferent to profitability in the section. In fact, if you want to encapsulate Wal-Mart’s problems in one thought, then think this: Wal-Mart’s food sales are its low margin products, and each year Wal-Mart has a higher percentage of its sales in these lower margin products and a smaller percentage of its sales in higher margin products.

Amazon may play out differently. Executives at Amazon believe it could sell much more of its non-fresh product if it could get it to consumers faster, ideally with same day delivery. One of its motivations in building a perishable supply network for consumers is to have that network cover the cost of this delivery network. If Amazon Fresh can roll out and sustain such a network, the rest of Amazon can piggyback on the break-even distribution network and Amazon will make a killing.

Using logistics as a way to gain an edge in business is not, of course, novel. This columnist was once the “Coconut King” in America, though we never made any money on coconuts.

We had a large public warehouse in New Jersey where we stored many low-volume produce imports, such as Greek figs, Italian chestnuts, French Granny Smith apples, Belgian endive, Salsify and Mâche, Juan Canary melons from Spain and much more. 

The products were limited in demand, and we would send out mixed loads to travel as far as Oakland, California, clear across the country. But the volume was small and we would sit with standing orders from Minneapolis and cities across America and be unable to get the one skid to the customer. 

We decided to make a deep dive into coconuts simply because they are big and bulky and filled up the trucks. We never made a dime, but by defraying the transportation costs, they allowed us to find a way to deliver to customers nobody else could deliver to. So coconuts sustained the transportation system, and we made the profits on the Italian chestnuts and other items.

Amazon’s ambitions are very similar in the consumer space.

Now, ‘there’s many a slip twixt the cup and the lip’, and it is not at all clear that Amazon can create a break-even rapid-delivery network; one could easily imagine food being a big success for Amazon on the top line but a big drain on the bottom line. But as long as the stock market believes in the project and is willing to support a high multiple on the Amazon stock, Amazon can do a lot of damage to competitors even if the plan never works.

This is especially true because there is some sense that many retailers are uncertain about how to think about the online space. Recently there has been a move to increase delivery charges and minimums. It makes perfect sense, as these are additional expenses incurred for these orders. They are visible and easy to quantify. Yet it is not clear the degree to which – or even if – the costs of delivery are higher than the costs of serving consumers through retail stores.

Sure, if one views the bricks-and-mortar as a fixed cost and imagines delivery as meaning rolling out a pound of grapes to a consumer, then, of course, delivery is more expensive. But if you imagine a retail world where you don’t need the store at all, and you imagine every house on the block ordering something, whether it is food, books or dry cleaning delivery, then the relative costs are not so clear.

We have to avoid getting caught up in settled expectations. Take something such as credit cards. Because they charge the merchant a fee, there is an obvious and explicit cost to the retailer in accepting credit cards. But if one reflects on the costs of accepting cash – the training, the equipment, the security, etc. – it is not obvious that credit cards, fees and all, don’t cost a retailer less than accepting cash. 

The challenge of Amazon is really for conventional retailers to reimagine their business and see if they can make their online operations something more than an old grocery delivery service done via the web.

Bricks-and-mortar retailers have many advantages. There are many indications that consumers often prefer click-and-collect to delivery, for example, and conventional retailers are better positioned to execute on this than an all-digital concept.

Amazon has many advantages. A good brand; a stock market that believes in it and allows them to invest; experience at making online sales work; a diversity of product… but the primary advantage Amazon has is that it sees things fresh and so Amazon isn’t thinking about compelling a new business model to fit into old ways of doing things. 

The challenge for conventional retailers as they seek ways to prosper in the digital age is to find ways to overlook legacy costs and legacy concepts and to imagine things afresh. That is a leap not all retailers will be able to make. But for those that are able to recreate themselves, uncommon success awaits.

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