Will These Companies Be Amazon's Next Victims?

Andrés is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Amazon (NASDAQ: AMZN) is well known for having disrupted different retail areas over the course of its history. Companies like Barnes & Noble and Best Buy have seen their sales and earnings fall over the last years due to the aggressively low prices charged by Amazon. There is no end in sight for this trend, and mass merchants like Wal-Mart (NYSE: WMT) and Target (NYSE: TGT) are looking increasingly vulnerable from a long term perspective.

Pricing competition

The problem faced by companies like Barnes & Noble and Best Buy is that Amazon has a much lower cost structure. Rent, inventory and salaries among others are a big advantage for the online retailer. The products are commoditized, and pricing is the main determinant of a purchase decision for articles like books and electronics. Once the customer has decided what he or she wants - perhaps by “showrooming” at Best Buy - Amazon becomes the most convenient alternative to make an order.

When it comes to Wal-Mart and Target, the difference in cost structure may not be so big. After all, these brick and mortar retailers have considerable scale, and they have streamlined their operations to efficiently compete in pricing through the years.

Amazon is investing heavily to build warehouses all over the country, and the company will have to collect sales taxes in more jurisdictions in the following years. This may erode Amazon's cost advantage to some degree.

On the other hand, as the company keeps exponentially increasing sales, it gains in terms of efficiency and margins, so the trend looks positive for the online retailer in the long term. Even if in the middle term it sees rising costs due to warehouse building and other issues, if Amazon keeps outgrowing the competition, it will also gain in terms of cost structure.

Besides, pricing is not only about costs. Amazon is willing to bring margins to razor thin levels in order to gain market share, and investors are arguably supportive of this strategy since the stock has recently made new all time highs in spite of falling profit margins over the last years.

Amazon has decided to voraciously gain market share in different categories at the expense of almost nonexistent margins. This puts Wal-Mart and Target in a very uncomfortable position to compete in the much important issue of prices.

Fighting for the consumer

Some product categories like groceries are not particularly prone to online shopping, since customers will always prefer to see and touch these items before purchasing. But as Amazon expands into new categories, and customers become more involved with the company via services like Amazon Prime, it has been gaining market share versus Wal-Mart and Target on several categories.

This can be seen in global macroeconomic trends: over the last three years, general merchandise retailers have seen their market share of total retail sales drop from 14.4% down to 12.5%. This represents the lowest share of total sales since October 2001. Online retailers, mostly Amazon, have increased their share of the total to a record 9.3% in December.

Both Target and Wal-Mart are fighting back against Amazon; this is a positive sign for investors since it shows that these companies are actively trying to step up to the increased competitive pressure. But it’s also a clear indication that they are feeling the heat form the online retailer.

Target has recently announced a price matching policy which includes Amazon, Wal-Mart and Best Buy among others. Wal-Mart has introduced same day delivery in select locations with no minimum order for a cost of $10 per delivery, competitively close to Amazon's $8.99 same day delivery service. Wal-Mart has also been heavily investing in its online operations over the last years, and the company has discontinued Amazon's Kindle products from its stores.

After seeing what has happened to other retail categories, Wal-Mart and Target are smart to fight back before the situation becomes too dire for them. But this still doesn't change the fact that Amazon is the disruptor looking for growth opportunities, while traditional mass merchants are simply trying to defend themselves against a very serious threat.

Bottom line

Wal-Mart is a very efficient operator with a big global scale and an enviable supply chain structure, and it’s still feeling the pressure from Amazon. I wouldn´t say that the company will necessarily suffer the same damage as Best Buy, but it’s not immune to Amazon either. When it comes to Target, whichdoesn't have the same competitive strength, things could get much more complicated over the next years.

acardenal owns shares of Amazon. The Motley Fool recommends Amazon.com. The Motley Fool owns shares of Amazon.com. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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