Amazon’s Brilliant New Strategy

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

Quick! What’s the first word that comes to mind when I say “” Perhaps books, electronics, or DVDs. How about groceries? Yeah, that wasn’t my first thought either.

But believe it or not, Amazon (NASDAQ: AMZN) is a player in the online grocery delivery business. In fact, AmazonFresh has been operating under the radar in Seattle for almost six years. Recently, Amazon expanded the business to the Los Angeles area as well, and some speculate that further expansion could be in the near future.

Is the grocery business good for Amazon, or should the company check out of the industry? I think Amazon should stay put. Here’s why.

At first glance

I’ll admit, at first glance, the venture seems like a bad idea. Why would Amazon want to be in the grocery market? Brick-and-mortar retailers such as Wal-Mart (NYSE: WMT) dominate the extremely-low-margin industry. Wal-Mart, which operates over 5,000 stores in the United States alone and boasted a 3.31% profit margin last quarter, is notorious for leveraging its size to obtain higher margins than competitors. And in a business as competitive as groceries, a slender .5% can mean the difference between outrageous success and quick doom.

Amazon’s entry into groceries raises an obvious question: when considering shipping costs (overnight or same-day delivery is the only option for many products), how can online companies like Amazon compete independently?

I don’t think they can. Do you remember Webvan? Or These ill-fated online grocers went bankrupt when the tech bubble burst in 2001. Why? They couldn’t bring down delivery costs, and they couldn’t get margins up.

So what is Amazon thinking?

A different angle

Let’s get one thing straight. Amazon isn’t in this business to profit from groceries.

Sure, some profit would be nice, but CEO Jeff Bezos as much as admitted that AmazonFresh isn’t profitable, even after six years. I would argue that the groceries are simply a way to bring more consumers to Amazon’s core marketplace. Wouldn’t it be great if you could buy an iPad, Star Wars Episode VI, and fresh milk and eggs, all in the same order? It seems that people in Seattle think so, because AmazonFresh is expanding.

Wells Fargo Analyst Matt Nemer said, “Amazon could really use this as a means to drive sales of general merchandise, which have better margins than groceries.” I think Nemer is right on. Bezos’ game isn’t groceries, but rather everything else that consumers might buy along with groceries And that “everything” can range from a DVD to women’s makeup to a new Crocodile Mile for the kids. The “tack-on” possibilities are limited only by Amazon’s inventory.

Thinking local

These days, large corporations are not exactly popular with local small businesses. Local grocers in my area were livid when Wal-Mart opened a new Supercenter a few years ago, and many have since gone out of business.

Amazon takes the opposite approach – Amazon would rather tag-team with small businesses than add a third competitor to the ring. Instead of crushing local grocers and bakeries, Amazon seeks to partner with them. For example, Seattle customers can purchase products from local merchants like Pike Place Fish Market, The Stumbling Goat Bistro, and FROST Doughnuts (the list of local merchants is quite extensive – you can see it here).

I think this strategy is excellent. It will help Amazon build a better reputation, and therefore sell more in its core industry. Amazon isn’t the first company to use a local strategy. Companies like Groupon (NASDAQ: GRPN) continue to be successful by partnering with local businesses. Groupon pioneered the local business model by selling coupons online for businesses of every shape and size. From shoe sales to one-day boat rides, Groupon does it all. Is the strategy working? Groupon’s revenue has increased 415% and 45% the last two years, and in June, Deutsche Bank recommended Groupon as a Buy, prompting a 17% increase in Groupon’s stock price to date. You be the judge.

More importantly, can Amazon use the strategy too? Yes.

Bottom line

Amazon knows what it’s doing. The expansion into LA shows that the venture is working – even if groceries aren’t the main objective. I don’t think that a national expansion is doable, but I do think that further West Coast operations (and also New York) could be beneficial to the company.

So next time you are in LA, you might be craving a bowl of cereal, and a movie, and you still need that anniversary card for your wife. Now you know exactly where to go.

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This article was written by Randy Holcombe and edited by Chris Marasco. Chris Marasco is Head Editor of ADifferentAngle. Neither has a position in any stocks mentioned. The Motley Fool recommends The Motley Fool owns shares of 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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