This Giant Retailer Plans to Get Bigger

Gaurav 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) will soon be your friendly neighborhood grocer. Through its grocery subsidiary, Amazon Fresh, it will be offering same-day grocery delivery services known as Prime Fresh in Los Angeles. If all goes well, this initiative may expand to as many as 20 more markets in the US, and even abroad. The company has been testing the waters in its hometown, Seattle, for the last six years.

There are not too many success stories in the online grocery segment. So, from brick-and-mortar retail rivals to stock market experts, everybody has the same question – can Amazon do it? 

The opportunity

Let us first understand why Amazon would get into the challenging and low-margin online grocery business in the first place. A few statistics may hold the answer.

According to the Food Marketing Institute, 2012 supermarket sales amounted to a staggering $602 billion. Plus, according to IBISWorld, broadband Internet connections have been growing at an average rate of 16.4% annually since 2007.

With growing Internet penetration and more people preferring to buy from the comfort of their homes, online selling is invading the entire retail industry. With grocery being one of the largest segments, it is bound to have its share of online growth.

For the online grocery segment, IBISWorld has forecast a 9.5% annual growth rate through 2017 compared to the 1.2% growth this segment had between 2007 and 2012. This means a several-billion dollar opportunity.

This is what Amazon wants to leverage, but it is not the only one harboring these dreams. Internet search giant Google (NASDAQ: GOOG) is also thinking along the same lines. It is testing a same-day grocery delivery service called Google Shopping Express in San Francisco.

Logistics will be a challenge

There are reasons why online grocery sales with deliveries to customers have not resonated with retailers so far. First of all, arranging the logistics can be tricky. It is a big challenge to optimize the travel routes for the delivery trucks. Same-day delivery makes this task doubly difficult.

Also, handling perishable goods require added management skills. In case a delivery cannot be completed either because nobody is at home or for other reasons, it may not always be possible to deliver the same goods on the next day.

This is a unique issue that a retailer will not face with non-grocery items like books or electronics. So, Amazon would need to have its strategies in place to ensure minimal delivery failures.

Consumer mindset will be a bigger challenge

The next big challenge has to do with the consumer mindset. According to Food Marketing Institute’s 2012 survey only 54% of survey-takers buy groceries at least occasionally. Out of them, only 4% buy core grocery items like fresh foods and produce online, and 12% buy dry groceries and beverages.

Mintel researchers says, “Though consumers are becoming increasingly comfortable with Internet purchases of books, movies, and the like, many appear to be hesitant to make food and drink Internet purchases." This is where brick-and-mortar retailers like Costco Wholesale (NASDAQ: COST) score a point.

Costco is not ruffled by Amazon’s entry into what has been the forte of big-box retailers like itself, Wal-Mart, Target, etc. It has a loyal customer base that loves its everyday low prices. The company’s scale of operations allows it to get good bargains from suppliers, which help in keeping prices low.

Costco grew its same-store sales by 7% in its recently concluded 2013 third quarter. This was despite the bad weather and consumers' lower disposable income on account of high gasoline prices and delayed income tax refunds, which weighed on most retailers.

Costco’s secret probably lies in its growing membership base, which keeps patronizing the stores. In the third quarter it saw a 19% increase in new signups. Amazon will have quite a task on its hands if it has to create holes in Costco’s armor.

Amazon’s Plan

Amazon, to its credit, has not jumped into this tricky online grocery business in haste. It has been testing same-day delivery in Seattle for years before beginning a national roll out.

The company will offer Prime Fresh service in Los Angeles to its prime members free of cost for 90 days. Subsequently, the service will be available for annual fees of $299.

Prime members currently get unlimited two-day shipping for $79 per year. Prime Fresh members will get unlimited same-day or next-day early morning deliveries. Subscribers get to choose from more than 500,000 items including groceries. All orders will be fulfilled from Amazon’s new delivery center at San Bernardino, Calif.

Amazon is banking on the fact that in order to maximize the full benefits of their subscriptions, Prime Fresh subscribers will often pair high margin non-grocery items along with regular groceries. This will drive overall sales and make the entire venture more profitable.

Google will keep company

The Internet giant is testing its Google Shopping Express in San Francisco. Interestingly, this may be Amazon’s next destination after L-A, as per industry sources. Google launched this in March and will test out the service for another six months.

The company has tied up with national retailers like Target, Walgreen, etc. Its modus operandi is that buyers wanting groceries delivered from the partner retailers will place orders through a central website. Google will use tie-ups with courier services to pick up the merchandise from the stores and deliver them to customer doorstep. All delivery persons will be in Google uniforms and vehicles will carry the company logo.

Other than foraying into the grocery retailing, Google is seeking to do is push up Internet usage, which will give it more playing ground for boosting its ad revenue.

What are Amazon’s chances?

Given Amazon’s experience in delivery service and its prolonged testing period, the company stands a good chance of pulling it off. It has made big investments in warehouses and distribution centers, which would lend appropriate support to this venture.

Combining grocery and non-grocery items is strategic because of the cross-selling opportunity involved. Besides, the high-margin and low-margin mix increases the venture’s profit prospects. This can be a good edge that Amazon can have over Google.

So if the company can work out the logistics and succeed in creating a good value perception in the minds of its customers, it can see explosive growth. Once that happens, it would create tremendous shareholder wealth.

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Gaurav Basu has no position in any stocks mentioned. The Motley Fool recommends, Costco Wholesale, and Google. The Motley Fool owns shares of, Costco Wholesale, and Google. 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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