The Big Retail Battle For The Grocery Aisle

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

Groceries are big business. The US grocery business, in fact, did about $568 billion in sales last year. Food is a low-margin business, but selling groceries has been an increasing trend for many retailers. Low-margin business is right up many of these retailer's alleys -- especially if they have the economies of scale to successfully profit from volume. 

Amazon fresh...

Large-scale, low-margin retail can't be brought up without mentioning Amazon.com (NASDAQ: AMZN).

The company is planning to begin selling groceries online and deliver them to customers in as many as 20 markets by 2014. Los Angeles will apparently be the first new market to receive the service.

The service was initially offered in Seattle, where overnight delivery of things such as eggs, produce, and even meat from local retailers was free (if a minimum order price was met) and was delivered by Amazon's fleet of delivery trucks. The company, by using the grocery business it is developing to underwrite its expansion of its fleet of delivery trucks, may also be evolving another business – delivery. Amazon may be looking to eventually cut out middlemen like UPS one day.

While groceries are low margin and may not make enough money to justify Amazon's costly expansion alone, the real money maker will be if people decide to also buy higher-margin items such as electronics and bundle them with their shipped groceries. Supermarket analyst and consultant Bill Bishop explained:

"The fear is that grocery is a loss leader and Amazon will make a profit on sales of other products ordered online at the same time... That's an awesomely scary prospect for the grocery business."

And then there is Wal-Mart...

Amazon was beaten to the punch in groceries by none other than Wal-Mart (NYSE: WMT), who is now the nation's largest grocer and retailer. Wal-Mart now sells about a quarter of all U.S. groceries.  

Forbe's stated that the company now has a 25% “franchise” on America’s grocery budget.

About 90% of Americans live within 15 minutes or less of one of the company's 4,000 locations. Wal-Mart has also been aggressively expanding its grocery business over the last decade -- with groceries now accounting for 55% of sales, as opposed to only around 20% of sales 10 years ago.

Wal-Mart has also apparently been testing same-day and next-day delivery for groceries and other items in their stores, which will help it match and compete with Amazon.

Target is also expanding its groceries business

After reporting a disappointing quarter with disappointing sales, Target (NYSE: TGT) also cut its full-year guidance as well. Sandy Skrovan, U.S. research director at Planet Retail, elaborated:

"This is Target's weakest quarterly same-store sales performance since the Great Recession year of 2009."

The company does have some positives going for it, however. In Canada, where the company has been expanding lately, there were apparently stronger sales than expected. Canadians also like Target stores because they carry things that aren't usually available in their home country -- such as Jif peanut butter.

While the company's higher-margin apparel and home decor have also been attractive to consumers, Target seems to be having troubling luring these same consumers to the grocery aisle. The company does, however, seem to be looking to move further into groceries to compliment its higher-margin businesses like apparel.

With a new 360,000-square-foot distribution center in Denton, Texas, Target is looking to not only expand its grocery business, but to also solve another problem that even other competitors such as Wal-Mart face: keeping shelves stocked. It will be the company's fourth distribution center, and will serve 235 stores in eight different states. The company looks to be leaning all the way into controlling its own distribution network, as opposed to relying on partners of the past, such as Supervalu.

The bottom line...

Big retail is increasingly getting into groceries in a big way, looking to grab their slice of the $568 billion grocery pie. Wal-Mart is already established and has locked up a quarter of the United States market, while Amazon is pushing itself into the very same market in an unique way which may steal some of Wal-Mart's thunder. Target also knows groceries are lucrative, and this is why it is expanding and strengthening its distribution network. The real losers here going forward 10 years or more may be the traditional grocery stores and chains, who may not outlast the massive economies-of-scale and "cheapness" of the Wal-Marts and Amazons of this world. 

While Amazon seems to be taking on some risk selling groceries that will perpetuate its already low margins in hope that consumers will also buy higher-margin items like electronics along with their groceries, this model works much better for brick-and-mortar. Wal-Mart doesn't have to deliver groceries and take on that burden and cost like Amazon does, so it makes more sense and seems to be more profitable for them to offer groceries to consumers. Not only that, its huge economies of scale allows Wal-Mart to sell a huge amount of groceries (nearly a quarter of all of the U.S. market), and small margins applied to massive revenues adds up.

Target is currently immersing itself deeper into the game by gaining better control of its distribution network. It is following in Wal-Mart's footsteps. Both Target and Wal-Mart can be successful at selling groceries with their physical stores, and groceries do tend to draw more customers to buy higher-margin items as well. This is much easier to pull off with physical stores than it is for an online-retailer like Amazon, because delivering groceries is not as much of a concern cost-wise when your physical stores can hold groceries and fresh produce in freezers and refrigerators while they are waiting to be sold. This also gives physical retailers less of a logistical challenge if they don't have to deliver. 

One long-term positive takeaway for Amazon, even if groceries turn out to be a losing proposition profit-wise in the short-term, however, is the building up of the company's fleet of delivery vehicles. If it build its fleet large enough, it may be able to cut out its current delivery middlemen such as UPS and FedEx, thus reducing overall costs. Maybe this strategy will pay off in the future and help to more than offset the low-margin grocery business. As of now, however, Wal-Mart is the grocery king of the retail world.

 

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Joseph Harry owns shares of Wal-Mart Stores. 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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