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Amazon, Whole Foods Ignite Grocery Digital Transformation: Part 1

In purchasing Whole Foods Market, Amazon became a major player in the grocery store channel, and also forced established retailers to go more boldly into the digital space. HomeWorld’s Supermarket Report looks at Amazon’s Whole Foods initiatives, online trends in the grocery channel and how technology is playing a key role.

Today, part 1 looks at the Amazon effect. Parts 2 and 3 will look at the Whole Foods effect and the influence of technology, respectively.

The Amazon Effect

Amazon is changing the way supermarkets and other food retailers are looking at their businesses. Investments in omnichannel operations in just about every retail channel reflect, at least to a degree, an attempt to leverage existing assets as a means of coping with a retailer that is growing by leaps and bounds, and, as a consequence, grabbing share from competitors.

Kroger and a few other supermarket operators, including Albertsons and Ahold, have been developing omnichannel strategies to make them more effective competitors in a more complex food retailing environment.

Neil Stern, senior partner at consultancy McMillan Doolittle, said three major factors are going a long way in driving the grocery store business, and squeezing traditional food retailers, including the development of Amazon and online operations, the growth of the deep discount grocers including the established Aldi and newcomer Lidl, and a Walmart resurgence catalyzed by a need to compete more effectively with expanding rivals in the physical and, especially, the virtual retailing space.

Online penetration in the grocery business is still less than 2%, Stern noted, but Amazon’s entering food retailing in a significant way via the Whole Foods purchase changed how both participants and observers viewed the market.

“The day they bought Whole Foods, Kroger stock went down 20%,” Stern said. “The outside world woke up to the fact they they could take over the grocery business just like they took over other businesses. The calculation after that for any major food retailers sitting on the sidelines from an e-commerce perspective, was to realize they had to be serious.”

Walmart pushed its service allowing customers to order online and collect groceries store side while Kroger, among other initiatives, developed a relationship with online supermarket Ocado, which gave it access to Ocado smart platform technology.

In a June 21 conference call, Kroger CEO Rodney McMullen said, “We believe the future of retail will include both physical and digital customer experiences. Everything we are doing today will enhance our ability to provide everyone in America with convenience of shopping for anything, anytime, anywhere. We are incredibly excited that it is Kroger who is bringing Ocado technology to the U.S. for the first time. The platform includes online ordering, automated fulfillment and home delivery capabilities, so it’s a perfect fit with our vision and strategy. We look forward to innovating together with Ocado to enhance Kroger’s digital and robotics capabilities. And we are already working to identify the first three sites for development of the new automated warehouse facilities in the U.S. to deploy Ocado’s proprietary technology and distribution expertise.”

On August 1, Kroger also announced the launch of Kroger Ship, a new direct-to-customer e-commerce platform in four markets, Cincinnati, Houston, Louisville and Nashville, which it will operate despite the market presence of 2,800 stores it operates in 35 states.

Ship isn’t the only grocery delivery program Kroger recently developed. Just five weeks before it unveiled Ship, for example, Kroger partnered with Nuro to develop fully autonomous vehicle delivery. Through it, customers will be able to place same-day delivery orders through Kroger’s ClickList ordering system and Nuro’s app. Nuro’s fleet of autonomous vehicles will deliver orders in a test market, yet to be announced, beginning this fall.

Market Share Changing

Traditional food retailers have seen their market share erode over the past 40 years as a variety of retailers challenged their dominance. According to Willard Bishop Analytics, in 1988, traditional food retailers held a 90% share of the grocery and consumables market.  At the time, convenience stores controlled 8% of the market and non-traditional retailers such as warehouse clubs and supercenters controlled 2%. By 2009, those figures were 48%, 16% and 37% respectively and, by 2016, they were 44%, 16% and 40%.

Consumers have shown themselves open to new methods of purchasing groceries and consumables. However, it should be noted that the majority of erosion in the traditional food retailer position occurred prior to 2009 and particularly between 1988 and 2006, a period when the traditional food retail share fell from 90% to 50%. The numbers suggest that traditional food retailers have managed to find responses to the challenges they’ve faced and/or that consumers retain the habit of visiting traditional supermarkets for at least some of their needs.

Online food sales could generate a second significant change in who the market rewards. The Future of Food Retailing Report projects 25% annual growth in e-commerce food and consumables, more than triple that for the next fastest growing segment, limited assortment grocers, such as Aldi and more than 10 times the estimated food inflation growth rate of 2.2%. The report anticipates that traditional supermarkets will suffer shrinking share.

When food inflation is taken into account, said James Hertel, svp/Inmar Analytics, parent of Willard Bishop, the position even of traditional food retailers who are reporting sales growth, doesn’t look altogether secure and real gains are pretty much nonexistent. The issue, said Hertel, is where the real growth is occurring both in terms of trade channel and product categories.

“Where Amazon has potential to disrupt, even if it’s at one or two percent share, is with high growth. If it grows at 30% a year, that’s a disproportionately high percentage of growth. When they acquired Whole Foods, all of a sudden they started to look different than a pure play e-commerce provider. They became a hybrid. Food retailers say it’s all about the fresh part of store. Now, they’re looking at Amazon and saying it’s a totally different proposition,” Hertel said.

The report doesn’t predict a precipitous decline in traditional grocery prospects through 2021, even for traditional supermarkets. However, the ability to cope with and adopt to the growth of e-commerce in food and consumables will substantially influence prospects for traditional food retailers. The report notes that, in 2016, e-commerce accounted for $33 billion, or 4%, of overall $795 billion in food and beverage sales as Willard Bishop defined them.

The Future of Food Retailing Report included projections indicating that, in 2021, e-commerce will account for $70 billion, or 8%, of food and beverage sales. Food retailers that expand online operations will do so faster than other retail channels have done in the past, providing companies that have grown with brick and mortar stores a fair chance of grabbing a piece of growing digital revenues.

Yet, Amazon could through a monkey wrench into a lot of calculations. Stern noted that Amazon looms over the growth of digital food sales for many reasons, key among them its ability to efficiently launch initiatives then amend, grow or abandon them as circumstances dictate. At the same time, the financial community holds Amazon to different standards, so it can sink money into fresh food operations and massive promotions, think Prime Day, in ways that might prompt Wall Street into taking competitors to task.

Stern pointed out that, even in preparing for what was an inevitable thrust into food retailing, retailers such as Kroger and Walmart continued to look at their responses in terms of return on investment and financial readings Wall Street expected them to respect, readings that it allows Amazon to ignore.

“Amazon is playing a completely different game than everyone else with a completely different set of rules. They are not measured the way other retailers are measured, so they have a different mindset. They have carte blanche. And they have a track record that ultimately says they will make what they are doing work. That presents a significant problem for retailers that are still being judged by same store sales and gross margin,” Stern said.

What could prove even worse for food retailers as they constitute the market today is Amazon’s history as a company that doesn’t only disrupt but blows up markets as it creates a clean field in which to operate.

“It’s the nuclear option,” Stern said, noting that Amazon’s Jeff Bezos has a particular mindset and “thinks, ‘Food retailing is the largest retail category, and we’re going to figure out how to be a significant player in this category.’ If you look at what they’ve done and the different ways they are trying to do that, including buying a physical retailer, Prime Fresh, Prime Now, prescription service, Dash buttons in peoples home, this is how they are pre-empting everyone. Those are like probes into the market. They keep on probing and they figure out which one of those or all of them are the right way to do it.”

Indeed, in its second quarter conference call, Brian Olsavsky, Amazon CFO, provided some sense of how broadly the company regards its opportunity to upend the retail space in and around traditional food retailing.

“We have the delivery services, AmazonFresh, and Prime Now which serves a certain need. We have a traditional grocery store now with Whole Foods, and then we have the combination with home delivery, and we’re using Prime Now or Whole Foods products through Prime Now to make those deliveries as well as the new kind of stores with Amazon Go that we’re experimenting with. So lots of innovation, invention,” he said.