How Amazon's Whole Foods purchase could solve its grocery supply chain puzzle

The $13.7 billion deal marks a turning point in Amazon's strategic efforts when it comes to cracking the $600 billion grocery market.
Written by Natalie Gagliordi, Contributor

Amazon rattled the retail world Friday with news that it would purchase organic upscale grocery chain Whole Foods Market for around $13.7 billion.

The all-cash deal -- Amazon's largest to date -- turns the ecommerce giant into a top five US grocer over night. It also marks a turning point in Amazon's strategic efforts when it comes to cracking the $600 billion grocery market.

Grocery is one of the highest frequency purchase categories in all of retail, yet it remains one of the last areas of commerce to develop a firm digital identity. To its credit, Amazon has been trying out grocery store concepts and pickup services in its hometown of Seattle, but the scalability of those projects has remained in question.

By adding Whole Foods to the mix, Amazon is building a brick-and-mortar tentpole that supports its overall ecommerce empire.

Whole Foods gives Amazon an immediate physical grocery footprint and the ability to alleviate some of the supply chain problems it faced with Amazon Fresh, including perishable inventory and delivery services. It also gives Amazon the ability to sell fresh and organic food on its online marketplace while at the same time giving shoppers the option to quickly pick up their online orders without having to schlep around the aisles.

Ultimately, Amazon wants to make same-day delivery for groceries the norm, with Whole Foods stores serving as specialized fulfillment centers for Prime Now and Amazon Fresh.

"Whole Foods has the supply chain question completely nailed," said Brent Franson, CEO of retail analytics firm Euclid Analytics. "And now Amazon has access to customers who may be open to home delivery."

And then there's the data. Unlike most modern grocery chains, Whole Foods has avoided implementing a loyalty program. That means Amazon won't have immediate access to a rich customer data set, but it also clears the path for Prime membership to step in and fill the void.

"Amazon has an opportunity to give Prime members automatic entry in a new Whole Foods benefits program," added Franson. "They could also offer the option to pay for groceries using the Amazon app, or sync your Alexa-made grocery list with your app while in-store. New app downloads and Alexa purchases en masse means Amazon now has visibility into what its members are doing offline. Talk about rich data."

What's more, Whole Foods' roughly 30 million (typically affluent) customers are also likely to be Amazon Prime customers already, which further strengthens the connective tissue between the two brands. Here's an excerpt from a research note by JP Morgan:

Whole Foods currently records ~8 million weekly customer visits, and has 30 million customers -- which we believe overlaps significantly with Amazon's projected 60 million domestic households.

With Whole Foods, Amazon now has 464 stores in markets that we believe have significant overlap with Prime customers as the broader grocery market transitions online at what we believe is likely to be at an accelerating pace.

As for Whole Foods, the company has been behind the curve somewhat when it comes to digital transformation. The grocery chain inked a co-innovation partnership with enterprise software vendor Infor in 2015, with the aim of revamping its supply chain and merchandising systems. Whole Foods also uses Microsoft's Azure Active Directory software.

In 2016, Whole Foods expanded its partnership with Instacart to create a network of store locations enabling online ordering and same-day delivery. It remains to be seen how Amazon's ownership impacts the Whole Foods/Instacart relationship, but it's likely that Amazon does not intend to keep it going for the long term.

In other words, Whole Foods is ripe for innovation when it comes to managing and digitizing its distribution network, and Amazon has plenty to offer in terms of IT infrastructure.

While it's difficult to predict just how much success Amazon will find in its grocery endeavor, investors are so far bullish that Amazon CEO Jeff Bezos is on to something big. In fact, Amazon's market capitalization increased by more than $30 billion on the day the Whole Foods acquisition was announced -- more than double the grocery chain's price tag.

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