Can Amazon Compete In Groceries?

| About:, Inc. (AMZN)


Retail behemoths are readying major efforts to gain dominance in the online grocery business.

So far, the online grocery business forays of large retailers have been confined to major metropolitan centers on the West Coast.

Amazon stock price has entered the realm of fantasy.

Short on toilet paper and lettuce? Your groceries might soon be delivered to your front door.

Retail behemoths Walmart (NYSE:WMT) and Amazon (NASDAQ:AMZN) are both readying major efforts to gain dominance in the online grocery business, which currently accounts for less than 1% of sales in a $568 billion market.

Centralized grocery delivery makes a lot of sense. It saves shoppers more than just time and gas-money. Moving groceries from stores to multiple customers' refrigerators in the most fuel-efficient manner a computer can devise can cut carbon emissions by as much as 90 percent, compared to the way we ordinarily shop for our celery.

But enough about the environment and consumer convenience. More companies are getting behind grocery delivery because it makes good business sense as well.

Walmart has started delivering in the U.K. and San Francisco

In the United Kingdom, Walmart (WMT) owns a subsidiary called Asda that has rolled out the second-largest grocery delivery business in that nation. It's working so well for them that in the U.S., Walmart has begun testing a similar service in San Francisco and San Jose, Calif.

Using its existing big-box stores as ad hoc warehouse centers, the company's "Walmart To Go" service delivers groceries to surrounding locales, fulfilling orders placed on its website.

Having proven the concept (Walmart's been running its test program since 2011), the company's now biding its time before it rolls out the program in a big way.

As Walmart's Global e-Commerce President Neil Ashe recently explained,

We've proven we know how to do it. We haven't proven market density - we haven't proven that customers want it. The reason we think grocery delivery worked in the U.K. was that so many people threw in behind it - Tesco, Asda, Sainsburys, Ocado, etc. So there was density and enough customers who wanted it.

If somebody else wants to pay to develop the market [in the U.S.], we are ready to go. We can pick from our own stores and roll that capacity out in months. If the customers say that's what they want, we are good to go.

So Walmart is waiting for its retailing rivals to blaze the trail and help popularize the grocery-delivery concept. After that, it won't be long before Walmart is delivering groceries to your front door.

Wal-Mart also said recently it has cracked the code for speedy, same-day grocery delivery in Mexico. Wal-Mart's Superama chain in Mexico uses mock stores and cheap labor to offer a service that is still cost-prohibitive in the U.S.

Amazon tiptoes into groceries

Last year, Amazon expanded its AmazonFresh grocery delivery service outside the company's home city of Seattle.

Amazon Fresh expanded to portions of the Los Angeles area, offering "free same-day and early morning delivery on orders over $35." Amazon Fresh customers must subscribe to Amazon Prime Fresh, which includes all the benefits of Amazon Prime. Amazon offers a free 30-day trial of Amazon Prime Fresh. After the free trial, customers are charged $299 for the next year and annually after that, unless and until they cancel the subscription. The service became available in San Francisco on December 12, 2013.

Economic obstacles to grocery delivery services

Megan McArdle has written an excellent article on the fact that we do our own "fulfillment" when shopping for groceries:

Grocery delivery also poses a price challenge that Amazon hasn't faced before. It's pretty easy for Amazon to undercut Best Buy, not only because it can forgo the expensive leases in shopping malls, but also because its labor model is so much more efficient. Best Buy clerks get paid to spend a lot of time standing around the store, scanning the floor for stray tendrils of dust and the shelves for stray items that have gone out of stock or were put back in the wrong place. On a good day they go into the back and fetch you a pricey television or appliance maybe five times; their productivity is constrained by the number of customers who come in. Amazon's warehouse workers, on the other hand, have amazing - some would say inhuman - productivity. Every minute they are working, they are making money for the company.

Amazon can't produce this kind of cost differential in groceries, because grocery stores rely on free labor - yours - to do all the laborious bits of fulfilling orders. You wander around the store with your cart, pile it all in, compare the prices of various brands of frozen chicken tenders, and these days, you may even be your own checkout girl. Then you drive it home to your house, unload the car and put the groceries in the kitchen. In order to deliver your groceries, Amazon has to pay someone at least $10 an hour to do all that work for you.

As McArdle points out there are things that work in Amazons' favor as well, the experience of other companies in the same space is that there's a great deal less wastage of stock (both from theft and from going off) in the warehouses where people are picking to pack for delivery to people.

If we are rich, it may well be a better use of our time to pay the higher price to have all delivered. In fact, the higher your wages now (and thus the implied value of your leisure) the more likely this is to be the case.

What about Costco?

Eric K. Clemons, Professor of Operations and Information Management at Wharton has said that as Walmart and Amazon clash, it could cause plenty of stress for smaller grocery chains, including Safeway (NYSE:SWY), Kroger (NYSE:KR) and Whole Foods (NASDAQ:WFM). "But consumers will enjoy great convenience and great selection, and they are likely to enjoy the benefits of a serious price war".

Clemons points out that there is another chain that is poised to dominate the online grocery sales market - Costco (NASDAQ:COST), the second largest retailer in the U.S., with 622 locations and 2013 sales of $105 billion:

Costco's presence in major metropolitan areas with high population densities makes distribution costs manageable, the chain also has a sufficient physical presence to implement a hybrid model and a global sourcing network for meat, produce and fast-moving consumer goods. Costco's customer base has above-average income and tech sophistication, is loyal and recognizes superior quality.

My take on Amazon, Wal-Mart and Costco

The eventual future of grocery business is crucial for these companies. In my view, Walmart is a nice investment if you are older or looking for yield. Despite my worries about Walmart expressed in this article, I still find this company investable. It is not going anywhere soon.

Costco is, at these stock price levels, suitable for investors with a long horizon, as it is still, I believe, a growth company.

Buying Amazon at these levels is equivalent to purchasing a lottery ticket. With its P/E ratio currently at 536, this company's stock price has long ago entered the realm of fantasy.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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