Amazon Says... Let's Get Physical

| About: Amazon.com, Inc. (AMZN)

Summary

Amazon is getting ready for launch of physical stores.

Where it missed it with online groceries.

The company goal would require over $30 billion in grocery sales by 2025.

As many as 2,000 stores may be opened.

Source: Amazon

Not that long ago it would have been difficult to believe e-commerce giant Amazon.com (NASDAQ:AMZN) would even consider a physical presence in the retail market, and yet, it has already opened a couple of trial stores and is getting ready to roll out hundreds of them in the near future.

There are a couple of things to consider when taking in the potential impact of this initiative. The first is, the company will introduce items in the stores that people prefer to buy in person. Second, it'll include a lot of grocery items that the company failed to gain much traction with in regard to its online grocery business.

That combination should provide a stronger revenue and earnings performance than would otherwise have been generated online. Over time, this will be a strong growth catalyst, using the same items it offered online, with the obvious caveat it'll initially spend more to get the project going.

Amazon has focused on the ease of shopping at these Amazon Go stores, rather than the specific products offered.

Margins could be unprecedented

Amazon consultant Brittain Ladd has provided some insight concerning the range of margins in the stores. He said:

"Based on my analysis, I was able to achieve margins of between 22 percent to 40 percent depending on the size and configuration of the multi-format store design and merchandising assortment. Such margins are unheard of even in the best-managed grocery retailers operating today."

If Amazon is able to achieve that, it will be like developing an entirely new business and the accompanying revenue and earnings stream, basically using the same products it already sells.

Also, the low cost and ability to quickly build the stores, which will reportedly be closer to 1,800 square feet, rather than the larger sizes some media outlets have reported.

Why Amazon failed in the past, and why Amazon Go should do well

The major reason Amazon failed in the past is it, along with numerous others, thought the convenience of online grocery shopping would be received positively by consumers. The reality is, many people actually enjoy going out to grocery shop, which is why the overall sector has performed so dismally.

Now that it has learned and knows the most desirable grocery items consumers want, it's ready to leave beta and go prime time.

Amazon has said it has a goal of being among the top 5 grocery retailers by 2025, according to Bloomberg, which would mean the company would have to generate over $30 billion in sales by that time. Now it sells a respectable but relatively small $8.7 billion in groceries. That's small because the total U.S. grocery market is valued at $800 billion.

The company may open up as many as 2,000 Amazon Go stores, according to the Wall Street Journal. If it wants to sell more than $30 billion by 2025, I think that may be understating the number of stores it will build.

Conclusion

Why make so much of this? In the U.S., while Amazon still has a lot of upside potential, as e-commerce only accounts for about 10 percent of all retail sales, it still needs another revenue stream to ensure future growth. To use a lot of its existing product line and expertise to present it in a different format is a good move by the company. I think it has a winner here, with the major question for me being how much automation should it have and how much human contact.

Since so many retail outlets already have limited customer service, it's unlikely that'll be a big factor for Amazon - especially since the stores are going to be so small. It doesn't take many workers in a smaller retail environment.

If Amazon is able to sell groceries on the low-side margin of 22 percent, that would be extraordinary. If it's able to widen that, this could be a major revenue and earnings stream basically designed out of nothing. It's only a matter of fine-tuning the process in order to make the experience a positive one for consumers, who would rebel if the technology fails and frustrations multiply.

For that reason, I would think in the beginning there will be at least a couple of employees on hand that know how to deal with all the variables in order to mitigate all that. How Amazon Go performs from the public launch will determine how rapidly it'll be accepted.

With the prior failure to provide the highest-quality food with its online grocery business, it needs to immediately prove this time around it really is different. If it does that, Amazon will have another reason for investors to take or increase their positions in the company.

Disclosure: I/we 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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