By Tristan Kitchener
Jeff Bezos, founder and CEO of Amazon, says that the reason Amazon is successful is that for the last 20 years they’ve had three big ideas that they’ve stuck with: ‘put the customer first, invent and be patient’. However, if you’re a retailer, or in fact have any business that could be touched by Amazon, another of his sayings might make sitting comfortably a thing of the past: ‘your margin is our opportunity’.
Amazon is valued at over $350 billion and is undoubtedly hurtling towards world domination across a wide range of sectors, including online marketplaces, home delivery, cloud computing, content development to name a few. So, principally, business disruption in general. Furthermore, Amazon’s appetite to improve the customer experience through upstream and downstream supply chain integration is unprecedented – as illustrated by their recent US$1.5billion airport acquisition and leasing 40 planes to guarantee on-time deliveries. This demonstrates Amazon’s determination to be a business that strives to charge customers less, and provide greater value through superior customer service.
Being customer-focused allows you to be more pioneering and Amazon’s strength as a brand is that it’s associated with being innovative and on-trend, with high levels of appeal and a fun place to shop. Amazon’s now fabled Amazon Go concept store in Seattle is looking to revolutionise grocery shopping for the benefit of the consumer by providing a simpler time-saving shopping experience; consumers just walk in, select the products they want and walk out, with the payment fully automated. The ‘staff-less’ supermarket is the equivalent of the driverless car. This stands Amazon in good stead as it looks to provide a full online grocery offer, in a market where its rivals are struggling to differentiate their brands – how much difference is there really between Coles and Woolworths? The unique challenge for Amazon will be how they will adapt their business model in Australia to consider the high-cost of labour and land, large freight distances and being an unknown to consumers in grocery retailing.
What is Amazon?
Amazon was founded in 1994 as an online bookstore that diversified into selling electronics, video and music downloading, cloud computing infrastructure and in 2018, Jeff Bezos is planning to launch suborbital human flight into space. Whilst Amazon’s online marketplace is undoubtedly the engine room of business, it’s a hugely diversified business, with a range of B2B and B2C offerings. Businesses can use the Amazon platform to sell their products across 11 global marketplaces for a 6-13% commission, they can choose to manage their own delivery or use Fulfilment By Amazon, which includes picking, packing, shipping and management of exchanges.
The marketplace model allows open-access for all consumers and businesses, with simple sleek websites and superior customer service, and generates economies of scope (lower costs through stocking more types of products) and economies of scale (lower average cost). Efficiency savings are reinvested into lower prices and a wider range, to provide further value to consumers, and thereby increase customer satisfaction. This in turn increases Amazon’s loyalty and brand strength, and ultimately enables Amazon to ‘own the customer’ and have pulling-power with suppliers.
Amazon is essentially a digitally enabled supermarket, with Amazon Prime the brand used for selling online groceries. Amazon Prime is a bundled subscription offering, which includes movie and music downloads, photo storage, access to special deals and one-day delivery on all purchases. The objective is to create consumer dependency through continual value-adding, and provide consumers with access to a huge range of products and services. This model also helps drive consumer uptake of other Amazon businesses and ultimately forces vendors to supply through Amazon, and creates a positive feedback loop.
Amazon generates and collects vast amounts of data that it can analyse to identify further opportunities. For example, if a product is selling well, Amazon will produce a lower-priced private label equivalent as an alternative to the national brand, thus giving consumers more value, and capturing sales volume and margin for Amazon. Furthermore, as momentum builds, Amazon advertises their private label products across their range of different platforms. Amazon’s perspicacity has enabled it to continually expand its private label categories, with consumer packaged goods now a focus; private label sub-brands including Mama Bear in grocery food, Amazon Elements for household and clothing products and Amazon Basics for electronics. Their private label strategy is no different to that of the major retailers, it’s just quicker with better analytics.
How attractive is Australia to Amazon?
Like Aldi, Amazon has a long-term growth agenda with no desire for profits in the short term. Back in 2001, many retail analysts were surprised when Aldi chose to enter Australia, given the large geography and small population of Australia. It was the large profit pool that attracted Aldi, with the complacent duopoly of Coles and Woolworths making some of the highest margins in the world.
Both the majors are making EBIT margins over 5%, well above the retailer global average of 3.9%, and whilst grocery industry growth has halved from 8% to less than 4%, the fact that Lidl, Marks & Spencers and David Jones are all rumoured to be developing grocery offerings in Australia, suggests the profit pool is still large. (And you can now also add Kaufland, the sister of Lidl that is owned by the same parent company, Schwarz Gruppe, which turns over $105 billion/year and may be opportunistically looking to take over the recently vacated Masters sites). By way of comparison, Amazon has sales of US$136 billion and 4% EBIT, and took six years to turn a profit.
Australia has the most metropolitan population in the world, which is attractive to retailers since they can focus on the population dense areas of Melbourne, Sydney and Brisbane. This is the hub- and-spoke expansion strategy that ALDI uses, with a single distribution centre surrounded by 60 to 80 stores. Amazon is already successful in markets that are much more competitive, so if Amazon believes the market in Australia is big enough to be worthwhile, there is no reason why they wouldn’t enter
Who will be impacted most by the entry of Amazon?
In other countries, the retailers that have suffered the most are those that share the most similar demographic to Amazon consumers. Given Amazon’s broad appeal (over 90% of consumers in the UK have shopped with Amazon), it suggests that the mainstream retailers, Coles, Woolworths and ALDI, will bear the brunt of the onslaught. However, given Amazon’s appetite for vertical integration and expansion into adjacent sectors, it suggests that the broader supply chain and related businesses could also be directly impacted, and that means everyone makes less money.
So, will Amazon Fresh succeed in Australia?
That’s the multi-billion-dollar question. Few details are known about the full grocery service model Amazon might use in Australia to deliver a fresh food offering (Amazon Fresh). Amazon is essentially an online marketplace with a sophisticated logistics network, but is largely geared to moving boxes of ambient products, and not fresh foods. Success in fresh foods, and particularly fresh produce, will be dependent upon navigating the changing seasonal growing locations across a large geography, establishing a supply chain that can cope with the temperature extremes in Australia and generating enough volume to provide the necessary economies of scale. Just like the Australian retailers, Amazon will have to domestically source most of their fresh foods due to strict quarantine restrictions. They could also focus upon just the major cities – Australia has the most metropolitan population in the world and it’s certainly working for Aldi!
The most comparable market to Australia in grocery retailing is the UK, and Amazon Fresh launched there in June last year, with 130,000 products spanning fresh fruit and vegetables, meat, seafood, baked goods and dairy produce, as well as a wide range of pet supplies, baby, health and beauty products. It’s still early days but early indications are that it will be tough for Amazon to make a dent in a mature retail market with well-established online retailers, namely Ocado and the major four retailers, Tesco, Sainsbury’s, Asda and Morrisons who all have online businesses.
Amazon could partner with an established business as they have in the UK, where Morrison’s is supplying Amazon Fresh with a range of ambient and fresh food products (and to return the favour Amazon is providing an online solution for Morrisons with ‘Amazon at Morrisons’ through Amazon Prime). Confusing, but it’s essentially collaboration for mutual benefit; Amazon Fresh for primary shops and Morrisons at Amazon for secondary shops. It would be surprising if conversations hadn’t already happened between Amazon and/or Coles and Woolworths; combining the existing sourcing and buying infrastructure of a major retailer with the online capabilities of Amazon would make an attractive proposition, and provide a swift low-cost entry solution. Coles and Woolworths would have to manage the corporate conflict, as helping Amazon grow would hurt Big W, Target and Kmart, but a partnership would allow Amazon to build scale much quicker, without the need to invest in dedicated fulfilment facilities as stores could be used for picking. And for Coles and Woolworths, it could be a case of ‘keep your friends close but your enemies closer’.
The partnership model will be important for suppliers. If Amazon go it alone, then the increased competition could benefit suppliers as there will be greater demand for their products, but a partnership with either Coles or Woolworths could mean the opposite, with even greater buying power for the majors. In the short term, Amazon is unlikely to build a large enough grocery business to trouble the main players, but Amazon certainly has the potential to become a major player in the online grocery market.
Whatever the business model, Amazon Fresh will need to make money to be a viable long-term business. In the UK, to access Amazon Fresh, consumers must firstly purchase an Amazon Prime membership for £79/year (or £7.99 month) and then also purchase the Amazon Fresh ‘add-on’ for an additional £6.99/month. Whilst Amazon Prime memberships provide a bundle of other benefits, including unlimited movie access, photo storage, music downloads, one-day delivery, it will be interesting to see if this is too expensive for consumers.
Why does Amazon Fresh charge a membership fee?
Amazon’s mantra is to charge consumers as little as possible and is happy to take a long-term view regarding profitability, so one must assume Amazon Fresh has exceptionally high operational costs and the fee is required to offset the costs. Costco also has a member’s card ($60/year), and membership revenue accounts for 75% of net profit with incredibly high renewal rates at 87%. However, Costco only has 1% market share and for Amazon to be successful it will need to grow quickly to capture scale benefits. Australia is a price-conscious market and ideally Amazon Fresh will need to reduce or eliminate the need for any type of membership fee to succeed. The only alternative, and a more likely solution, will be to bundle more value into the membership fee – as founder Jeff Bezos put it “we want Prime to be such good value, you’d be irresponsible to not be a member.” This would also provide plenty of opportunity to leverage the services provided by other Amazon businesses.
What’s the Amazon effect?
An interesting side effect of Amazon raising the bar, is that competitors are forced to innovate to stay in business and more innovation swiftly follows. Probably the most notable is an innovation from Microsoft Australia partner Lakeba called Shelfie ‘combining the latest robotic technologies with intelligent image capturing and cloud-based data analytics to improve inventory management’; in other words, making sure retail shelves are filled with the right amounts of stock all the time. Shelfie is an in-store robot with the ability to automatically travel around store aisles scanning shelves, enabling real-time stock reporting to help identify sales trends and optimise merchandise layouts. The sales opportunity for retailers is huge, not to mention the improved shopping experience for consumers.
Amazon also has plans to launch cargo spacecraft to shuttle goods, and eventually, humans, to and from the Moon by 2020. Business strategists often encourage focus on the domestic market first before considering overseas expansion. The fact that Amazon is exploring new frontiers, suggests they feel that they have planet earth sorted…. but then again, Jeff Bezos, does say ‘think big, and then think bigger’!
So, is it just a question of when?
The rational argument says Amazon should focus on brand building in emerging markets, such as India, where the opportunity is much larger. Amazon already has over 10% (about $2 billion/year) of the Australian online spend (through amazon.co.uk and amazon.com sites), so why bother with a market as small and challenging as Australia? The reason is that Amazon is about world domination and understands the benefits of first-mover advantage. They want to get in before a potential competitor such as Alibaba from China does (China is the only market that Amazon has entered and then withdrawn due to the intense competition), and they will have learnt their lesson.
The UK will be a test for Amazon. The odds are stacked against them; online is small at only 7% of the grocery market, Ocado (the main pure online retailer) took 10 years to reach 1% market share – and at a time when there was virtually no competitors. Furthermore, Tesco, the largest UK retailer, has only 3% market share, with 14% penetration, 3.8 million shoppers and an average annual spend of £876! Aside from the numbers, perhaps a bigger hurdle is that humans are fundamentally social creatures; people like to shop in physical stores, and ‘bricks and mortar’ consumer loyalty could be hard to transfer to online.
At its heart, Amazon’s operating model revolves around building scale and loyalty quickly. So, in Australia, Amazon will lead with Amazon Marketplace and go after the low hanging fruit first, and target electronics and general merchandise – watch out JB Hi-Fi and Harvey Norman. Then they will tackle the niches, and their suite of other businesses will follow, with Amazon Fresh most likely being a later arrival. It’s also worth noting that Amazon has an office in Sydney and is currently recruiting 110 roles. So it’s happening!
The strength of the Amazon brand makes it a disruptive force in any sector and market it enters, and the online grocery market in Australia is likely to be no different. Amazon’s track record and deep pockets suggest that it unquestionably has the capabilities to succeed. It’s probably just a question of when.
Am I certain? Certainly not.
This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.