March 21, 2019

Wharton's Barbara Kahn and Columbia's Mark Cohen analyze Amazon's plans to open supermarkets in major U.S. cities.

Amazon’s plans to launch physical grocery stores this year is just the latest affirmation that, ironically, bricks-and-mortar stores are crucial to the e-commerce giant’s future growth. Amazon may launch as many as 2,000 supermarkets in major U.S. cities, according to a recent report in The Wall Street Journal. It will be Amazon’s sixth physical retail format after Whole Foods, Amazon Books, Amazon Go, Amazon 4-Star and Amazon Pop-Up.

Amazon’s plans are likely to rattle major grocery purveyors such as Kroger’s and Walmart, whose shares fell on the news. But the expectation is that Amazon will introduce a different business model — one that merges bricks-and-mortar and online experiences, then powering it with data analytics, according to experts at Wharton and Columbia University who spoke about Amazon’s grocery-store strategy on the Knowledge@Wharton radio show on SiriusXM. “It was a natural next step,” said Wharton marketing professor Barbara Kahn. Opening supermarkets makes sense for Amazon because its business model is to offer low prices and convenience, which is what shoppers look for when getting groceries. “If you look at their bookstores or Amazon Go (fully automated convenience stores), they’re fine stores, but they’re not beautiful stores. They’re the kind of stores where you can get what you want at a cheap price, fast and convenient,” she said.

Amazon’s expansion of its grocery business — it already has Prime Pantry, AmazonFresh and Whole Foods — also lets it collect consumer data more frequently since people shop for food regularly and prefer to do it in person. “Their game is data and they need to have frequency. What’s really attractive about grocery is not really the margin; it’s the traffic,” Kahn said. “When you go into an Amazon store, you have to log in with your app and everything you do in that store is then connected with everything online.”

The Journal said Amazon’s supermarkets will take up about 35,000 square feet compared to 60,000 square feet for a typical grocery. Talks reportedly are underway to open stores in Seattle, Philadelphia, San Francisco, Chicago and Washington, D.C.

It’s About Data

Whatever retail store format Amazon uses, it “would be built upon this tremendous capacity they have to gather, analyze, understand and use what customers are saying to them every day,” said Mark Cohen, director of retail studies at Columbia University who had been CEO of Sears Canada. “Amazon is proof-positive of the value of big data and the way in which you collect it and the way in which you examine it and use it.”

Cohen cited the smart use of data by 7-Eleven, the convenience store chain. “7-Eleven has enterprise-wide systems that enable it to manipulate, modify or not modify its assortments to be extremely relevant and also extremely efficient so that not only is the right brand on the right shelf at the right depth, but it’s in a place in the store where customers expect to find it.”

Amazon’s opening of physical grocery stores also could solve some hurdles to growth. “Amazon has a fundamental barrier to its organic growth, and that is that there are may be millions of customers who can’t participate in e-commerce either outright or who find it inconvenient,” said Cohen. “That’s largely because they don’t have a place a package can be delivered because no one’s home and they’re not comfortable or in any way or willing to have something left on a doorstep.”

Physical locations are helpful also for folks who cannot buy online because they don’t have or cannot get credit cards — or don’t want to use them. “Having a network of locally convenient places with which to interact with those customers like an Amazon grocery convenience store that will accept cash would give them access to an enormous number of customers who very well might want to do business with Amazon but who can’t at the moment.”

Testing Bricks-and-Mortar

Amazon’s supermarket plans follow other forays into physical stores, the biggest of which thus far was its June 2017 purchase of Whole Foods for $13.7 billion. It gave Amazon nearly 470 stores, including about 20 in Canada and in the U.K. Six months ago, the company launched Amazon 4-star stores that carry the most popular products from its online store, including consumer electronics, devices, toys, books and home items.

“What’s really attractive about grocery is not really the margin; it’s the traffic.”–Barbara Kahn

In January 2018, it opened Amazon Go convenience stores where consumers take what items they want and leave without seeing a cashier or checkout counter. Sensors track their purchases, which are automatically charged to their Amazon accounts. There are now 10 Amazon Go stores with more to open soon. In addition, the company has opened 17 Amazon Books locations. Amazon also has Pop-Up stores in malls, Whole Foods and Kohl’s, but it is closing all 87 of them because the format didn’t work out.

As for its coming supermarkets, Amazon could redesign the traditional grocery format. Typically, staples like milk purposely are placed in the back so shoppers will spend more time in the store. Kahn said Amazon CEO Jeff Bezos could have a different design in mind. He could say, “Let us design the store so you can find what you want as fast as you need to find it and get in and out of there,” she said. “I bet once they start working on it and use their data, they will change things that make sense from the customer perspective. So that’s going to be pretty cool to see.”

The Journal said Amazon’s supermarket concept strongly resembles ideas from a 2013 report by former Deloitte consultant Brittain Ladd, who now works for AmazonFresh. That report sees Amazon’s supermarkets combining its discounting strategy with online capabilities, adding drive-through grocery pick-up and placing Amazon Lockers inside. The goal is to create “an ecosystem of channels centered on food and groceries capable of meeting the needs of all customers through all available channels,” he wrote.

As for concerns that Amazon is entering a low-margin business, Cohen said it doesn’t have to be problematic. “They view that as an opportunity in many cases,” he said. “At the end of the day, I think this is [about] creating more and more of an efficient connection to customers, especially those who they’re not doing business with, who would like to do business with them.”

Dynamic Pricing

Kahn said one of Amazon’s dilemmas in selling groceries is how to manage the costly effort of delivering to each home and business, the so-called ‘last mile.’ Amazon has to deliver because until it purchased Whole Foods, it didn’t have a lot of stores where people can shop, unlike traditional supermarkets. Walmart got into the grocery business and handled the industry’s thin margins by focusing on “operational excellence” to lower its costs. “They are a low-cost supply chain master,” she said.

“Amazon is proof-positive of the value of big data.”–Mark Cohen

Amazon’s priority is customer convenience. But deliveries can be quite costly because they’re inefficient, Kahn said. Therefore, opening more physical grocery stores could work so there will be more places for customers to pick up their orders. “They need it because their model is so different from a typical operationally-excellent grocery business,” Kahn added.

Moreover, Amazon will find it tough to convince competing bricks-and-mortar retailers to let it open one of its Lockers in their stores. Amazon has been “aggressive in trying to place those lockers throughout the realm. Many stores just don’t have room for them and some don’t really want Amazon delivering through a locker [the same products] they’re trying to sell,” Cohen said. “Amazon is not likely to convince Target to install Amazon Lockers, unless some incredible combination occurs.”

By opening its own stores, Amazon also gets control over pricing and margins. Kahn pointed out that it already uses “dynamic” pricing. At Amazon 4-star stores, prices are in digital form and match the ones on its website. However, the prices “can change as things happen,” she said.

Similarly, at Amazon Books, no prices are displayed. Instead, customers have to open up the Amazon app to find how much the books cost. This way, Amazon could play with the pricing too, perhaps setting different prices for Prime and non-Prime members. “In both of those ways — with ‘price’ and ‘place’ — Amazon is redefining the model,” Kahn said.