Vertical Farming is Amazon’s Next Bold Step
Associate Consultant at Bain & Company | Los Angeles | Harvey Mudd ’17 | lakshayakula.com
Nov 4, 2017
Vertical Farming is Amazon’s Next Bold Step
An artist’s (i.e. my) impression
Vertical farming complements Amazon’s business model, the Whole Foods acquisition, Jeff Bezos’s ambitions, and Amazon’s capabilities — it’s only a matter of time until Amazon pours money into vertical farming.
From data centers to organic kale
Amazon is well known for investing in bold, new technologies and businesses. Here’s a list of some of their noteworthy moves:
- In 1997, Amazon set the stage for their logistics network by building theirfirst two fulfillment centers in Seattle and Delaware
- In 2006, Amazon launched Amazon Web Services (AWS); today, as Google is to search, AWS is to the cloud
- Later in 2006, Amazon became a logistics provider by offering Fulfillment by Amazon
- In August 2007, Amazon launched AmazonFresh, starting their ongoing journey to become a grocery provider
- A couple months later 2007, Amazon entered hardware and brought e-readers to the masses by introducing the Kindle
- In 2012, Amazon made a significant step in automated warehouses by acquiring Kiva Systems for $775M
- In 2014, Amazon brought the Amazon ecosystem into the living room, with the home assistant Alexa (and the smart speaker it runs on, Echo)
- This year, Amazon acquired Whole Foods for a whopping $13.7B
At first, it seems like there’s very little in common among Amazon’s ventures. There’s no connection between data centers and organic kale. But there’s method to the madness. A simple business model underlies Amazon’s success.
The Amazon model
For a venture to fit into Amazon’s business model (i.e. the Amazon model), it only needs to have three characteristics:
- High fixed costs with huge economies of scale
- Have Amazon as the first and best customer
- Can be modularized, to offer infrastructural components to third-parties
Here’s how it works. Amazon invests in a new venture with high fixed costs and economies of scale. It can justify their initial investment and provide scale because Amazon’s existing businesses will be a customer of the new venture. The services are modularized to third-parties, increasing scale and decreasing costs, making the new services even more attractive, further increasing scale and feeding a virtuous and unrelenting cycle.
Here’s a diagram of the model. Note that growth is central to the model.
Supposedly drawn by Bezos on a napkin; also resembles a fried egg (Source: Stratechery)
AWS is the best example of the Amazon model at work. AWS is distant from Amazon’s core e-commerce business. For one, the former is B2B whereas the latter is consumer-facing. With conventional goggles, it’s difficult to see why Amazon launched AWS or why AWS has become so wildly successful. With the lens of the Amazon model, we can understand the beauty of AWS.
Let’s see how AWS fits those three characteristics from earlier:
- Cloud services is an industry defined by high fixed costs with huge economies of scale. It’s expensive to build the infrastructure and buy servers at first, but once that’s done, adding the marginal customer is practically free.
- Amazon.com was the first and best customer of AWS. Amazon.com benefits from free web services and AWS gets a jump-start with the initial scale.
- AWS may be the most modularized service in existence — I counted 124 products across 22 categories. It’s so modularized that any company can use its products, from fast-growing startups to multibillion dollar companies to the CIA.
To summarize, AWS started with Amazon.com as a customer, justifying the initial investment in AWS and providing initial scale. It was then modularized for 3rd parties, increasing scale, which AWS used to invest in more capabilities and reach more businesses, further increasing scale and decreasing costs. Today, AWS is in a league of its own in terms of market share and leadership.
AWS’s market share, execution and vision are unmatched by competitors (Sources: Synergy Research Group & Gartner)
The Amazon model is precisely why AWS is so successful. If you want to learn more about the Amazon model, I’d recommend reading Ben Thompson’s blogStratechery (particularly this one).
Making sense of Whole Foods
I promise to get to vertical farming soon, but first, we need to understand why Amazon acquired Whole Foods. The most common explanations are: 1. AmazonFresh will benefit from selling Whole Foods products 2. Amazon can use Whole Food’s urban, retail space, and 3. Amazon Prime can synergize with Whole Foods’s loyal and affluent customer base. These explanations are reasonable but they misunderstand Amazon’s strategy.
Ben Thompson wrote an excellent explanation for how the Whole Foods acquisition ties into Amazon’s business model. In it, he details how the acquisition is effectively Amazon purchasing a customer to provide scale for their grocery efforts.
Amazon’s food delivery service, AmazonFresh has floundered for the past decade. It hasn’t expanded beyond a few urban centers, nor has it given traditional grocery stores a run for their money. The problem is that AmazonFresh fails criteria #2 of the Amazon model — have Amazon as the first and best customer. As a result, AmazonFresh has never built the scale to become competitive.
With the Whole Foods acquisition, AmazonFresh is re-positioning itself as “Amazon Grocery Services” (AGS). The parallelism with AWS is intentional. AGS’s first, large customer is Whole Foods. With this initial scale, AGS will be competitive and Amazon can justify investing in AGS. AGS will modularize and offer services to other grocery stores, restaurants and customers. With increased scale, costs will go down and AGS will become more competitive.
But Amazon isn’t about being competitive. Amazon is about being dominant. In order for AGS to be dominant, AGS needs a technological advantage over its competitors. This key differentiating factor will be vertical farming.
Vertical Farming’s perfect fit for Amazon
Vertical farming comes in many flavors and forms. For Amazon, I envision warehouses near population centers producing greens and herbs. These warehouses will be highly controlled environments, optimized to produce maximum yields.
Currently, vertical farms like these not economical because of high energy costs for artificial lighting. I’m expecting Amazon to be the one to solve this problem and take vertical farming off the ground. And in case Amazon is looking for a name, I have an idea — “Amazon Vertical Farming” (AVF).
Why boils down to three reasons:
- AVF synergizes well with AGS
Both services cater to urban locales and will scale in lockstep. It’s a perfect union. AVF gives AGS a competitive advantage and improves AGS’s scale. Whole Foods will be AVF’s first and best customer. AVF can be modularized by using AGS to sell produce to other grocery stores, households and restaurants. AVF may not be as perfect of a fit for the Amazon model as AWS, but it’s still a great fit. - Amazon has the know-how for vertical farming
To execute successfully, vertical farming will require developments on both the technological and supply-chain fronts. Amazon is the only player with both. Amazon Robotics can automate much of vertical farming and Amazon Logistics can deliver the product to customers. - CEO and Founder Jeff Bezos wants to
To be honest, this is probably the most important reason of the three. Bezos has personally invested in the vertical farming startup Plenty twice: once in a Series A round in 2016, and again in a Series B round in July 2017 just after the Whole Foods acquisition. Clearly Bezos is a believer in vertical farming.
He also has a track record for taking risks. He launched the experimental drone-delivery services Prime Air and created the spaceflight company Blue Origin. Taking a risk with vertical farming wouldn’t be out of character for him.
Most importantly, what more could the third-richest person on Earth want to do than solve one of the biggest problems facing the planet? Agricultural pollution and food waste are pressing issues. With vertical farming, Bezos can make a significant step forward for humanity in addressing these problems.
What’s next?
How Amazon will enter vertical farming is up to debate. It’s possible that Amazon will enter a partnership with Plenty, the vertical farming start-up Bezos has already invested in. I personally believe Amazon will be much more ambitious and acquire Plenty. It’s also possible that Amazon will develop vertical farming capabilities independently, but I find that unlikely given Bezos’s existing investment in Plenty.
Google searching amazon vertical farming as of 09/25/2017, for future reference
Regardless of how Amazon enters vertical farming, one thing is certain. At the time of writing, Google searching “amazon vertical farming” brings up vertical farming products sold on Amazon, including this book and this indoor vertical garden. The 7th link down is the first one to discuss Bezos’s investment in Plenty. With certainty, I can promise that those search results will change significantly in just the next year or so.
Thanks to Rohan Nagpal for the conversations that led to this piece and reviewing my drafts. This really was a collaborative effort. Thanks, bud.