‘A defense strategy’: How Amazon’s slow growth in grocery sparked industrywide competition

But Amazon has moved uncharacteristically slow in the category, with its attention on grocery split between its longer-standing online programs, Whole Foods and Amazon Go, its cashier-less convenience store. While physical retail sales ballooned at the beginning of the year to $4.3 billion, thanks to the addition of Whole Foods’ in-store revenue, that figure has remained flat through the last three quarters, showing that early attempts to lure Prime members into Whole Foods stores with a 10-percent-off discount and Prime Day deals haven’t stuck.

“Knowing how fast Amazon tends to move, it is surprising to see the lack of progress here,” said Cooper Smith, director of Amazon research and strategy at Gartner. “What it’s done is give legacy grocers and retailers plenty of time to establish a defense strategy against Amazon and build a moat around their businesses.”

While Amazon has been positioned as a frontrunner for grocery’s online business, digital sales only accounted for 1.6 percent of the $640 billion in overall grocery sales last year, according to data from IGD, a retail analytics firm specializing in food and grocery insights. IGD expects that to increase to just 3.5 percent by 2023. Essentially, traditional grocery retailers aren’t facing a shift-to-online tidal wave that could leave them shuttering physical stores. For Amazon, that means the tactics it’s used to dominate in other categories may fall short in grocery, putting the company on the brink of a much larger overall transition.

Who’s really winning?
For a while, grocery felt like a now-familiar narrative in the Amazon age: Amazon enters a sleepy category and eats up online sales, then quickly blows out investments demonstrating its commitment to taking over. At the beginning of the year, market analytics firm One Click Retail released a report that showed Amazon taking up to 70 percent of digital sales in some grocery categories. But in October, Deutsche Bank shrunk Amazon’s share down to 12.5 percent, tabbing Amazon’s online grocery business at $2 billion. It’s still ahead of other industry players — Walmart accounted for $1.8 billion and an 11 percent market share; while Kroger had 6.4 percent — but its dominance is much more subdued. And with online grocery such a nascent category, plenty of the market is left for grabs.

“It’s somewhat controversial where Amazon actually is in the pecking order of digital grocery,” said Jason Goldberg, svp of content and commerce at SapientRazorfish. “Even if Amazon has used Whole Foods to its full ability, that’s a tiny portion of the market. And they haven’t done so.”

Confusion can be attributed, said Goldberg, to loose definitions of what “grocery” entails. If you count diapers and paper towels, Amazon’s positioning looks a lot better. But packaged and fresh foods tell a different story.

For Amazon customers, the grocery category is sprawled and hard to navigate between Fresh, Prime Pantry, Whole Foods and Prime Now, the on-demand delivery service that serves to shorten the delivery window on timely orders, like fresh groceries. Not to mention, Amazon’s core retail business sells packaged foods from both first- and third-party sellers, outside of all of these initiatives. According to Gartner data, the vast majority of grocery sellers on Amazon sell first-party so that they can participate in programs like Fresh and Pantry. But in Amazon’s most recent earnings report, revenue fell short of expectations at $56.6 billion, showing signs that it was failing to stimulate more customer spending in categories that aren’t yet saturated, like grocery.

“Amazon’s grocery business has been extremely fragmented, which is frustrating from a customer perspective,” said Smith. “They need to merge and consolidate this business because right now, it’s far too confusing.”

Already, Prime Now has been rolled into the Whole Foods business to make free two-hour delivery available from Whole Foods stores in 60 cities, while curbside pickup for online orders is now available at 22 cities, a number Amazon just expanded on this week when it added eight new markets. But as it works to bring Whole Foods up to speed, other retailers have been catching up and capitalizing on much bigger store networks to meet customers in between online and offline shopping.

The last mile
The grocery industry is complex, made up of a large network of regional players that leave little room for national players to win overwhelming market share. Walmart controls the biggest portion of the market, and with nearly 4,000 physical locations, it only accounts for 20 percent of total sales, according to a study commissioned by the organization Oxfam America. Combined with Whole Foods, Amazon accounts for 2.5 percent.

It’s not an easily dominated category, unlike the department store industry, which has fallen prey to Amazon thanks to its large, slow-to-adapt national players. And in acquiring Whole Foods, Amazon lit a fire under players that had already been eyeing new innovations, particularly when it came to figuring out better delivery capabilities to serve changing customer behavior.

“Amazon acquiring Whole Foods sent a shudder through the industry and was a major turning point where grocery chains had to say, ‘Here’s a major tech company coming into our space,’” said Sylvain Perrier, CEO of Mercatus Technologies, a platform that helps grocers facilitate online-offline orders. “It shook people to think beyond the status quo. People were able to convince execs, if they weren’t on board already, the time to innovate or die is here.”

Increasingly, stores have realized that their advantage lies in tying online orders to physical stores, and companies like Walmart and Kroger proceeded to pour billions of dollars in expanding services like free same day ship-from-store delivery and curbside pickup. The hybrid lets customers place big orders online, then go to the store and stop at the butcher or produce section to select more perishable goods themselves.

Andy Ellwood, the co-founder and president of Basket, a company that crowdsources pricing information across grocery competitors, has been watching how customers make decisions based on different values when going to buy groceries since launching his app in 2013. He said that customers tend to bounce between valuing price over convenience, and added that online shopping remains “an option, not the option.”

“The death of offline grocery was greatly exaggerated,” said Ellwood. “The hybrid of offline-online still requires offline. As much as can be poured into logistics of the last mile, what wins is the physical store presence.”

As two industry giants, Kroger and Walmart can afford to pump up their businesses with expensive last-mile delivery capabilities, like free same-day shipping and personal shopper order fulfillment. For everyone else, third-party partners have swooped in to assist, like Peapod and Instacart. Instacart, a former Whole Foods partner now valued at $7.6 billion, announced a major expansion this week, rolling out a pickup grocery service to all of its retail partners nationwide. Now, customers of the 15,000 grocery stores that work with Instacart can use the service to buy items online, then pick them up the same day.

‘They’re not throwing in the towel’
What Amazon is lacking in physical store infrastructure, it makes up for by being Amazon, essentially.

“I would be shocked if Amazon was committed to anything less than fully winning,” said Goldberg. “They have formidable competition in existing players, which is somewhat new, but they’re not even close to throwing in the towel.”

Amazon doesn’t comment on its future roadmap. But all of the regional players in the grocery industry could leave more acquisitions on the table as a keep-up-or-die shakeout commences. Amazon could be in prime position to buy up more chains that weaken under category stress. And it’s likely that Whole Foods is going to get an even heavier Amazon treatment in the coming year. Perrier predicts that eventually, the Whole Foods brand will disappear altogether in favor of Amazon branding. Smith expects Amazon Go cashier-less checkout technology will eventually be fused into those stores. And more fresh food fulfillment centers being built aren’t out of the question.

Grocery isn’t going down without a fight. But if the Whole Foods acquisition was the wake-up call, competition is just starting to heat up.

“Expect to see a long stream of acquisitions next year as retailers and tech partners try to protect themselves,” said Perrier. “Retailers will reach out and acquire expertise. Walmart will go on an acquisition streak to prevent Amazon from buying more market share. Amazon has changed the game, and it comes down to competing in a handful of key areas: inventory fulfillment, delivery, logistics and customer personalization.”