Why Coles and Woolworths should worry about Amazon

Alex Pollak
29 June 2016
AFR

The biggest thing on the radar of Woolworths and Coles isn’t Aldi, it’s Amazon. Richard Goyder, Wesfarmers chief executive said in his address to the Retailers’ Leaders forum in March: “Amazon… will eat all our breakfasts, lunches and dinners.”
But why should they be scared of Amazon?
Increasingly, the success of the really big platforms and the slow growth of the remainder boils down to logistics and the ability of Amazon (or Chinese giant Alibaba, or Latin America’s Mercado Libre) to get its product – any product – to the customer within 48 hours.
These companies have spent billions of dollars building distribution and logistics capability over two decades.
Distribution centres
Amazon started by selling books and music 20 years ago, but quickly realised that margins were contracting and growth was slowing. To ensure relevance, it realised that it needed to be across a greater proportion of purchasers’ choices. So it began investing heavily – about $US20 billion ($27 billion) – in big, capital-intensive distribution centres, placed strategically near population hot-spots in the US, UK, Europe and even China.
At first this was viewed as a costly millstone around its neck. But this was in the early days of the internet.
Since then, companies with last-mile logistics such as Amazon have grown faster than those that don’t, such as eBay.
Amazon has since realised the missing piece in the retail value chain is the ability to source fresh produce and deliver it within a few hours. Amazon recently completed a deal in the UK to deliver fresh produce sourced from UK retailer Morrisons and dispatched by Amazon Pantry, a part of Amazon Prime.
Amazon is using the push into fresh food in tandem with its Prime membership product. It has about 54 million Prime members, who pay $US99 a year for free delivery, with a turnaround of less than one day. That’s $US5.34 billion a year in Prime memberships.
Below zero margin

Prime allows the e-commerce business to run at zero or below zero margin, while still growing customers and sales and profitability overall. From the customer’s perspective, once the $US99 fee is paid, it makes sense to push as much retail as possible through this channel because the deal gets better the more it’s used.
Previously, shoppers were compelled to go to the shopping centre to buy their fresh food and filled the rest of the grocery list at the same time. Amazon Fresh negates this and in the process marginalises the big retailers with their heavy fixed costs in property. In doing this, value is transferred from mall owner and supermarket chain to the Amazon customer and shareholder.
The importance of the UK deal is that Amazon is working on the theory that if this can work quickly and cheaply enough it can pick up the entire grocery shop. The rest of retail will then follow.
E-commerce is inexorably taking over more of the US retail sector and Amazon is taking 50 per cent of that e-commerce growth. That’s why Coles and Woolworths executives and the entire industry should be watching Amazon’s move into fresh produce so closely.
Alex Pollak is founder and chief executive of fund manager Loftus Peak.
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