Constellation Insights

In a stunner of a move, Amazon will pay $13.7 billion to acquire upscale supermarket chain Whole Foods Market. It's a move that will significantly change Amazon as a company and has implications for the future of retail, omnichannel commerce and supply chain practices. 

Once the deal closes in the second half of this year, it will be business as usual, with Whole Foods CEO John Mackey remaining in that role, and the chain's stores retaining their branding and supplier relations, according to a joint statement.

The companies' announcement emphasized Whole Foods' track record as a purveyor of healthy, fresh foods—67 percent of its business comes from fresh products—and with the deal Amazon gets a major jumpstart into the grocery business, which is estimated at nearly $700 billion in the U.S. alone.

Whole Foods logged about $16 billion in revenue last year, a small piece of the overall pie but much, much more than what Amazon has generated to date with its home-delivery grocery service. Whole Foods has been experimenting with grocery delivery through a partnership with Instacart, but that pact is undoubtedly doomed in light of this week's announcement. 

Amazon was reportedly planning to open as many as 2,000 Go stores, which use technology to eliminate the need for checkout lines and cashiers. But only a test store open to Amazon employees exists, with an announced 2017 launch yet to occur.

It's not clear whether Amazon will proceed with the smaller-store concept now, and has instead decided to buy an established grocery store player in Whole Foods, leveraging its brand, mitigating risk, and focusing on growing the delivery component.

Meanwhile, Amazon's vaunted supply chain expertise should be a boon for Whole Foods, helping it drive down costs than in turn could be passed on in lower prices. In turn, Whole Foods has something to teach Amazon about the perishable foods business.

Amazon can bring a vast amount of bleeding-edge technology to bear on Whole Foods' operations as well, but the grocer has already been working to upgrade its technology. It began partnering with Infor in 2015 to build a new cloud-based retail management ERP system, which will be used to consolidate a tangle of homegrown applications. (As it happens, Infor uses Amazon Web Services for its cloud infrastructure.) 

For one thing, Amazon has already built out an extensive network of distribution centers, but the addition of Whole Foods' more than 460 locations in the U.S., Canada and the UK instantly creates another concentric ring of distribution points, ones typically located in highly populated areas. 

No, Whole Foods won't be changing its name to Whole Warehouse. But it's easy to see how Whole Foods stores could include a countertop where shoppers could pick up Amazon packages, as well as make returns. Regarding the latter: Given storage and other logistical considerations, it's unlikely that these locations would handle returns on bulky items such as televisions or appliances. 

But clothing, on the other hand, would be an ideal candidate. Amazon is already poised to become the single largest U.S. clothing and accessory seller, with nearly $30 billion in clothing sales projected for this year. Amazon has also recently shifted toward higher-end apparel, a move that aligns well with the economic profile of many Whole Foods' shoppers.

While return rates for online clothing purchases will likely remain eye-watering, if Amazon customers know they can return clothes to a local store—while getting their food shopping done—they may be inclined to make more clothing purchases overall through Amazon.

Another possibility would see small, Amazon-branded retail shopping sections within Whole Foods' stores. The emphasis here could be on a frequently changing selection of high-margin, impulse buy items catering to the sensibilities of Whole Foods shoppers. 

Skeptics should note that many supermarket chains already house non-grocery related businesses, such as bank branches. Whole Foods itself has been steadily adding both quick-stop and full-service restaurants to its stores. It also stocks some housewares and home goods. 

Still, Whole Foods will still be primarily a grocery store after the deal closes, and Amazon's goal will be to grow its home-delivery business. Online grocery sales have been touted as the next big thing for well over 15 years, but it simply hasn't happened, as Amazon itself knows all too well. What's going to be different this time?

One challenge Amazon and other online grocery sellers have faced is the simple fact that consumers like to pick out their own perishables, particularly fruits, vegetables and meats. Delivery services provide convenience, but people do the picking for you. This will remain an inhibitor with Whole Foods customers, for whom part of the experience has always been the vast arrays of high-quality meat and produce found in the stores. 

Second, consumers don't want to pay more money for food purchased online. Rather, they want to pay less, just as they perceive to be the case with other online purchases. It costs money to pay workers to pick orders, and delivery drivers to make the deliveries, and the grocery industry's notoriously narrow profit margins don't care. 

Amazon has shown time and again it is willing to lose money in the name of gaining market share. Whether this will be the case with Whole Foods remains to be seen. Certainly, technological innovations could smooth the transition—automated checkouts like those found in the Go store could free up workers to handle delivery orders—but it's nonethless a vexing challenge that lies ahead.

This post was written on the same day Amazon and Whole Foods announced the deal. There will be much more to chew on in the weeks and months ahead, but one thing is for sure: Amazon has made yet another industry-changing move.

24/7 Access to Constellation Insights
Subscribe today for unrestricted access to expert analyst views on breaking news.