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Why Amazon Whole Foods' launch gets a B+

  • The Amazon Whole Foods deal closed on Monday, August 28th, marked by price discounts on multiple products.
  • Amazon announced a four-pronged strategy for making the merger work including benefits for Prime members.
  • Here's how I think those strategies will pan for the companies and consumers out in the long run.

As Amazon geared up to close its acquisition of Whole Foods last Thursday, the company said it would focus on four areas going forward: (1) A price decrease on a set of items from organic responsibly farmed salmon and tilapia to organic butter; (2) A switch to Amazon Prime as Whole Foods' customer rewards program; (3) The availability of Whole Foods' healthy and high-quality private label products through Amazon's channels; and (4) The introduction of Amazon Lockers in select stores, so that customers can pick up Amazon.com ordered items while shopping their local Whole Foods, and even return Amazon products.

Here's a detailed look at each one of these goals and how they will help or hurt consolidation.

  1. There will be two segments of shoppers at Whole Foods' in the short run: the old faithful and the new switchers drawn in by the price cuts on items presumably most likely to attract them. For the old faithful, the new model will no longer be 'Whole Paycheck,' as the tired old cliché went, but a welcome respite from high prices. Will they buy more, as our old demand curve would suggest? Perhaps, but likely not so much. The net result with the old faithful will be a loss of revenue (and margin), even if the volume of shopping goes up. How about the new switchers? Will they be enough to offset the revenue drop? Even without specific numbers, it seems likely there will be more than enough, at least in the short run because of the price drops. These "new switchers'" sales numbers should be monitored to get an early warning whether these are good strategies.

    The other side of this question is margins. Will Amazon's supply chain expertise and footprint help reduce the costs enough to keep the margins at Whole Foods levels? No, because Whole Foods has very healthy margins. But they certainly will be higher than Amazon's customary margins. Indeed, Amazon's margins will improve, but perhaps not to a great extent as Whole Foods constitutes a relatively small part of Amazon overall sales. (For 2016, Amazon's was $136 billion, while Whole Foods was $15.4 billion.) Whole Foods margins will be lower than before, but that will still be higher than Amazon's margins; for that reason, the new entity -Amazon plus Whole Foods-will have a higher margin than Amazon did before, although only by a small amount.

  2. The company's move to establish Amazon Prime as Whole Foods customer rewards program is a simple way of adding more members, even though half of all Whole Foods customers are already Amazon Prime members. The "new switchers" to Whole Foods are likely to be the target of this strategy, especially as Amazon recalculates product prices to attract price-sensitive shoppers. Adding Prime rewards should generate a good volume of new switchers formerly held at bay by high prices. As long as they are drawn in by lower prices, and as long as Whole Foods keeps its new margins healthy, although not as high before, these shoppers can be profitable. Specifically, if Prime rewards and perks are managed well, the switchers will provide profitable growth for now. What remains to be seen is whether they will stay after the novelty of an affordable Whole Foods shopping trip wears off. Quite likely, Whole Foods will be an occasional trip for them, spurred on by timely Prime rewards, rather than how the old faithful shop at Whole Foods.

  3. Making Whole Foods' health and high-quality private label products available online will be a net benefit because it makes these products accessible to more customers than are in the orbit of Whole Foods' 460 stores. Yes, some in-store sales will suffer if the prices are different, but overall, these brands will see an increase in sales. After all, according to estimates only 34 percent of U.S. households live within 5 miles of a Whole Foods store; a good number of consumers in the other two-thirds could be interested in purchasing Whole Food's private label products.

  4. Amazon Lockers? What were they thinking? Perhaps there are savings to be had by using Amazon's logistical prowess to ship packages internally. But what's the advantage for the consumer? Most would rather have their Amazon order delivered to their doorstep than making a trip to Whole Foods. Shipping is free either way. At best, I'd give this idea a half-star, even though some retail experts are quite upbeat about this feature because of the cross-channel opportunities: Use lockers to pick up and return Amazon orders and Whole Foods for produce. On the delivery to doorstep versus my local Whole Foods, there should be no advantage, and if any, it should favor the doorstep (of course, when videos of delivery men tossing packages at the doorstep go viral there will be a temporary rise in the use of the Amazon Lockers).

The bigger question is whether Amazon will gain from having physical locations. Although Amazon has been toying with physical locations here and there, it is not a major move. Will Whole Foods locations provide an instant physical presence to push Amazon products beyond food? That would be a bad idea, as the Amazon brand is so strongly identified with a screen, and Whole Foods with a store. There is no advantage to turning Whole Foods into an Amazon outlet. Unless the new switchers come in droves and change the very nature of Whole Foods.

So, Amazon is playing the Whole Foods strategy well: Lowering prices to draw in some switchers while not off-putting the old faithful; possibly using the Prime rewards to keep the price conscious switchers coming back, although details have not been provided; and, spreading the reach of the Whole Foods brands to the two-thirds of the population that doesn't live within five miles of a Whole Foods. The Amazon Lockers idea will be a novelty, used a lot in the beginning, but quickly to fade. With three good ideas and one iffy one, this merger is off to a good start in the marketplace; other dangers, like culture mismatch between the two companies, and competitive counter moves still loom large. Overall I'll give the launch a B+.

Commentary by Joseph Cherian, assistant chair and teaching professor, Department of Marketing at the University of Notre Dame.

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