Amazon's Ambition in Groceries: Part 2

Part 1 of this series can be read here

Doug Herrington, the current CEO of Amazon Retail, became part of the S-team at Amazon in 2011. Herrington has been a key figure to push Amazon to groceries. Brad Stone in his book “Amazon Unbound” mentioned a particular memo by Herrington published internally back in 2012 (emphasis mine):

Herrington had joined the vaunted leadership council a year before, and his blunt memo would resonate inside the S-team for years. Even its title was provocative: “Amazon’s Future is CRaP.”

In company parlance, CRaP stood for “can’t realize a profit”…in his memo, Herrington was talking largely about the inexpensive, bulky items stocked by supermarkets, such as bottled water, Diet Coke, or even a bag of apples. In the wake of the Webvan fiasco, most online retailers at the time considered these types of products to be economic quicksand. To the extent it sold them at all, Amazon had developed an “add-on” program to minimize their harmful financial impact. Customers could only include CRaP in their orders when they were making a broader assortment of purchases, such as books or electronics at the same time.

Herrington’s memo pointed out that Walmart, Carrefour, Tesco, Metro AG, and Kroger were the world’s five largest retailers at the time. “All of them anchor their customer relationship in groceries,” he wrote. If Amazon’s retail business was going to grow to $400 billion in gross merchandise sales, it needed to transform a model based on infrequent shopping for relatively high-priced goods to more regular shopping for low-priced essentials. In other words, if the company was going to join the ranks of the biggest retailers, the S-team had to figure out a way to profitably sell supermarket items. If they didn’t, Amazon was going to be vulnerable to rivals who already enjoyed the shopping frequency and cost advantages of the grocery model.

Indeed, grocery delivery is one of those “CRaP” businesses that require massive scale to even enjoy positive unit economics. Former Instacart CEO Fidji Simo mentioned in their very first earnings call as a public company the punishing reality of grocery delivery business:

“…it took us 100 million orders before we were able to get to positive unit economics.

So scale matters enormously in order to deliver this business not only profitably but also at scale and efficiently. And so the reason you're seeing all of our large partners partnering with us year after year, choosing to continue our relationship with us is because we are the most efficient, and we are offering them a service that they know is both efficient for their own P&L, but also allows them to keep the service as affordable as possible for their customers, which does drive growth.”

Today, Amazon’s grocery business is segmented into broadly three categories: a) nonperishables (consumables, canned goods, pet food, health and beauty products), b) Whole Foods Market (organic grocery), and c) Amazon Fresh (mass physical presence).

Amazon actually got into nonperishables long before they entered the rest of the grocery market. So, they entered the nonperishables grocery business back in 2006, launched “Amazon Fresh” in 2007, and acquired Whole Foods in 2017. Amazon seems to have made the highest progress in their nonperishables segment since even if you exclude Whole Foods and Amazon Fresh, their gross sales exceeded $100 Billion. From Q1 2025 call:

Amazon's grocery business, which includes everyday essentials, grew more than twice as fast as the rest of their business. Grocery accounted for one out of every three units sold on Amazon in the U.S. Even without Whole Foods Market and Amazon Fresh, Amazon is one of the largest grocers in the U.S., with over $100 billion in gross sales last year.

While acquiring Whole Foods, Amazon mentioned in Q2 2017 call that they are "experimenting with a number of formats for groceries, including physical pickup points, Amazon Go, online ordering, and delivery through Prime Now and Amazon Fresh", and that "there will not be one single solution for grocery delivery."

Unlike Walmart which got into grocery in 1988 and became the market leader in just thirteen years, Amazon’s experiments in groceries weren’t as smooth. Amazon even took $720 million in impairment charge in Q4 2022 for Amazon Fresh and Amazon Go physical stores.

Despite some of these failures, given what they experienced post-pandemic there was hardly any doubt that Amazon would invest heavily on groceries. In Q2 2020 call, Amazon mentioned their online grocery sales tripled YoY. However, this success didn’t quite reverberate in every facets of the grocery business. In Q1 2023 call, Amazon management sort of lamented that they haven’t quite found the right approach in groceries especially in the stores format. From Q1 2023 call:

We wish we were further along at this point. We’ve tried lots of ideas. We haven’t yet found conviction around the format that we want to go expand much more broadly. We have a set of experiments and ideas and concepts that we’re working on across our dozens of stores there. And we’re pretty optimistic that we have something that may very well work. And we’re hopeful over this next year we find that

Did they find the right format a year later? They indeed sounded quite optimistic about Amazon Fresh’s new store formats in 4Q’23 and 1Q’24 calls:

We've been testing V2 of our Fresh format in a few locations near Chicago, in a few locations in Southern California. It's very early, it's just a few months in, but the results thus far are very promising and on almost every dimension (Q4 2023)

Amazon Fresh V2 format shows "meaningfully better" results in almost every dimension. (Q1 2024)

Then just a couple of weeks ago, Amazon announced “one of its most significant grocery expansions”. From the company’s press release:

“Amazon is undergoing one of its most significant grocery expansions by introducing thousands of perishable grocery items at a great value to its Same-Day Delivery service. Customers in more than 1,000 cities and towns across the U.S. can now order fresh groceries with their Same-Day Delivery orders with plans to expand to over 2,300 cities by the end of 2025.

For Prime members, Same-Day Delivery is free for orders over $25 in most cities. If your order doesn’t meet the minimum, you can still choose Same-Day Delivery for a $2.99 fee. For customers without a Prime membership, the service is available with a $12.99 fee, regardless of order size.”

This announcement shouldn’t come as a surprise if you read Andy Jassy’s 2023 shareholder letter in which he pretty much hinted at their ambition in perishables:

“We have a very large and growing grocery business in organic grocery (with Whole Foods Market) and non-perishable goods (e.g. consumables, canned goods, health and beauty products, etc.). We’ve been working hard on building a mass, physical store offering (Amazon Fresh) that offers a great perishable experience; however, what if we used our same-day facilities to enable customers to easily add milk, eggs, or other perishable items to any Amazon order and get same day? It might change how people think of splitting up their weekly grocery shopping, and make perishable shopping as convenient as non-perishable shopping already is.”

So, making perishable grocery part of the same-day delivery promise is something Amazon has been chasing for a while, but we may finally be getting closer to the reality in couple thousands cities across the US by 2025. In the latest earnings call, Amazon highlighted some positive data points about consumer adoption on buying perishables on Amazon:

75% of customers who used the perishables service that year were first-time shoppers for perishables on Amazon. 20% of customers who used the service returned multiple times within their first month.

Frankly speaking, Amazon had a lot of confusing subscription plans for their grocery offerings, and I much prefer the simplicity of same-day delivery that comes with the Prime membership. But is same-day delivery enough?

Walmart seems to be way ahead of Amazon in this regard. From Walmart’s most recent call:

“Speed of delivery is important to customers, and we're continuing to get faster. Approximately 1/3 of deliveries from store in recent weeks were fast delivery in 3 hours or less, reinforcing the value of our store network and driving speed and 20% of those deliveries arrived to our customers in 30 minutes or less.”

While I do think that grocery market is large enough and still have plenty of laggard grocery operators for Amazon to catch up to Walmart’s speed over time, the reality of retail is that it is inherently a deeply relative game. Customers can flock to the best value proposition and even if you improve but consistently falls short of the best operator, it may not be enough.

To drive this point home, let me share an excerpt from the book “The Halo Effect”:

To show how company performance is intrinsically relative, I’ll present some data about a major U.S.-based retailer, a well-known company with hundreds of stores nationwide. I’ve made an effort to include only things that seem objectively verifiable and not shaped by the Halo Effect. To disguise the identity of this company, I’ll give it a fictitious name: “Qual-Mart.” According to the report of an independent industry analyst, Alex. Brown & Sons, during the early 1990s, “Qual-Mart” did these things:

• Installed point-of-sale terminals in its stores, which provided better information on sales by item and improved the inventory planning process.
• Expanded central buying to 75 percent of its merchandise, helping to reduce the costs of procurement.
• Modernized its inventory management and thereby significantly improved its “in-stock position.” One result: better management of seasonal inventory, boosting Christmas and Halloween sales by 60 percent.
• Conducted physical inventory counts more frequently, not just once at year-end, resulting in greater accuracy and efficiency.
• Reduced its expense levels as a percentage of sales.
• Improved its merchandise assortment to match current demand trends, helping to raise sales.
• Installed a toll-free customer service number, which led to a sharp improvement in customer satisfaction.
• Implemented a sophisticated client/server technology that led to better merchandise management and savings of $240 million.

Thanks to these many steps, “Qual-Mart” saw an improvement in inventory turns — that is, how many times in a year it sold its inventory, a key measure of retailing efficiently — from 3.45 in 1994 all the way to 4.56 in 2002. That’s a jump of 32 percent, not bad at all.

Would you say “Qual-Mart” improved its performance? Of course you would — it got significantly better at a number of important things, each one measured objectively. So you might be surprised to learn that the company we’re talking about is Kmart. That’s right: Kmart, the Evergreen Project’s Loser with a capital L, the poster child of mismanagement, the guys who supposedly got everything wrong. How can a company seem to do so many things better and still wind up in the bone yard? Because its rivals improved at an even faster rate. Over the same eight years, Wal-Mart’s inventory turns went from 5.14 all the way to 8.08, up 63 percent. Wal-Mart had faster turns at the start of the eight-year period than Kmart had at the end. Kmart got better in absolute terms and yet fell further behind at the same time — and the gap between the two retailers was growing ever wider.

As for other measures of performance, Alex. Brown & Sons noted that Kmart improved in “the key areas of expense ratio reduction, in-stock position, and visual presentation,” but its major rivals also got better — in fact, much better. It went on: “Both Wal-Mart and Target, by our estimate, continue to enjoy significant advantages on the expense ratio front — allowing them to be quite assertive on price and to post still higher financial returns than Kmart.” And that wasn’t all. By the early 1990s, while Kmart raised the amount of centrally purchased inventory to 75 percent, Wal-Mart reached 80 percent. Kmart installed point-of-sale scanning in its stores by 1990, but Wal-Mart had done the same two years earlier. No wonder Kmart was scrambling. Its rivals were driving down costs and improving logistics at an even faster rate. By 2002- just as inventory turns were reaching an all-time high!­- Kmart hoisted the white flag and shuffled off to bankruptcy court. It’s irresistible to infer that a bankrupt company must have been poor at execution, but the evidence doesn’t support that view at all, at least not if we’re talking about execution in an absolute sense.”

Given this reality, I will take a closer look at competitors, especially Instacart and Walmart in the next part of my “Amazon’s ambition in groceries” series.

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