The real reason why Amazon bought Whole Foods

As an Amazon Prime subscriber and someone who shops frequently at Whole Foods, I was quite excited when the Amazon- Whole Foods acquisition was announced. I was aware of all the challenges Whole foods was facing over the last couple of years and began wondering what this means to its future. In this essay, I hope to present my thoughts with some facts, assumptions and hypotheses.

Whole foods initially started out as a health food store selling fresh organic produce to health conscious, upscale customers. It enjoyed a period of high growth and now has over 400 stores in the US. Whole foods business model is centered around charging a premium on grocery items by selling high quality organic produce coupled with an aesthetic grocery shopping experience and excellent customer service.

Figure 1: Whole foods and its declining margins

This model was challenged by competitors of all types who began offering cheaper organic alternatives with a similar shopping experience. Whole foods soon lost its primary differentiator to its rivals and started seeing declining margins ( see figure 1).

Costco emerged as the biggest retailer of organic produce passing Whole Foods in 2015.
Figure 2: Fragmented grocery industry. source: statista

If you dive deep in to this industry as a whole, you will notice many characteristic signs of a classic red ocean. Its a highly fragmented industry (See Fig 2 and 3) with most companies operating at very low operating margins around 1–3 % and high fixed and variable costs. Most of the competition is price based: Target’s offering has been centered around Expect More. Pay Less while Walmart has been pushing its Great value pricing. The other main competitive advantages tend to be centered around logistics, labor costs, warehousing and other fixed asset turnover strategies.

Fig 3: Low operating margins. source: ycharts

Customers on the other hand are are expected to dig through a ton of coupons, walk across long shopping aisles and wait in long check out lines. In fact, the biggest changes in customer experience in these stores were probably the introduction of shopping carts and self-check out kiosks. While Amazon took the non-grocery aspects of retail by a storm with its customer experience, it is still a new entrant to the grocery domain which gives it an opportunity to do things differently (see figure 4).

However, incumbents like Walmart, Target and Krogers have a pressing need to play by the old rules because their current business models, cost structures, and competitive advantages are centered around it.
Figure 4: Amazon and its share of grocery industry

The best approach Amazon+Whole Foods can take to transform this industry is to back to the drawing board, study the customers needs and reimagine the grocery stores for the future. In Amazon’s own words —

Customer Obsession: Leaders start with the customer and work backwards. They work vigorously to earn and keep customer trust. Although leaders pay attention to competitors, they obsess over customers.
Invent and Simplify: Leaders expect and require innovation and invention from their teams and always find ways to simplify. They are externally aware, look for new ideas from everywhere, and are not limited by “not invented here”. As we do new things, we accept that we may be misunderstood for long periods of time.

Figure 5: Understanding the real job to be done
If you carefully think backwards from the user (see fig. 5), you will realize that we as humans are really looking for one thing: food experiences.

This is probably why we have been moving closer to what we really care about: layers A and B. Less than 100 years ago, humans actually owned the production layer and were living in farming communities. Post- industrialization, we have outsourced the production layer in exchange for convenience, efficiency and economies of scale. Then came the grocery stores (layer C) who owned the job of procuring, stocking and delivering the groceries. Humans have been moving up this chain and are currently centered around layers A and B.

Depending on your personal preferences and needs you may do more of 1 or 2 below — you may pay for your food experience or you may choose to create your own.

  1. We pay for food experiences when we dine out at restaurants, when you order take out to binge watch your favorite TV show, etc. This is the business Chipotle, Cheese Cake Factory and your local Chinese restaurant are in.
  2. We create our own experiences by cooking at home and dining with our family. Grocery stores do the job of supplying us with the building blocks needed to create these experiences — groceries. This is the business Trader Joes, Whole Foods and Target are in.
For a new player like Amazon+Whole foods with a tiny market share (see Fig.2 and 4), there is no need to fit in to the current red ocean to meet the core user needs 1 and 2 — they can invent and simplify!

Before the acquisition, Whole foods was at the start of this very process when it started rolling out the new 365 stores a year ago. The new 365 stores are a reimagined version of the current grocery stores with a good mix of solutions designed to meet the needs 1 and 2. If you look at the layout below in figure 6b, you will notice a prepared foods bar at the center of the store G. They have digital screens advertizing the latest deals — which means deals can change dynamically with all the data being collected.

Figure 6a: Digital pricing based on data
Figure 6b: 365 store layout

There is also a check out kiosk that supports apple pay and other digital wallets to cut down the waiting times; also a hangout space for people to dine together. The focus of the store layout is really on making it a nice hangout spot where you can have a quick lunch or a snack while checking your instagram or email.

In short, Whole foods realized that it can build a strong differentiation by meeting needs 1 and 2 at a competitive price.

Enter Amazon.

Amazon has the capability to add extra differentiation layers to what Whole foods has already planned. Amazon can use the Amazon go technology to bring down the labor costs involved which would increase the operating margins of whole foods (see figure 3). There are other obvious synergies that would accrue to Amazon like: supply chain integration, amazon fresh expansion, leveraging whole foods retail space and loyal customer base, for pickups and returns, etc. Ben Thompson also wrote a fantastic piece on how this would be a starting point for Amazon Grocery Services and how Whole Foods is its first customer. However, I think there is so much more Amazon could do with this acquisiton — especially around the layer A.

Think of the following: A Prime rewards program that includes purchases at whole foods, Alexa powered grocery lists and pick up, learning from customer data to manage inventory, fixed assets and supply chains.

If you deep dive in to a customer’s behavior, you would notice that there a critical element of discovering new foods or items and the joy that brings along with it. Whether its the first time you tasted the fiery Sri Racha sauce or the day you discovered the existence of a mango habanero kombucha, you made a huge change to your life— you welcomed an alien food in to your daily life while shopping at a grocery store. This is also why you are more likely to take a pic and share it with your friends on instagram or snapchat. It is this surprise and joy of discovery that can be used as a major competitive advantage in this business. In fig.6 area A, you will notice an area called Friends of 365. Whole foods’ plan was to partner up with local businesses and introduce customers to new types of foods and products.

Figure 6b: Firends of 365. source: whole foods
There is a remarkable social angle to this idea that is hard to miss. Its basically creating an ecosystem of trending and constantly changing food experiences — food discovery as a service.

Depending on the latest trends, location and time of the week or day, your new Whole foods can host events for you to discover new foods, try out new cuisines and possibly Amazon products! Apart from adding an additional layer of differentiation to the Amazon+ Whole foods business model, it will also bring in extra revenues from the booming local businesses competing to be discovered by the young, tech savvy demographic.

Figure 6c: physical locations and synergies between Whole Foods and Amazon

What does all this mean to the larger Amazon business model? As Walmart is quickly trying to grow in the online space by acquiring Bonobos, Jet.com etc., Amazon is doing the opposite by acquiring physical locations and building brick and mortar touch points to get closer to its customers. Powered by data and the newly acquired building blocks from Whole foods, Amazon can now create several physical store configurations that can be scaled up and down based on changing trends and location specific needs.

My previous essay Why Alexa is a big deal? was centered around how Alexa makes Amazon virtually omnipresent across millions of households in the US. The Whole foods acquisition boosts it further by giving Amazon the physical omnipresence that was previously limiting its growth. Amazon now has 400+ touch points to interact directly with its customers!

Prime delivery +Alexa+ Whole foods building blocks = Amazon’s Omnipresence