Everyone loves Amazon buying Whole Foods. Some so bullish they worry Amazon is now too powerful. Why aren’t pundits questioning a tech company buying a 36 year old grocer for $13.7 billion? Why is this deal a sure thing to so many?

The Numbers

Whole Foods Revenue — Revenue and profit of Whole Foods

Whole Foods is healthy but stagnant. 2016 revenue came in at $15.7B and $507mm of income. This income is lower than the two previous years. Sales have declined in six straight quarters. Whole Foods closed nine stores in February. At $500mm of income a year, Amazon is 27 years away from recouping the $13b spent. Of course this isn’t Amazon’s plan. Amazon believes they can modernize Whole Foods, improve logistics and empower online purchasing. Using the 462 Whole Foods locations for Amazon’s needs is the icing on the cake.

Competitive Advantage, Company Mission and Identity

Google & Motorola. Microsoft & Nokia. AOL & Time Warner. These are the disasters that come to mind when you think of a tech company acquiring an older company. In each example the tech company attempted to enter a space that was not part of their core competency.

Amazon has had an amazing run. Amazon has shown they can sell online better than anyone. Ecommerce at scale is Amazon’s core competency. Along the way to becoming the largest ecommerce company in the world Amazon had to learn how to create software at scale efficiently. AWS was born from this and Amazon developed a new core competency. AWS has been a massive success, generating $12.2B in revenue with a 31% profit margin in 2016. But Amazon has become drunk with success. AWS has lead Amazon to believe they can do everything. Core competencies be damned.

Amazon’s Former Vision –

Our vision is to be earth’s most customer centric company; to build a place where people can come to find and discover anything they might want to buy online.

Amazon use to have an identity. Amazon sold shit online and wanted to sell anything you could imagine online. This vision was edited to “Our vision is to be earth’s most customer centric company” which is broad and meaningless. It would have been a lot harder to justify a brick-and-mortar purchase with the old vision statement.

Midas Touch?

Some only remember the hits – Amazon.com, AWS, Kindle and Alexa but there have been failures as well. A $170mm write down on the Fire Phone. A $175mm loss on a LivingSocial investment. Failed attempts at payments (WebPay), auctions (Amazon Auction) and Q&A (AskVille). Not everything Amazon touches turns to gold.

Why Whole Foods?

I don’t love Amazon buying a brick-and-mortar store but the $5tn market size of the food retail industry is attractive for Amazon. Is Whole Foods the best fit? Whole Foods is known for their high-end, expensive food and stores. Amazon is known for their low prices. Do the customers of Whole Foods want lower prices? Sounds silly but some believe the high prices at Whole Foods keep the riff raff (like me) out and make the store more desirable to their core customer.

There are two grocers who seem like a better fit. Trader Joe’s, with their 461 stores in 41 states and low price model. Kroger, with ~2700 locations in 31 states and a $20b market cap also seems like a better fit. I’d love to know what other options Amazon considered and why they settled on Whole Foods.

Stretching Thin

Ben Thompson believes Amazon’s goal is to take a cut of all economic activity. Is that feasible? Is Amazon getting too big for their britches?

Ben Thompson –

I said at the beginning that Mackey mis-understood Amazon’s goals, strategies, and tactics, and while that is true, the bigger error was in misunderstanding Amazon itself: unlike Whole Foods Amazon has no desire to be a grocer, and contrary to conventional wisdom the company is not even a retailer. At its core Amazon is a services provider enabled — and protected — by scale.

Indeed, to the extent Waterloo is a valid analogy, Amazon is much more akin to the British Empire, and there is now one less obstacle to sitting astride all aspects of the economy.

In Ben’s bullish post he compares Amazon to the British Empire. Does Ben remember the British Empire’s fate? In the British Empire’s attempt to control all economic activity they stretched themselves too thin. The colonies and territories under their thumb revolted.

Can this happen to Amazon? Will Amazon’s ambitions cause customers to revolt? For example, if Amazon Video becomes more of a threat to Netflix will Netflix move away from AWS instead of feeding their competition?

Bottom Line

Keep in mind 70%-90% of M&A deals fail. Amazon’s purchase of Whole Foods is far from a no-brainer. This deal is a risky $13b bet with tremendous upside. Can Amazon utilize Whole Foods to improve what Amazon does best – allowing people to buy stuff online? Or will the Whole Foods deal become an expensive lesson on focusing and staying humble?

Bezos is no idiot. In fact, I believe he’s masterful in his handling of Wall Street. You can play the ever-growing profit game, but unless you’re Apple, you will undoubtedly fall victim to the law of large numbers sooner or later. Then good luck recovering your stock from stagnation.

Or you can plow your profits back into initiatives that continue growth. And if you have the right type of business, which Amazon does, you can live off the cash flow. As a result, you don’t really need profits to operate, but few people realize this. So, again, they demand to see them from time to time.

And, again, Bezos is happy to show them from time to time. But it’s more for show than anything else. Yes, Amazon can turn a profit if it chooses to. And don’t you forget it! (At least for a few more quarters until you do once again.)

ParisLemon: Punxsutawney Jeff

Profits aren’t necessary to operate but they’re ultimately why you’re in business. Is Bezo’s being a genius or arrogant? Do you let the cash flow determine how much money you invest into new initiatives or does the merit of the initiative drive what you invest in?

The question you have to ask yourself when evaluating Amazon is are they investing in initiatives that continue their growth or could they have spent the money better else where?

Amazon has plenty of examples of flops.

Amazon believes it can do it all. As much ink that has been spilled on Apple and their arrogance, Apple stays relatively focused and does not appear to think they could or should do it all. Apple sells phones, tablets and computers. They do a lot of other stuff but all of the other efforts are around making sure they sell a bunch of phones, tablets and computers.

Apple invests in what they think will return a large bang for their buck. If they don’t see anything obvious to invest in that utilizes what they specialize in, they hoard the cash. Eventually they give it back to the shareholders or buy back their own shares.

Amazon attempts to invest all the money they have back into initiatives that aren’t necessarily towards moving their main focus forward, which is “Sell a bunch of shit online”. They make hardware, they sell hosting services, they make original TV programming, they make games, yet none of these appear to have a measurable impact on the amount of goods they sell through the store, their cash cow.

I like that Amazon is investing in the future and thinking about the long-term versus appeasing Wall Street with short-term profits. I question how they are investing that money and the general lack of focus and specialization.

Disclaimer – I own a couple of shares of $AMZN and do not currently plan to sell.

Tag: amazon

The Amazon Empire