Retailer Spotlight

Amazon’s Future Grocery Growth Will Live or Die on its Brick and Mortar Success

Erich Kahner

Competitive Strategy

Executive summary

In our inaugural eCommerce RPI study, H-E-B edged out Amazon and Amazon Fresh as the top grocery retailer for eCommerce. Our study details H-E-B’s winning formula against Amazon and omnichannel titan Walmart. In this article, we look at things from a different angle, offering grocers aspiring to beat Amazon a close analysis of why Amazon is winning and what makes it vulnerable. (After all, there are more retailers out there interested in beating Amazon than in competing against H-E-B). More importantly, this is perhaps the first detailed look at the rising omnichannel threat posed by Amazon Fresh.

Despite glowing Customer reviews and financial success, Amazon isn’t as secure as you might think. If you look just at eCommerce, where, up until a year ago, Amazon.com/Amazon Fresh banners dealt almost exclusively, the rest of the grocery market has been growing faster than Amazon. Additionally, while Covid helped increase the share of online grocery, the lion’s share of grocery dollars is still spent in brick and mortar and will continue to be, far into the future. But with Amazon’s expansion into mainstream brick and mortar, it is taking the first real steps down the path to becoming the existential threat that grocery retailers have long feared.

The Amazon Fresh brick and mortar store’s current offering is misaligned with its target shopper: the time-starved omnichannel shopper. Amazon Fresh’s assortment and department space allocation is not tailored enough to this shopper, and Amazon misses big on basic blocking and tackling of brick and mortar grocery. If these things aren’t fixed, Amazon Fresh risks merely being a secondary destination for the time-starved omnichannel shopper, or it may even become another of Amazon’s failed forays into brick and mortar (see “4-star” and its bookstores).

Amazon Fresh has good brand equity, but simply extending that brand to a brick and mortar store will only take them so far. If it doesn’t display a better understanding of shopper behaviors and its own competitive weaknesses, Amazon will continue to be limited to tap into brick and mortar grocery sales. This would severely limit its potential for growth in the grocery market, given brick and mortar sales are ~90% of the grocery market today and are likely to remain the lion’s share of grocery sales far into the future.

The good news for Amazon Fresh is the strength of its aforementioned brand equity, as well as its war chest of profits, people and proprietary technology, which give it the time and resources to fix its issues.

To prepare for a future in which retailers will engage in regular, head-to-head battle with Amazon Fresh brick and mortar, retailers should start today on four key initiatives:

Better align your own offering with the omnichannel shopper, without alienating the equally large brick and mortar only population.
Exploit Amazon Fresh’s weaknesses by being excellent at dependability and consistency, especially in managing out-of-stocks and pricing consistency.
Negate Amazon Fresh’s biggest strengths, especially private brand.
Leverage your own unique assets to drive your own competitive advantage.

Despite glowing Customer reviews and financial success, Amazon isn’t as secure as you might think.

INTRODUCTION

Why Amazon.com Is Among the Market Leaders

To many, Amazon and “grocery store” are words that don’t belong together. A couple dozen Amazon Fresh stores aside, you can’t walk into Amazon.com’s doors, say hi to a sales associate, smell the rotisserie chicken cooking, see the piles of neatly arrayed produce reflecting the lighting from above or have a new product you’d like to try catch your eye. But, if you look only at results, it’s clear that Amazon not only is a “grocery store,” it may be one of the best grocery stores in the U.S. While quickly amassing a grocery market share that, according to Edge Ascential, places it 5th overall, tied with Publix and just ahead of Target, Amazon has also accumulated a strong emotional connection with its shoppers, performing better than all other industry goliaths and reaching fourth overall on the measure from our eCommerce RPI on “I would be sad if this store closed” (out of 66 different grocery retailers measured). The only retailers with higher scores on this measure are Market Basket, H-E-B and Wegmans.

Amazon’s Customer Value Equation is superior to most in how it balances delivery of Customer benefits with the costs it asks Customers to pay. Customers perceive both Amazon.com and the Amazon Fresh portions of its platform to be clearly above average in perceptions of both benefits – thanks mostly to time savings delivered – and costs:

Avoiding the Mission Blindness Trap

Amazon.com’s most typical Customer mission is the quick, non-food top-up trip. In this mission, basket sizes are smaller, and the basket is disproportionately represented by common household items (like paper towels and toilet paper), personal care items (like toothpaste), pet products and packaged, shelf-stable food items. You might also call this mission the just-in-time top-up mission. Amazon.com essentially allows a shopper to tap directly into a supply chain and, from the shoppers’ point of view, reroute the product so, instead of having to go grab it from the shelf in a store, it ends up at their front door. Contrast this competitive positioning with Kroger, which tries to have a solid offering in product categories for every grocery mission a Customer might take. The catch is that when a retailer tries to be a solution for every category and all missions, it isn’t making trade-offs in the business when executing its position. If a retailer doesn’t make trade-offs and prioritize investment in certain Customer categories over others, it is are less likely to be able to achieve a Customer value proposition that stands out in any one category or trip mission. This feedback cycle, which we call the Mission Blindness Trap, is a trap most grocery retailers get stuck in. But not Amazon.com. Instead of going head-to-head with retailers, it is the perfect complement to most, for very focused missions, and Customers show their appreciation for this clear, compelling value proposition.

The Mission Blindness Trap

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Grocery retailers want to grow share of wallet

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So they try to be a destination for all occasion and don't prioritise investment in certain trip missions over others

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This leads to a lack of compelling value proposition in any single mission

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This leads to lukewarm financial growth and emotional connection

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Lower emotional connection means shoppers are more likely to give their share of wallet away when the competition gives them any reason to

Avoiding the Mission Blindness Trap is critical to producing positive outcomes – it is more often associated with positive outcomes than any other single pillar of the Customer value proposition. Amazon.com focuses better than anybody.

Why eCommerce isn’t Enough and Amazon’s Future Growth Depends on Brick and Mortar Success

Amazon’s success in grocery has been well-documented in our annual U.S. Retailer Preference Index: Grocery Channel Edition report, but there is more to the story. Despite the glowing Customer reviews and financial success, Amazon isn’t as secure as you might think. If you look just at eCommerce, where, up until a year ago, Amazon.com/Amazon Fresh banners dealt almost exclusively, the rest of the grocery market has been growing faster than Amazon. This has been especially true during Covid. Amazon’s competitors have been the driving force behind eCommerce’s overall grocery growth, pushing online grocery from 5.7% of total sales in 2019 to 9.7% today (according to Edge Ascential data on the top 66 grocery retailers in the U.S.). This growth in competition has pushed Amazon’s share in online grocery down from ~65% five years ago to ~45% today.

In 2020, the rest of the grocery market surpassed Amazon in grocery eCommerce sales and widened that gap in 2021. However, while many retailers are reacting to the threat of Amazon and increased consumer adoption by prioritizing eCommerce investment, Amazon is making headlines with their investments in the brick and mortar space. Even Amazon knows that online isn’t the future of grocery. Rather, the grocery future is more omnichannel than eCommerce, and, for a huge chunk of the consumer population, their grocery future isn’t even omnichannel. Covid presented the biggest motivation for consumers to buy groceries online they will likely ever face. Especially during the uncertainty of 2020, being in a crowded grocery store meant, for many, putting one’s life at risk. Still, the percent of shoppers buying groceries online increased from 43% pre-Covid to only 56% during the fall of 2020. This means that about four out of every six people who didn’t shop online pre-Covid still chose to remain brick and mortar only. For them, the sensory needs that only brick and mortar can fulfill are too great. Additionally, while online grocery does have some conveniences, it also introduces a brand-new inconvenience to the grocery shopping process – having to arrange your day around a pick-up or delivery time slot, rather than shopping when it suits you. With so many moving pieces already in one’s day and so many things to schedule, just one more of the below considerations may be one too much.

While grocery eCommerce remains a hard sell for 44% of the population, 56% of the population see value in being able to buy groceries online. However, 19 out of 20 of the 56% who see value in online groceries also shop brick and mortar, and allocate the majority of their spend into brick and mortar stores. If Amazon continued to exist mainly in the pureplay grocery retail space, or in the specialty organic space, it would only have access to about 13% all grocery dollars spent by Customers today. Even if we assume that eCommerce will go back to growing at its pre-Covid annual compound rate of 30.1%, eCommerce share of total grocery sales would be ~20% in five years. This assumption of returning to pre-Covid eCommerce growth rates is likely very aggressive, given it means more than doubling eCommerce’s share of sales today in five years. eCommerce as a share of sales didn’t even double during Covid, which was a once-in-a-generation-sized shock to consumer behavior. Prior to Covid, it took nearly two decades of nudging consumers for grocery eCommerce to hit even 5% of sales, and this wasn’t for lack of trying from big players Walmart, Ahold and Kroger. Recent articles by The New York Times and MarketWatch point to slowing eCommerce growth or even declining eCommerce sales, and Edge Ascential, in a forward-looking projection, assumes online grocery sales will grow at an annual compound rate of ~10% over the next 5 years, far lower than the ~30% 5 YR CAGR pre-Covid. Quality grocery web traffic over the past 12 months has consistently been lower than the same months in the 12 months prior. This is the case for all major eCommerce players, Amazon, Walmart, Target, Kroger and Costco. Amazon, for instance, since April 2021, has seen quality grocery web traffic come in 3-12% lower compared to the year prior. For Kroger, the range in visit decline in any given month is wider, between 1-35% lower.

From a profitability side, brick and mortar grocery isn’t exactly the most attractive industry, but, at 2-3% net profit margins, it is profitable. At the same time, Amazon.com retail in general, which includes grocery, ran at a negative operating profit margin according to Amazon’s Q4 2021 earnings report. Regarding grocery eCommerce, struggles with retailer profitability are well-documented, and, profitability is, for the meantime, reserved for those with a “world class” eCommerce operation. A world class eCommerce operator is one who is targeting the heaviest users of eCommerce, generating high profit supplier insight revenues, using micro-fulfillment at scale, and optimizing delivery practices by appropriately balancing click and collect and delivery volumes. For more information on what it takes to be a world-class eCommerce operator, click here to learn more about the e-Commerce Maturity Model and how to use Customer data science to advance maturity. On the other hand, if retailers struggle with any (or, even worse, most of these elements), every $10M of revenue made in eCommerce may subtract $1M from the bottom line.

All of the above is not meant to be a case against retailers expanding their current eCommerce offering. In fact, we generally argue for carefully expanding these capabilities with a focus on Customer profitability rather than simply short-term channel profitability. But more on that later, when we discuss how retailers can respond to Amazon. Amazon, first and foremost, is in the growth business, and growth is hamstrung as a pureplay and specialty grocery operator. If it wants to access most of the trillion-dollar grocery industry, as quickly as possible, it needs to scale up a mainstream brick and mortar grocery operation. It knows this. Enter, the friendly neighborhood Amazon Fresh store.

Why Retailers Have Only Just Begun to Feel the Might of Amazon in Grocery

Amazon, as of this writing, had just over two dozen Amazon Fresh brick and mortar stores in operation, with about 24 more under construction and reportedly even more planned to be built over the next few years. While this number is tiny in store count compared to most competitors, about 1 in 5 Amazon.com grocery shoppers claim to have shopped the Amazon Fresh property. In other words, though it has just a beachhead in the brick and mortar space, the Amazon Fresh brand already has high awareness and familiarity.

Customer perception of the Amazon Fresh value proposition is also very strong. In our most recent Grocery RPI survey, fielded in October 2021, we surveyed 462 Amazon Fresh shoppers, and Amazon Fresh scored 2nd only to Amazon.com in its ability to save Customers time, well ahead of 3rd place Target.

“Time Savings” is a composite of Customer perception on several dimensions, including:

eCommerce making shopping easier
One-stop shop-ability
Location convenience (for B&M locations)
Speed of checkout
Speed of shopping the entire store

Amazon Fresh also distinguishes itself against its most cross-shopped competition on measures of Quality. Amazon.com, meanwhile, falls to the bottom quartile on quality of products, due to its lack of a perishable offering. For product quality on the products it does offer, it scores a little above average. Amazon Fresh, on the other hand, gets above average marks on perishables.

Additionally, Amazon Fresh is a market leader in “making shopping fun” and offering “new and different products,” while also scoring highly in private brand and natural/organic variety.

It does all of this while managing to beat most regional, traditional grocers (including Kroger) and Target on perception of overall Customer Cost (a combination of base price perception and promo/rewards perceptions).

These Customer perceptions represent perceptions not just of people who shop Amazon Fresh brick and mortar, but the whole of Amazon Fresh. Fortunately for Amazon Fresh, when we cut our sample by people who shopped the Amazon Fresh stores, Customer perceptions, almost across the board, look even stronger. This may be because, at this early stage of Amazon Fresh’s brick and mortar roll-out, their stores are attracting Amazon Fresh super fans, or Amazon Fresh’s brick and mortar stores may just be an improvement on an already strong online value proposition.

In addition to already having a promising start toward a strong Customer value proposition, Amazon possesses a unique set of assets and competencies that position it to improve on this proposition and accelerate growth:

Diversification and a Well of Profit

Earlier in this article, we mentioned that Amazon.com retail runs at a negative operating profit. This is allowable for Amazon because its Amazon Web Services business operates at a ~30% profit margin and, despite accounting for only about 13% of Amazon’s sales, accounts for most of its profits. Additionally, Amazon leverages its portfolio of other consumer products and services (like Prime Video) by rolling them into Prime Membership perks. If Amazon needs to boost revenues, it can increase its Prime Membership fees with little churn, which it did again in February of this year. Amazon can use other ventures to fund its grocery expansion, whereas many of its grocery competitors cannot.

Destination for Top Talent

Amazon ranks in the top 10 among the grocery retail competitive set in Glassdoor Employee Satisfaction ratings, and its compensation plan is heavily tied to its high-performing stock. This attracts top talent who thrive off growth challenges, and in January 2022, it hired Tony Hoggett, Tesco’s former Chief Strategy and Innovation Officer, to be SVP of physical stores.

Proprietary Tech, Securing a Unique Advantage

Amazon’s Dashcart and Just-Walk-Out technology help it ensure its peerless leadership in saving Customers time is secure for the foreseeable future.

What Retailers Can Do to Compete with Amazon’s Omnichannel Approach

1. Align the Offering (especially the Online Offering) with the Heaviest Omnichannel Shoppers

The heaviest omnichannel grocery users are disproportionately represented by families with multiple children. Five out of every 10 heavy omnichannel users (buy online 5+ times a month), are these families, compared to just 1 out of every 10 brick and mortar only shoppers. Contrary to conventional wisdom, just being a millennial alone doesn’t make you notably more or less prevalent in a brick and mortar only population versus an omnichannel population. Children, and having more than one child, are the defining factor. Time is in short supply for these busy families. So, unsurprisingly, heavier omnichannel users are more likely to buy RTE meals. They are also buying healthier items, perhaps for their children. They are more likely to buy baby care and pet care items. Also, perhaps not unrelated to the stress of having all of these creatures to take care of, they are more likely to put alcohol in their basket than light omnichannel and brick and mortar only shoppers. Aligning the product mix, promotion and messaging – both in store and online – to these needs will help retailers win an omnichannel shopper.

2. Exploit Amazon Fresh’s weaknesses

For all of its strengths, Amazon Fresh has a glaring vulnerability. Of the 66 retailers in our annual Grocery RPI study, Amazon Fresh ranks 65th on perceptions of ability to keep products in stock and 66th on not changing prices too frequently. In other words, they have a consistency and dependability problem. If competitors perform well in this area, they can highlight this in their messaging. If they don’t perform well, they can make improvements here to drive a clear competitive advantage over Amazon Fresh. Improving both out-of-stocks and price consistency rely on integrated systems, data flows and applying the best data science possible.

A picture is worth a thousand data points, in this case.

Thoughts from my store walk

A recent store walk at an Amazon Fresh store provided great validation of what we’re seeing in the Customer data.

On the plus side, Amazon Fresh’s emphasis on its portfolio of private brands, which includes the Whole Foods 365 brand, helps explain its solid price perception and sense that the store carries unique items. Its perishables did seem fresher than what you might find at your typical, traditional grocer. Its Dash Cart was easy to use and (more on this in a minute) almost worked without fail. Just walking out of the store, with my items in the cart, without having to take my wallet or my phone out of my pocket, definitely provided a unique, fast shopping experience.

Validation of the data Amazon execs probably don’t want to see is on the operations side. Saying it is dead last in the grocery market in Customer perception of out-of-stocks somehow doesn’t do justice to the problem. A picture is worth a thousand data points, in this case.

The frozen section, beverage section, soup section, milk section, cheese section all looked similar to this barren yogurt section. If Amazon Fresh is going to rival your typical, mainstream, traditional grocer, which means being a destination for the everyday staples top-up mission or even a bigger, food-focused shop, it’s going to have to solve this reliability and consistency problem.

Their innovative Dash Cart could also be contributing to their inventory issues. I put two different flavors of bag salad in my cart, from the same brand, and the Dash Cart logged my selection as two identical bag salads of the same flavor. This happened again, with a set of baby food products. Somewhere, a warehouse is getting the wrong information on what is and isn’t available in this store. With all of the holes on shelves and the several eCommerce pickers pushing around double-decker pallets full of other peoples’ orders, it can sometimes have the feeling of a mini warehouse rather than your friendly neighborhood suburban grocery store.

Amazon has a great quality/price proposition and an enthusiastic fanbase of the broader Amazon retail brand, but its inexperience in brick and mortar grocery shows. It is going to be under a microscope as people trial them, and things more established neighborhood grocers might get away with won’t be given a pass for Amazon Fresh, especially given the severity of its out of stock issues. Right now, it seems like they are in danger of focusing too much on differentiation and not enough on the basic blocking and tackling of grocery. Good enough to generate some momentum off the starting line, but not good enough for the long run.”

Amazon has a great quality/price proposition and an enthusiastic fanbase of the broader Amazon retail brand, but its inexperience in brick and mortar grocery shows.

3. Negate Amazon Fresh’s Strengths

4. Leverage Your Own Unique Assets to Drive Your Own Competitive Advantage

If you are a specialty grocer like Trader Joe’s, Sprouts, Fresh Thyme or The Fresh Market, your perishable quality and in-store experience will always be your advantage. From an omnichannel perspective, building out a focus on RTE delivery and related foodie-focused in-store experiences may be your most ownable, differentiated extension. If you are a traditional, regional grocer with a loyalty program, your data and resulting ability to personalize the assortment, pricing, promotions and Customer relationship management will always be your advantage. Personalize the total omnichannel experience, using promotions, media, below the line pricing, communications, and story layout. If you are a discounter like Aldi, you’ve already tightly coordinated your value chain to drive costs out of your system, so low prices will always be your advantage. The smart choice here is perhaps to stay the course and not get too distracted by omnichannel, since building these capabilities add costs to the system. Partner and pick and choose the most cost-effective categories to enter into with omnichannel. Club stores and mass merchants are perhaps less likely to go head-to-head against Amazon Fresh for Customer missions and have to continue to worry more about Amazon.com taking bites out of their bread-and-butter non-food and non-perishable stock-up missions. Still, if club and mass market retailers view Amazon Fresh as a potentially enhanced version of the average, regional traditional grocery store of today (think H-E-B but with a national footprint, but minus the boost from Texas pride), there is definitely cause to worry, and national club and mass players will have to step up execution of their current strategies for effectively fending off the traditional grocer.

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