Why Amazon Has Bought Whole Foods

(In short: It’s their grocery playground.)

The decision, last week, from Amazon to buy Whole Foods for $13.7 billion, has been met with considerable criticism. Big acquisitions are not a part of Amazon’s usual playbook. Amazon has generally patiently built its services across many years, and relied on mergers only for specific technologies or, in rare cases, to buy competitors such as Pets.com.

It looks like a horrendous decision

This is all the more puzzling when one looks at Whole Foods in more detail. One, for all its growth, it has had tremendous difficulties in recent years, struggling to be profitable, and is now under attack of activist investors over its falling stock. Amazon will therefore have to somehow change Whole Foods to turn it into a success. Plus, Whole Foods is known for having a unique corporate culture in which welfare and the independence of store employees is emphasized. For instance, employees are allowed to vote on benefits every three years. A caricatural way of summing up Whole Foods’ culture is that there is no employee union because the work conditions are so good. This stands in contrast with Amazon’s corporate culture, which is reportedly brutal for low-level employees, and insanely competitive for high-level ones.

So, Amazon has bought, at a massive price, a flailing company in a low-margin, competitive market; seems to prepare itself to massive culture clash and the PR nightmare that could result from it; and, on top of that, some are already talking about the need of antitrust regulation to block this merger that would consolidate Amazon a retail behemoth. What on Earth is Jeff Bezos thinking?

Now, I am here to argue that the merger is strategically justified (and, as The New York Times mentioned, one of Amazon’s strengths is its willingness to fail.) But there is a pretty strong case for Amazon to buy a company like Whole Foods, and I am going to lay it out here.

The problem with the grocery industry

The sector of groceries has long been an area of future growth for Amazon. It is indeed one of the biggest sectors of the retail industry; and, notoriously, it has been pretty impervious to e-commerce. So, for the past years, Amazon has tried to spin their take on grocery shopping with a flurry of products. Most notable among them was Amazon Fresh, which allows customers, for a monthly fee, to have produce to be delivered or picked up. Or one could mention Amazon Prime Now, which allows Amazon Prime members to be delivered produced products in two hours, albeit for a hefty price.

The problem with that strategy is that, essentially, it has not worked out. Grocery services is a tough nut to crack, Amazon seems to have discovered. Groceries are indeed ordered pretty differently than books or households objects. Immediacy is very important: hence the value of a combination of physical presence and very fast delivery. Also, perishable products cannot be stored and presented in a way that is even remotely similar to the rest of their catalog. Therefore, Amazon has tried to innovate in both domains. It has opened physical stores and food trucks in Seattle. These experiments, although headline-grabbing, didn’t seem to be very scalable. If Amazon wanted to have a physical presence as ubiquitous as their website, it would have to acquire a lot of real estate and build stores there. These operations are notoriously lengthy, difficult and expensive to realize; at least, much harder than scaling their online presence.

You could buy Whole Foods for its real estate, but that’s not enough

Whole Foods partially solves that problem. Their physical presence across the US is relatively expansive; there are Whole Foods in virtually every major US city. The mere real estate of Whole Foods can be valued in billions of dollars. So, if Amazon wanted to convert all of the Whole Foods in Amazon Groceries, they would have a good jumpstart. This, in itself, not a sufficient reason to buy Whole Foods. After all, if Amazon really wants to be as gigantic as their $500 billion valuation suggests, it can’t content itself with a grocery brand that occupies only a percent of the market, focuses on organic products, and is itself under financial duress.

So it can’t be just about acquiring a grocer; Amazon will have to change Whole Foods somehow. One could imagine, instinctively, that Amazon would radically transform the Whole Foods stores, rebrand them under the Amazon brand, and change the catalog to make it appealing to every American. And, because this Amazon, make Whole substantially bigger. But that probably would engender a heavy culture clash. This probably explains that, after the acquisition, Amazon declared that Whole Foods store would continue to operate as before, and that no jobs cuts were in store.

Whole Foods is a playground for Amazon

And honestly, there is plenty of ground to believe that. Amazon is probably not thinking of Whole Foods as their endgame, but rather as their playground in the grocery space. And you can think of playground as a demeaning word, but it really isn’t. A playground is what Amazon needs to be able to succeed in the grocery space.

The flurry of experiments that Amazon conducted in the past few years have failed because of a kind of chicken-and-egg problem. It is hard to prove that a single grocery experiment is viable without economies of scale, but it is hard to scale that experiment without financial viability. That problem surely existed for previous business like books, but they probably were less complicated.

So, Amazon needs scale from the get-go to jumpstart their grocery experiments. That is what Whole Foods offers. It is a grocer that is big without being as big as Walmart. Plus, their culture emphasizes the independence of each location, which makes it easier to run local experiments. Therefore, it seems like Whole Foods was bought to be a guinea pig.

This seems all the more logical that it very much fits Amazon’s structure and history. Amazon is structured around small teams that have a lot of independence. This means that a lot of them are running live experiments that are validated or axed based on their results. This is the corporate equivalent of throwing stuff against the wall and see if it sticks. More crucially, a lot of these teams operate as APIs: they are supposed to treat both the rest of Amazon and the external world as customers. This explains, for instance, that the Amazon supply chain is available to both Amazon.com and third-party retailers; or that their web services hosts both Amazon’s websites and other customers.

If one takes that framework to think about the Whole Foods acquisition, it is simple to see how this will unfold. Amazon will run experiments in countless Whole Foods stores (and potentially opposite experiments in two different stores to compare them,) and see what works and what doesn’t. In addition, they will probably will reconfigure the back-end of Whole Foods to make more efficient, and, crucially, more flexible so that it can be modularized. (This has led some writers such as Ben Thompson to think that Amazon could use that supply chain to deliver produce to other groceries or even third-party restaurants.)

Despite this acquisition, they are still hard questions that Amazon will have to answer. Even if Amazon is comfortable with being a modular company, it is dubious that they would only keep Whole Foods as their only customer-facing operation, especially outside of the US where Whole Foods is unknown. It seems probable that they would create Amazon branded stores; what they would look like is probably a mystery to the company itself. (But the experience acquired from running Whole Foods, I think, would give them clues to how to conceive them.) And the question of culture compatibility, which has sunk so many mergers before, is still crucial to Amazon’s success.

These issues will still be here next year; hell, they may very well be there in five years. But, at least, Amazon won’t have to worry anymore about the first step of their grocery business, as they will have a jump base to start from.

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