An Amazon Mindset

A $13B merger, two distinct business mentalities and an Amazon store on every corner.

“Jeff, what does Day 2 look like?” That’s a question I just got at our most recent all-hands meeting. I’ve been reminding people that it’s Day 1 for a couple of decades… “Day 2 is stasis. Followed by irrelevance. Followed by excruciating, painful decline. Followed by death. And that is why it is always Day 1.” Jeff Bezos, 2016 Letter to Shareholders, April 11, 2017

Overview

Amazon’s been a frustrating company from a value investing perspective. Their share price seems as astronomical as founder Jeff Bezo’s side business – building rockets with Blue Origin. The stock has buoyed to a half-trillion dollar market cap while making about $2.3B in net income for 2016. In its latest move, the company has bid $13.7B for Whole Foods, a high end grocer with a starkly contrasting set of business principles.

Whole Foods has 440 stores and 17.8 million square feet of retail space in the US. This shouldn’t be thought of as directly acquiring real estate since Whole Foods only owns 18 of its 440 locations. Despite renting hundreds of stores for about $285M per year, Amazon quickly gets 440 locations and the customers who habitually visit them.

Why it might work

“Good inventors and designers deeply understand their customer. They spend tremendous energy developing that intuition. They study and understand many anecdotes rather than only the averages you’ll find on surveys. They live with the design. I’m not against beta testing or surveys. But you, the product or service owner, must understand the customer, have a vision, and love the offering. Then, beta testing and research can help you find your blind spots. A remarkable customer experience starts with heart, intuition, curiosity, play, guts, taste. You won’t find any of it in a survey.” Jeff Bezos, 2016 Letter to Shareholders, April 11, 2017

It seems that Amazon’s key take away from its customer research is that we’re all too busy. We put off purchases until the last minute, so there’s Prime Now’s 2 hour shipping. We forget to buy laundry detergent and dog food, so they roll out subscriptions. We don’t want to think about checkouts, so they tease a stores without registers or checkout. Many of their services are focused on adding convenience and simplifying our set decisions. The following quote, pulled from a reddit forum sums up the target demographic nicely:

“And it occurred to me that the people who by and large don’t mind the loss of total internet privacy are the ones who benefit most from the data mining and predictive analytics that these companies do…because it reduces our mental load. If you never worry about the fact that you’re going to run out of diapers […] of course you think it’s creepy that Amazon would predict when you need diapers. But if that takes one ‘to-do’ off your mental to-do list, you think it’s amazing.” - Reddit user WomanInTheYellowHat on reddit.com

By integrating with customers’ habitual purchasing rituals, Amazon can ship a customer’s online product purchases to a nearby Whole Foods and package it together with the their regular groceries. In addition, a physical store facilitates some purchase categories. This could allow Amazon to sell prescription drugs, which tend to be a recurring purchase, as well as alcohol, which carries additional delivery restrictions.

Amazon could make the logistics of ordering, payment, and pickup easier for customers while benefitting from cutting out the final leg of delivery.

Why it might hurt

Because I think, sometimes, our company’s gone a little bit too much team member focus at the expense of our customers. And that’s one definite evolution that’s gonna happen. I love the passion these guys have around the customer. They put the customer first in everything they do and think backwards. And— we— we’re gonna be the same way. – John Mackey, Whole Foods CEO, June 16 2017 town hall meeting

If the stores and customers are an asset, the employees are likely a liability to Amazon’s efficiency maximization. Amazon has caught a lot of flak for treating its employees poorly in fulfillment centers. Some of the stories are so dire you’d have a hard time differentiaing an anecdote as originating from Foxconn or Amazon.

Over the past few years, Whole Foods has seen declining profits while increasing their store counts. The stock has dropped 6% since 2011 compared to a +113% rise in the S&P 500. Despite weak performance and its growth ambitions, Whole Foods has been increasing their dividends. There’s something bizarre about Amazon, a growing non-dividend payer, buying a slow-growth dividend-paying Whole Foods.

All full-time and part-time team members are eligible to receive stock options through annual leadership grants or through service-hour grants once they have accumulated 6,000 service hours (approximately three years of full-time employment). Approximately 94% of the equity awards granted under the Company’s stock plan since its inception in 1992 have been granted to team members who are not executive officers. - 2016 WFM Annual Report

It looks pretty clear that some employee programs are about to get changed for Whole Foods employees post-merger. Mackey’s description of Whole Foods as an overly employee focused company might have aggravated some shareholders, but it likely led to an outsized dividend participation among employees. Further, the prospect of being automated out of a job might be less daunting given Whole Foods employees have seen a share price bump from Amazon’s offer.

Why not buy another grocer?

If they wanted the retail space, they could have gotten Aldi with 1600 stores, Trader Joes with 460 stores, or maybe Publix for 1,100 stores. None of those stores appear to have the same employee-focus that Whole Foods has. On the flip side, Whole Foods is known for having affluent customers.

What other companies are affected

• United Natural Foods - Whole Foods’ primary distributor for the past eighteen years. They’ve got distribution agreements in place until 2025.
• Blue Apron - A food delivery focused on ready to cook meal kits. Their plans for an IPO are threatened now that Amazon has stepped closer towards their niche.