The early numbers are out on Amazon.com, Inc.'s (NASDAQ: AMZN) takeover of Whole Foods, and they are certainly promising.
Amazon sold $500,000 worth of Whole Foods items on its website in the first week it owned the company, according to One Click Retail, and better yet, Foursquare reported a more than 25% uptick in Whole Foods' foot traffic over the first two days following the merger.
Clearly, Amazon's reputation and price cuts resonated with shoppers, though it's unclear if the boom will persist. Morgan Stanley, for one, made the boldest prediction yet on the Whole Foods-Amazon combination, as analyst Brian Nowak sees Whole Foods' total shoppers more than doubling over the three years, from 12.5 million today to 25.2 million in 2020.
A match made in retail heaven
According to Nowak's math, there's not as much overlap between Whole Foods and Amazon customers as you might think. Nowak calculated that 80%, or 38 million, of Amazon Prime members don't shop at Whole Foods, while 38% of Whole Foods shoppers, or about 5 million people, aren't Amazon Prime members.
As Amazon makes Prime the loyalty program at Whole Foods and adds discounts and other perks to its slew of Prime benefits, Nowak expects the overlap between the two customers to dramatically increase.
Not only will about a third of those 38 million Prime members start shopping at Whole Foods, but he expects half of those Prime holdouts who visit Whole Foods to join the Amazon loyalty program over the next two years.
Nowak was careful to say that that wouldn't lead to a doubling in revenue as those customers would be lower frequency, but he saw the influx translating into a 12% increase in revenue a year, much better than the low-single-digit sales growth the company was originally forecasting for this year. That doesn't include an impact from new stores or drawing in other customers, who are not Prime members, with low prices.
All about customer loyalty
Margins are thin in the grocery industry, even for Whole Foods, which has historically outperformed its rivals and been able to charge higher prices due to its premium branding and products. Morgan Stanley sees its operating margin falling from 5.5% last year to just 1% to 3%. Still, that percentage is more in line with Amazon's own operating margin as the company has generally sacrificed profit for market share and competitive advantages. In other words, the old Whole Foods was almost too profitable for Amazon.
Amazon hopes that by bringing more customers into its ecosystem, it will encourage more spending on its website, greater brand equity, and a brighter future as it grows rapidly and expands into new industries.
The intensifying price war
American supermarkets were already locked in a price war before Amazon took over Whole Foods. Food deflation and expansion by the European discounters such as Aldi and Lidl led to poor same-store sales across the industry last year. That led to Kroger Co (NYSE:KR), the country's largest traditional supermarket chain, seeing its streak of 52 quarters of comparable sales growth come to an end.
With Amazon set to lower prices on even more items and offer discounts to Prime members, that price war is only likely to heat up. Still, I'm skeptical that Whole Foods can double its customer count in such a short time. The spike in customers following the merger was likely a result of hype and curiosity about the changes. While I'd expect customer traffic to be continue to be up at Whole Foods, a 25% increase does not seem sustainable.
Still, the synergies between Amazon and Whole Foods are self-evident, and the organic grocery chain makes Amazon a major player in the industry, something it's aspired to be for a decade now.
With the positive customer response both online and in-store, and more discounts and Prime benefits to come, the takeover already looks like a success.