Would an Instacart Investment Be a Wise Move for Whole Foods?

Source: Whole Foods Market.

Food delivery is all the rage in tech circles these days.

Fresh off tech giant Alphabet's (GOOG -1.21%) (GOOGL -1.34%) recent move to challenge Amazon.com (AMZN -2.50%) in grocery delivery, Whole Foods (WFM) recently reportedly deepened its own relationship with grocery delivery unicorn Instacart.

But will Whole Foods' moves make sense amid rising competition from Alphabet and Amazon? Let's take a look.

Whole Foods and Instacart make a deal
According to recent reports, Whole Foods is finalizing an investment in grocery delivery start-up Instacart. Though the size of the investment remains private, Instacart most recently raised a Series C in December 2014 that valued the 4-year-old start-up at a whopping $2 billion. Whether Whole Foods' investment is financial or strategic isn't clear, though the move is clearly intended to deepen the current relationship between the grocer and start-up.

Source: Instacart.

Beyond the latest reported investment, Whole Foods and Instacart also reportedly are signing a five-year delivery partnership that will make the Instacart the sole delivery outlet for all Whole Foods stores. Though additional details of the deal remain private, Instcart's delivery deals with other grocery partners have typically included a revenue-sharing component.

This presents Whole Foods investors with the prospect of a new, and much-needed, revenue source, as the company has struggled to counter increased interest in organic products from many of its rivals. So while the revenue-sharing portion of this deal should immediately benefit Whole Foods and its shareholders, how should investors view the long-term potential within Instacart's business model?

Source: Google.

A wise deal for Whole Foods?
Instacart's awe-inspiring rise coincides with wider renewed interest in grocery delivery from Amazon and Alphabet. Importantly, though, as a start-up predicated entirely on grocery delivery, Instacart shares little in common with massive, relatively diversified tech giants such as Alphabet and Amazon. That matters immensely in terms of projecting Instacart's long-term viability, especially after acknowledging the long history of now-defunct grocery delivery start-ups that have come and gone over the years.

Online grocery delivery was a hot topic of interest during the original dot-com boom around the turn of the millennium. Grocery delivery start-ups, most notably Webvan and HomeGrocer, attracted huge sums of private capital but spectacularly imploded when the high fixed costs common to nearly any delivery and distribution business combined with the recession of financing as the bubble burst. In fact, some remnants of the largest dot-com-era delivery start-ups now make up the technology powering Amazon's budding grocery delivery ambitions.

The fact remains, though, that grocery delivery remains a dubious business. In fact, noted venture capitalist Bill Gurley, who has funded successful start-ups including Uber and many more, cited the massive amounts of venture capital money funding grocery delivery start-ups such as Instacart as a sign of a potential bubble forming in the venture capital community. During an interview last year, Gurley commented on Instacart:

Everyone loved Webvan until it went out of business. ... It's like the old adage -- [when you're] handing out dollars for $0.85, you can go [infinitely]. ... Chosen unicorns are being given hundreds of millions of dollars, but you have to ask how much margin is there. The unit economics [with Instacart] would be very difficult, I'd think.

As a private company, Instacart has financials that are a black box for investors. However, the fact that standalone grocery delivery businesses have a well-documented history of failure should perhaps raise some eyebrows among Whole Foods' investors.

At the same time, it remains unclear how or to what degree Instacart's business model differs from past standalone delivery flameouts. Only time will tell whether Whole Foods' reported investment represents money well spent. To be sure, Whole Foods is certainly feeling the pressure from other grocery retailers that are increasingly incorporating organic offerings into their own stores.

As such, Whole Foods' Instacart investment will prove an interesting experiment into whether grocery delivery indeed is ready to take a more prominent place in our increasingly tech-driven lives.