AmazonFresh’s (AMZN) Sneaky Business Strategy – Compete with Premium Grocers, Build Out Distribution Model, Enter Mass Market With Force

This story was updated on October 3, 2013, at 4:15pm, with perspectives from former AmazonFresh executive Tom Furphy.

Amazon.com Inc.’s (NASDAQ:AMZN) online grocery arm, AmazonFresh, could be cooking up a smart long-term business strategy, according to one leading retail consultant.

In a draft report on online U.S. grocers, grocery retail expert Bill Bishop wrote that mass-market grocers seem to be sighing with relief, despite nervous buzz earlier this summer over AmazonFresh’s expansion into several cities, beyond its current Seattle and Los Angeles markets.

“Industry fears about immediate competition with the online giant soon began to diminish, primarily for two reasons,” read the report. “The combination of Amazon prices and fees suggested that Amazon Fresh wasn’t targeting the mass market. It appears that they plan to compete directly with upscale retailers such as Whole Foods (NASDAQ:WFM) and Costco (NASDAQ:COST).”

But that’s only the first step in a two-step strategy, Bishop told International Business Times. Mass-market supermarkets should remain on guard, he said.

Focusing first on upscale shoppers allows Amazon to fine-tune its knowledge of this key demographic and raise shopper satisfaction scores to match rivals Whole Foods and Costco.

But more importantly, it may tempt ordinary supermarket retailers into believing that AmazonFresh doesn’t pose an immediate or major threat.

Meanwhile, behind the scenes, AmazonFresh can optimize its distribution systems, plant warehouses and quietly correct blunders. And it can make some money, too, thanks to high margins from selling premium groceries.

“All this could be done while larger retailers see no immediate threat and, therefore, no need to react,” reads the report. “When ready, Amazon can begin to exploit these new advantages, along with lower prices, to win the business of the next-lower income segment of shoppers.”

“Let’s go someplace where no one is going to pay attention to us,” said Bishop to IBTimes, summing up this business strategy. “And by the way, earn the full premium while you’re doing it.”

“How could you have a more inviting entry strategy? No one’s studying you, and no one’s that worried about you,” he said.

The notoriously reactive retail industry will likely play down a distant threat, said Bishop, and so may feel reassured by a seemingly modest and minimalist approach from AmazonFresh.

There’s little that AmazonFresh’s brick-and-mortar supermarket rivals can do in the meantime, said Bishop, aside from upping their digital game.

Amazon has already targeted families with several children, who typically spend more than $10,000 annually at supermarkets, retail consultant Burt Flickinger, from the Strategic Resource Group, told IBTimes.

He pointed to Amazon’s interest in big-selling products like laundry detergent, diapers and coffee and tea, citing Amazon’s ownership of Diapers.com and Soap.com. Meat and produce only account for a fifth of food retail sales, he estimated.

Still, it’s far from clear that AmazonFresh can produce a delivery system and profitable customer base. That’s even as it ties AmazonFresh to Amazon Prime, its membership service which attracts loyal and wealthier customers, who shop online more frequently.

In the company’s most recent earnings call, in late July, Amazon.com chief financial officer Thomas Szkutak told analysts that the chief challenge to AmazonFresh is an economic one.

“The challenge that we had over the past several years is how to make it economically viable,” he said. “…It’s very, very early. So, it’s something they will continue to work on both from a customer experience and from an economic standpoint, and there is not much more I can add to that right now.”

He dodged a question about whether the AmazonFresh pilot in Seattle, which began in 2007, has been profitable. The company doesn’t disclose financial information specific to AmazonFresh.

Pricing and profitability are key unresolved issues for AmazonFresh, said Flickinger, though the fundamentals of the business model have been worked out.

“One of the things they have to work out in addition to the cost of logistics is … are they going to price at a loss, like Kindle? That will involve possibly questions from the Federal Trade Commission, or anti-trust enforcement at the Department of Justice,” he said.

Some of America’s brightest minds have worked on proofing the business model for online grocery delivery: “But they have not been able to take it profitably to scale, on a meaningful basis across many markets,” said Flickinger, citing the legendary Webvan bankruptcy in 2001, the most notorious failure among online grocers.

AmazonFresh is likely to expand into other cities in coming years, including San Francisco and New York. It’ll likely benefit from a slowly growing market for online groceries in the U.S., led by rich and young consumers.

But it will face fierce competition. San Francisco is a particularly crowded market. Competitors like Instacart, led by a former Amazon employee, are also targeting Chicago and several other cities in 2014.

“There’s no clear winner as of yet,” said Flickinger. “With the Fresh Directs and the Peapod model, there’s no clear winner, but tremendous opportunity.”

UPDATE - Comments from former AmazonFresh executive Tom Furphy:

Tom Furphy, a former vice president with AmazonFresh who helped run the unit from 2005 to 2009, told IBTimes in an email that Bishop's theory may be broadly accurate, but probably isn't a deliberate move to dodge attention from rivals on Amazon's part.

"They've ended up where they are (higher priced, premium service) as a result of their continued tweaking of the model to achieve a palatable level of profitability for the near term," he wrote.

He believes AmazonFresh has given up, for the near future, on reaching the sheer volume of fresh grocery deliveries needed for a profit, if those deliveries are free.

"They appear to be charging premium costs to subsidize their growth-stage inefficiencies and lack of scale," he wrote. "As they build efficiency and scale over time, they will likely be able to offer a more affordable service, which will be appealing to a broader segment of the population."

"I highly doubt they are intentionally competing with only the likes of Costco and Whole Foods now so that traditional grocers will dismiss them as a threat. Amazon could care less about competition," he continued.