Why Amazon Is Such a Threat to the Grocery Industry

How could a price drop at a chain with fewer than 500 stores scare a market with 38,000 of them?

On Thursday, Amazon announced that its deal to purchase Whole Foods for almost $14 billion will close on Monday. Once the sale is complete, one of the company’s first moves will be to lower prices on several grocery standards, such as bananas, eggs, and ground beef, as well as Whole Foods standbys like avocados, kale, and almond butter.

After the announcement, the stock prices of a number of the chain’s much bigger competitors—Kroger, Walmart, and the like—took a hit. Which was a little puzzling: There are fewer than 500 Whole Foods locations in the U.S., and yet these pricing changes scared an industry made up of roughly 38,000 stores. (Walmart alone has roughly 4,600 U.S. locations.) How could a company with the footprint of Whole Foods instill such fear in its much larger competitors?

Well, one answer is that it’s not Whole Foods that’s instilling the fear, but Amazon. “Perhaps [investors] think that Amazon's deep financial pockets will free Whole Foods from financial constraints, and a sudden ability to expand,” says Howard Smith, a professor of economics at Oxford University. Grocery chains’ worry is that Amazon could afford to furnish prices low enough to squeeze competitors with less cash—and with investors who want quicker payoffs than Jeff Bezos does—out of the market. It is this possibility that has critics of the acquisition worried that Amazon has attained a level of market power that is anticompetitive.

Another economist I talked to, Northwestern’s David Matsa, suggested that thinking on the scale of 38,000 stores might be misleading. "As opposed to a national thing … it's maybe localized in various markets,” he says. “It's maybe that those are important markets for these companies whose stock prices are responding.” In other words, a Walmart in Chicago might bring in a lot more revenue from groceries than a Walmart in a much smaller city, and the former is where Whole Foods is posing a threat.

Perhaps the most salient point is that grocery stores’ profit margins are so thin, and Amazon is better positioned to cut costs than competitors whose expertise is limited to selling groceries. For every dollar that gets spent at a typical store, about 70 to 75 cents covers the cost of goods, and then roughly two-thirds of the remainder goes toward labor costs. That means that from each dollar they take in at checkouts, stores have about 10 cents or less to put toward rent, utilities, marketing, managing inventory, credit-card fees, and other expenses. Profits usually work out to just 1.25 to 1.5 percent of revenue, according to Michael Ruhlman’s Grocery: The Buying and Selling of Food in America.

It’s not hard to guess the ways that Amazon could start reducing some of those costs, and even marginal improvements would be very threatening to competitors. The company’s technological dexterity could make distribution much more efficient. Its mastery of data could help it figure out exactly when to raise the price of avocados or lower the price of blueberries. And while Amazon told CNBC it wouldn’t be automating cashiers’ jobs anytime soon, it would be surprising if the company is not pondering how it could spend less on labor.

The price cut that Amazon announced Thursday was a bit of a publicity power move, and it counts as the first change of likely many that the company will implement at its newest acquisition. Indeed, there are several further-off possibilities that caused competitors’ stock prices to tumble when the Whole Foods deal was first announced. Amazon’s Prime memberships will become even more enticing once they start coming with “special savings and in-store benefits” at Whole Foods. And Amazon may use the urban real estate that Whole Foods holds as distribution hubs for the rest of its retail business.

After vowing to reduce the price of various best-selling products at Whole Foods, Amazon made an even bigger claim: “We're determined to make healthy and organic food affordable for everyone. Everybody should be able to eat Whole Foods Market quality,” an executive stated in a press release. This could just be high-flown PR talk, but if Amazon truly means “everybody,” it is hard to see how that would work. “Organic food is intrinsically expensive to produce upstream, and it’s hard to see how changes ​downstream (where Whole Foods operates) can change that,” says Howard Smith, the Oxford economist.

But if any company is going to figure out how to pull that off, Amazon would certainly be a contender. The company has logistical expertise that is practically unmatched, and a move toward affordability at a high-end grocery store fits with its announcement earlier this summer that it’d be cutting the price of Prime memberships in half for people on federal welfare. The company has brought about far-reaching changes in a wide range of industries, but it’d be remarkable, even for Amazon, to turn a responsibly-sourced gourmet food emporium into a grocery store that can compete on price.