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4 Possible Outcomes From Amazon’s Whole Foods Deal [GUIDE]

Posted On July 22, 2017 9:00 am
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The front door of the Amazon.com building

It’s been clear for several years now that Amazon has been making a systematic effort to seize ownership of its supply chain. Success for them means that every step of their shopping and distribution process will be run by the same company. This vertical integration strategy has demanded some aggressive maneuvering by Amazon, with the most conspicuous move recently being the acquisition of Whole Foods.

The rationale behind the vertical integration strategy is the ability to create a unified route from manufacturers to customers that will hedge out other competitors. This is clearly a monopolistic strategy at work here.

The question is whether political or business constraints will stymie Amazon’s efforts. There has already been some increased enforcement of antitrust regulations in Europe, especially against technology companies like Amazon.

What’s significant is that there’s also been signs of a similar trust-busting initiative brewing in the United States as well. The House antitrust subcommittee has asked the Judiciary Committee for a hearing on the Whole Foods deal and its effects on customers. The other question is whether any significant government action can be expected on this issue, from America or Europe, and what effects penalties might have on Amazon’s stab at vertical integration. There are several ways that this confrontation could play out, and each warrants some examination, so that investors can know what to expect in the future for the tech giant.

Outcome No. 1: Vertical Integration Succeeds

A handful of people standing in front of a Amazon Go wall

One possibility is, of course, that government action is either nonexistent or insufficient to induce Amazon to change its current course, and the company succeeds in its bid to craft an integrated supply chain. In this situation, Amazon’s buyout of Whole Foods is merely a prelude to more ambitious acquisitions in other sectors.

Amazon CEO Jeff Bezos has expressed his desire for Amazon to be everywhere its customers are. While it’s anyone’s guess as to where that kind of ambition will end, the starting point seems clear enough. Supermarkets are one thing, but retail in general seems to be Bezos’ target for disruption. A move on the retail sector could involve buying up low-end retailers like Dollar General, as some have speculated. A more ambitious move would be to follow a strategy that Forbes considered, and to purchase a department store chain like Macy’s to reinforce their position in the apparel business.

Regardless of their specific approach, a victory for Amazon’s vertical integration strategy would have a profound economic impact. There are some potential benefits to this sort of market development, namely reduced costs and greater efficiency. In this case, Amazon hopes to use a foothold in Whole Foods to expedite food and grocery deliveries to its customers, a long-standing goal of the company.

However, there is also the danger of monopolization. Much of the coercive power from this technique comes from what’s called market foreclosure; by controlling their entire supply chain, Amazon would be able to restrict buyers’ access to suppliers, or vice versa. By doing this, Amazon would be able to leverage their position to extract lower costs from suppliers on one end of the value chain, while also charging higher costs to the consumers at the other end.

It’s because of this danger that the US government takes an interest in these kinds of transactions, which leads us to considering the scenario where they do take action.

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Outcome No. 2: Vertical Integration is Abandoned

The outside of a Whole Foods store in Markham, Canada

There is also a chance that the US government may halt or significantly inconvenience Amazon’s integration strategy. The Whole Foods merger still awaits approval by regulatory agencies, and a rejection of the buyout may still be in the cards from them. Although politics is beyond the scope of this analysis, it would be remiss to ignore the fact that the Federal Trade Commission’s members are appointed by the President, and there’s some considerable animosity between Bezos and Donald Trump because the former’s ownership of the Washington Post.

Those personal details aside, what matters is that a rejection of the Whole Foods merger is a tangible possibility. While it’s unlikely that that alone would be enough to induce Amazon to forego the vertical integration approach, it’s worth keeping in mind the consequences if, as President Trump has warned, Amazon does come under government pressure over potential breach of antitrust regulations.

Although there doesn’t seem to be much serious concern over Amazon facing serious difficulties from most investors, there is at least one high-profile example of bearishness making the rounds, in the form of hedge fund manager Doug Kass. Kass has told Reuters of his intention to begin shorting Amazon’s shares, on the grounds that the due diligence being conducted in Washington over the Whole Foods deal could “lower Amazon’s shares by 10 percent overnight,” something he says “has the potential of being the biggest business story of the year.”

It certainly would be that, if such a damaging outcome came to pass. Although this level of pessimism seems excessive, calls for a Congressional investigation into Amazon’s impact on market competition are increasing. In addition to their vertical integration plans, Amazon also follows an unorthodox business model where profits are deliberately kept minimal quarter after quarter, making it hard for competitors to maintain their margins. Should they happen, these inquiries may yet prove a stumbling block to the company’s larger ambitions beyond the deal with Whole Foods.

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Outcome No. 3: The Whole Foods Deal Fails, But Amazon Adjusts

A green Amazon Fresh delivery truck

What may be more likely is an outcome that’s neither of the prior extremes, but something in between. In this case, Amazon still faces some serious hurdles in its efforts, but makes the calculation that a partially integrated supply chain is still preferable to none at all, and acts accordingly. There hasn’t been as much speculation on this possibility, perhaps because most commentators already treat the Whole Foods merger as a done deal, but it still bears mentioning.

As far as the grocery business goes, the purchase of Whole Foods merely represents Amazon’s latest venture into the industry. The subsidiary company Amazon Fresh was founded in 2008 and has progressively expanded since then, and even that followed a number of failed attempts at buying distributors. More than anything, the company’s main concern seems to have been the streamlining of distribution and delivery. Even if antitrust concerns scuttle the current deal, Amazon has faced numerous setbacks on this road before, so there’s no reason they wouldn’t continue towards this goal.

The main challenge to good grocery distribution has always been logistical, with “last mile” delivery driving presenting the most difficulties. One of Amazon’s favored solutions is to try and replace delivery of goods with pickup by consumers, where possible. This is the rationale behind AmazonFresh Pickup, where Amazon Prime members get to shop online and arrange a pickup time to come into a store with their selections ready to load up into the car. It also seems to undergird the Whole Foods purchase, since the chain’s spread of store locations will make a pickup-based strategy more convenient for a wide variety of consumers. Should the merger be blocked by regulators, a continuation of this plan to increase the share of Amazon-affiliated store locations seems to be the most likely outcome.

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Outcome No. 4: Amazon’s Competitors Escalate

Pictured, is a parked Google Shopping Express Car

In addition to federal regulation, there’s one other danger Amazon must contend with: retaliation from either rival tech companies, or else from the retail industry that they’re invading. The window of opportunity for a rival bid for Whole Foods has passed, but according to the SEC, there were at least seven other offers made, indicating that there was some desire by other companies to forestall Amazon’s success. Some possible competitors that were speculated on during the bidding process include companies like Sprout and Target.

In addition to retailers like those, another company to keep an eye on is Amazon’s fellow internet giant, Google. Google has spent several years attempting to break into Amazon’s core market with Google Shopping Express, a competitor to Amazon Prime. Like Amazon, Google has been aggressively expanding its reach nationwide, although its use of Whole Foods as a distribution partner will be complicated by Amazon’s move. If anything, though, the possibility that Whole Foods will now transfer its deliveries away from Google and towards Amazon provides additional impetus to respond.

Whether this takes the form of Google acquiring some food companies of its own, or else through expanded relationships with existing partners like Costco remains to be seen, but a successful attempt at vertical integration by Amazon is likely to encourage Google and other competitors to respond in kind. Barriers between e-commerce brick-and-mortar distributors are breaking down, and increased consolidation of the two sectors may prove a logical consequence of this shift.

What this means for investors is to expect some changes and turbulence in the world of supermarkets and retailing. Although some skepticism remains about the partnership’s long-term viability, the fact remains that supermarkets now face a low-cost, extraordinarily pervasive Amazon whose reach is wider than ever before. Profit margins in this industry are likely to face downward pressure from Bezos’ trademark business model, and companies that can’t adjust to this new reality are likely to either get bought up or fold altogether. The bar has been raised in this corner of the economy, and the impetus to lower costs and improve service has never been greater.

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