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Grocery Wars: Can Amazon Keep the Milk Fresh and Even Make Some Money?


Amazon is reportedly making a big push into online grocery sales.

For the past two weeks, I've hunted my neighborhood supermarkets for oyster sauce to complete my steak stir-fry creations. Frustrated by my inability to locate this evasive condiment (#firstworldproblems), I turned to the one source where I can get anything my heart desires -- (NASDAQ:AMZN).

And courtesy of my Amazon Prime membership, I'll have my Lee Kum Kee Panda Brand Oyster Sauce (along with my 3M Dual Lock Fasteners) shipped to me free by Thursday at 8:00 p.m. EDT:

Incidentally, around the time I was placing this order, the good folks at Reuters published a story indicating that Amazon may be planning a big expansion of its online grocery business.

So let's break it down.

Amazon has plenty of grocery items available for sale on its website, with the most popular items being K-Cups for Keurig brewers.

However, according to the Reuters report, the new initiative will be centered around AmazonFresh, which delivers fresh food items, including perishables like vegetables and ice cream, in the company's hometown of Seattle:

One of Reuters' sources indicates that AmazonFresh will be launched in 20 other urban areas in 2014, with another saying the company was targeting as many as 40.

Looked at this way, this seems like a kooky idea. It's one thing to manage mass quantities of books and digital cameras and any other untold number of items. But it's another thing entirely to deal with huge amounts of fresh, perishable food which will vary in quality and availability according to region.

After all, supermarkets (at least here in New York where many people don't drive) have delivered food for ages, but in those cases, people would bring items like milk and ice cream directly home to avoid spoilage.

Nonetheless, New York's FreshDirect has proven that Internet-driven sales of fresh groceries (including meat and milk) can work, and if Amazon's really planning on rolling this out in new areas, it's got to be doing well in Seattle.

And don't forget about Omaha Steaks, which uses a reusable cooler and dry ice to ship steaks around the country.

Incidentally, after poking around on the AmazonFresh site, I found that Amazon has "temperature-controlled tote bags" that will presumably keep items from getting too hot or too cold:

Now let's talk about the issue of margins.

The grocery business is typically described as low-margin, which is a major source of concern for Amazon's possible grocery adventure.

First, let's remember that investors don't really seem to care about Amazon's margins since the long-term bull case is that the company is taking over the world. (See: Why Amazon's Low Margins Deserve Praise.)

Amazon's gross margins have ticked up as of late, but the stock performed amazingly well from 2009-2012 with no margin improvement:

AMZN Chart

Now, let's take a look at gross margins across many major food retailers:

Amazon's basically smack-dab in the middle here, excluding the outliers like Costco (NASDAQ:COST) which makes money on membership fees, and Whole Foods (NASDAQ:WFM), which sells expensive stuff to rich people. So it's not like food is necessarily a big margin drag, especially when having people use Amazon more and more is a clear strategic benefit that also damages the competition.

And note, if Amazon really cared about margins rather than revenue growth, why would it be so big in consumer electronics, which, outside of Apple (NASDAQ:AAPL), is not a very profitable industry?

You can see here that Best Buy (NYSE:BBY), for example, has barely outpaced Amazon in terms of margins, which is almost certainly the result of sales of high-margin extended warranties at the former:

AMZN Gross Profit Margin Quarterly Chart

Additionally, on the shipping side, Amazon does not appear to be extending Prime to the AmazonFresh business. To get free shipping here, customers will have to to spend $100 or more (for doorstep delivery), or $50 for those who attain "Big Radish" status by spending $300 or more in the previous month. ("Big Radish" status is only valid for one month at a time.)

Occasionally, you'll see items on Amazon that most certainly should not ever be shipped free because of the cost, like this $28.75 25-pound barbell plate:

There is no such nonsense in AmazonFresh.

The idea of Amazon making a big push into groceries, either by simply pushing its existing capabilities or by expanding AmazonFresh, isn't as off-kilter as it may seem.

And in fact, as time goes on, Amazon is going to need new product categories as physical media disappears and traditional consumer electronics devices are destroyed by convergence. (See: Xbox One, PlayStation 4 -- and Apple? -- in the Age of Convergence.) There's $568 billion in annual spending on groceries -- you don't think Amazon wants a bigger piece of all that?

Twitter: @Minyanville

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