Is Amazon Crazy To Expand Its Online Grocery Shopping Business?

Earlier this month, Amazon (NASDAQ:AMZN) decided to expand its nascent online grocery business AmazonFresh to Los Angeles after testing it in Seattle for six years. There is no doubt that the company has built a big business by making it convenient for customers to buy products online. But will this work in case of groceries that pose different and unique challenges?

In theory, there is a huge opportunity for Amazon if it is able to successfully build this business as the online channel accounts for less than 1% of total U.S. grocery sales. This proportion is much smaller compared to that for other merchandise categories such as electronics, books, apparel and home furnishing products. However, maintaining an efficient supply chain will be a key challenge as Amazon will need to tackle issues such as refrigeration and freshness of grocery products.

See our complete analysis for Netflix

Supply Chain Will Be A Key Challenge

As Amazon expands its online grocery business, its biggest challenge will be controlling and maintaining an efficient supply chain for a merchandise category that it doesn’t have a lot of experience with. There are added complexities in case of groceries as the company has to worry about installing and operating refrigerators, anticipating customer demand since a lot of grocery items are perishable as well as transporting these items without significantly affecting their molecular integrity.

One could argue that Amazon could buy an existing player that can help it with required expertise in managing this business. There is an idea that was floated by an analyst that the acquisition of Ocado could give Amazon access to one of the most advanced technology/logistics platforms for online grocery. ^[1] That is an option but perhaps Amazon is looking for something better. The company has already spent a substantial amount of time testing the service in Seattle and would probably look to leverage its current infrastructure and supply chain to create synergies that can possibly come with expanding into something new.

Amazon Has Officials From Failed Startup WebVan, Lesson To Be Learned

AmazonFresh has several officials who had previously worked in online grocery startup WebVan that went bankrupt in 2001. This is an advantage for the company as these officials bring a valuable experience, having worked closely on resolving major issues associated with this business. WebVan struggled with maintaining its packing and delivery costs low enough to make the business economically viable. To address this issue, Amazon is focusing on catering to densely populated areas of Seattle and Los Angeles as delivery density is of utmost importance.

However, the market is more competitive than ever with pure play players such as FreshDirect and Peapod as well as big retailers such as Wal-Mart (NYSE:WMT) making efforts to expand their online grocery businesses. U.S. grocery sales stood at $586 billion in 2012 and less than 1% of that came from the online channel. There is a huge opportunity available but complexities involving execution will continue to haunt Amazon until it gets its supply chain formula right.

Our price estimate for Amazon stands at $241, implying a discount of 15% to the market.

Submit a Post at Trefis Powered by Data and Interactive Charts | Understand What Drives a Stock at Trefis

1. Amazon should buy Ocado, says Cantor Fitzergerald analyst, The Telegraph, June 18 2013 [↩]