Amazon Buys Whole Foods A Case in Mergers and Acquisitions Amazon Buys Whole Foods • June 16 2017, as Seattle based e-commerce giant Amazon announced that it would pay $13.7 billion to purchase Austin-based Whole Foods Market (Whole Foods), the leading U.S. organic and natural foods supermarket. • News of the merger precipitated a broad sell-off in the shares of grocery retailers and suppliers. Shares in Kroger, the largest U.S. supermarket operator by both sales and store numbers – lost 14.5%. Investors unloaded other grocery shares too. Supervalu declined by 17%; organic Sprouts Farmers Market by 12.7%; Costco by 7%. Shares in Whole Foods’ primary supplier, United Natural Foods Inc. (UNCI) declined by over 15%. General merchandisers with grocery revenues wilted as well. Target by 10% and Wal-Mart, the largest seller of grocery items in the U.S., by 7%. Amazon Buys Whole Foods (cont.) • Behind the precipitous declines lay recognition that Amazon’s bod move into brick and mortar assets offered transformational opportunities. For Amazon, Whole Foods offered expertise in perishable product sales and procurement, plus access to Whole Foods’ 30 million well-off shoppers and 463 physical store locations in key U.S. markets. For Whole Foods, opportunity lay in absorbing Amazon’s technology and process expertise to modernize and to reduce operating costs. • Under co-founder and CEO John Mackey, Whole Foods had one of the industry’s highest cost structure. The U.S. Retail Grocery Business • In 2017, the $800 billion U.S. grocery retailing business was more competitive than ever, amid heavy discounting. In recent decades, U.S. grocery retailing formats had proliferated. Joining traditional supermarkets, operated by firms such as Albertsons and Kroger, were general merchandisers and supercenters such as Target and Wal-Mart, membership-only discount warehouses such as BJ’s and Costco, natural foods retailers such as Whole Foods, discounters such as Aldi, dollar stores such as Dollar General (over 13,000 locations), drug stores such as Walgreen’s (over 8,000 locations), and online grocers such as FreshDirect and Peapod. • As a result, in 2016, the amount of food retailing space per capita hit a record 4.15 square feet, almost 30 times the level of 1950. The glut of space led Kroger to nearly halve its number of new stores planned for 2017. Wal-Mart expected to cut new stores from 132 to 55 in 2017. Retailers were closing stores. The U.S. Retail Grocery Business (cont.) • For 2016, operating margins in the U.S. grocery retailing businesses averaged 3.4% or 1/3 of the 10.4% average for all U.S. industries. This was due to 2016 being the longest period of falling food prices since 1960. In 2016, both food retailers (Costco and Whole Foods) and distributors (including Sysco and US Foods) blamed their lower margins on food price deflation. Stagnant real wages impeded retailers from raising prices. In 2016, the income of the bottom 60% of the U.S. population had not yet recovered to the level of 2007. Between 1980 and 2016, real median household income in the U.S. had risen just 25% while GDP had grown 154%. • On the input side, farmers, suppliers and grocers faced oligopoly pressure. As early as 2005, three firms (BASF, Bayer, and Syngenta) controlled half of the world agrochemical market. Nearly half of the U.S. corn and 85% of U.S. soybeans grew from genetically modified seeds and a single company, Monsanto, supplied the seed planted on 88% of the land growing genetically modified crops worldwide. • One company supplied over half of the U.S. synthetic fertilizer. Four firms supplied 80% of U.S. farm equipment. Another four controlled 60% of U.S. grain terminal capacity. Three firms handled 81% of U.S. corn exports. 65% handled soybean exports. Two massive mergers promised further concentration of control over inputs • Bayer agreed to purchase Monsanto in 2016. • Dow Chemical and DuPont merged in 2017, pooling the seed and agricultural businesses Some food suppliers responded with vertical integration: • Cargill was the leading global supplier of processed grain and food and a top supplier of U.S. beef and poultry. • Spain’s family-owned Munoz Group supplied European markets with fresh fruit and juice. Whole Foods Market • John Mackey and three colleagues founded Whole Foods in 1980 and grew it into a leading global retailer of organic foods. • It became the largest supermarket natural foods chain by acquiring existing natural food stores nationwide. • In the late 1990s and early 2000s, the company rapidly began building and opening new stores. • In 2002, Whole Foods expanded internationally into Canada and then by acquisition in 2004 into the U.K. • In 2004, the proportion of Whole Foods shoppers with incomes below $25,000 slightly exceeded the proportion of low-income shoppers patronizing the average U.S. supermarket. • In 2016, only 2.1% of consumers with incomes below $25,000 shopped at Whole Foods, two-thirds less than the average for all supermarkets. • Between 2004 and 2016, Whole Foods lost both millennial and senior citizen shoppers, instead adding adults aged 35-49. The company maintained a strong presence in the U.S., Northeast, Northwest, and among college graduates and individuals with household incomes greater than $100,000. Whole Foods “the Deal” • In 2012, Whole Foods announced plans to grow from 317 to 1,000 stores over the better part of the decade. After one year of operations, initial results were positive and stores were smaller but revenue per square foot increased by nearly 30%. • Unlike customers at most supermarkets, about 75% of existing Whole Food customers were willing to drive beyond the grocer that was most convenient to them in order to shop at Whole Foods. • The new Whole Foods stores caused significant unanticipated cannibalization of sales at existing Whole Foods stores. • Whole Foods began offering price promotions and discounts to attract shoppers from lower-priced rivals. • Whole Foods absorbed supplier price increases to keep retail prices steady. Whole Foods “the Deal” (cont.) • In 2015, Whole Foods partnered with enterprise software firm Incor to improve its supply chain management. Whole Foods had handled some logistics manually unlike other grocery chains. The system started to capture hundreds of data points about perishables, not simply units in inventory but produce water consumption and harvest date. Data on product origins and growing conditions would facilitate traceability, thereby offering Whole Foods greater accountability for inventory quality. • In 2016, Whole Foods centralized its non-perishables purchasing, replacing its reliance on buyers spread across 11 different regions of the U.S. This was very complex and too costly to manage. • In May 2016, Whole Foods opened its first line of value-oriented stores called 365 by Whole Foods market in order to target Millennials. Additional stores in California, Ohio, Oregon, and Texas followed. Added digital-only price tags to more easily and efficiently update prices and speed up checkout with electronic-only pay. Whole Foods “the Deal” (cont.) • Offered mobile coupons in January 2017 through the Whole Foods’ app. • Whole Foods revenue and earnings growth declined each year between 2012 and 2016. In July 2016, Goldman Sachs issued a sell rating, arguing that the company is losing share in core natural and organic business to many grocery stores. In November 2016, Mackey’s co-CEO, Walter Robb, stepped down but would remain a director. Between 2015 and 2017, shares of stock lost 50% of its value. In April 2017, Jada Partners took an 8% stake in Whole Foods to force management turn and pushed to sell the company. UNFI supplied 33% of Whole Foods purchases and Whole Foods generated 35% of UNFI’s $9.3 billion in revenue. They had a contract through September 2025 but UNFI was unsure about continuing. Amazon • Amazon built a massive but flexible supply and fulfillment chain that emphasized focus, innovation, operational excellence, and frugality. Its distribution centers had no obligation to display products attractively or ensure easy access to them. Supermarkets were obliged to provide wide aisles for customer access and ADA shelving heights. Amazon was not reliant upon register receipts and loyalty programs for consumer behavior data. Amazon recorded every webpage on its site. Amazon owned data on customer names, credit card numbers, addresses to build customer profiles. • By 2017, Amazon operated 80 distribution centers worldwide to speed delivery service and enhance customer satisfaction. The 2012 acquisition of Massachusetts-based robot developer and manufacturer, Kiva Systems, improved warehouse efficiency by automating order picking and cut Amazon’s fulfillment costs by 20%. Amazon invested in its own fleet of delivery vehicles and leased dozens of Boeing 767 cargo aircraft. Amazon can route orders to drop shipment partners to handle shipment and delivery. • Amazon’s size and scale gave the company influence over suppliers. In 2016, Amazon captured nearly $1 of every $2 Americans spend online. Amazon does not have the limits of store size. It can offer more product assortments online and maintained low physical inventories. It relies on producers and wholesalers to supply product as orders arrived. Amazon and Groceries • Amazon entered the grocery market in 2007 with AmazonFresh and invested in HomeGrocer.com (an online supermarket) in 1999. This expansion was consistent with its mission to add product and services that offer value to Prime members. • AmazonFresh was a membership only online grocery store. For $14.99 per month, Prime members could receive home delivery of produce, etc. Deliveries were made during scheduled time windows in insulated containers. • Problems resulted with mismatches between supply and demand, limited appeal of selecting foods from a screen, and a high cost structure. Amazon Whole Foods Deal • Amazon believed that buying Whole Foods was a way to mitigate those challenges. • Amazon’s all-cash deal to purchase Whole Foods for $13.7 billion valued the company at $42 a share, a 27% premium over its previous day closing price. • Largest acquisition to date but its cost is less than 3% of Amazon’s market capitalization of $475 billion. • On the day of the deal, Amazon’s share price closed up 3% at $987.71. This was unusual. Usually, the share price falls. • In return, Amazon took ownership of 11 distribution centers, 470 Whole Foods stores, and nearly 89,000 employees. After the Merger • The deal was closed on August 28, 2017 and after that immediate changes were made. • Whole Foods stores cut prices by 43% on key organic and conventionally grown perishables, like bananas. This boosted Whole Foods traffic by 25% within 2 days. • Whole foods placed Amazon delivery lockers at the front of the stores for pickup and return of online orders. • Over 100 Whole Foods stores began displaying and selling Kindle e-readers, Fire TV digital media players, and tablets, and Echo smart speaker devices. • Amazon added 2,000 products from Whole Foods of its 365 Everyday Value private label branded goods and sold out of all but 7% of the 100 most popular items. • Delivery options included use of AmazonFresh, Prime Now and Prime Pantry (home delivery of individual packages of non-perishables for $6). • In the first week, Amazon sold $500,000 worth of Whole foods products through the Amazon website. • As the deal closed, Amazon announced that Amazon Prime would become Whole Foods’ customer loyalty program, replacing the company’s limited efforts to create its own. By offering discounts and offers unavailable to other Whole Foods shoppers, the move sought to encourage Prime customers to explore Whole Foods offerings and to induce Whole Foods patrons to enroll in Prime. Whole foods would now receive data on customer shopping patterns to optimize in-store display, selection, layout, and sourcing. Amazon would gain the ability to overlay its online customer data with in-store display, selection, layout, and sourcing. Amazon would gain the ability to overlay its online customer data with in-store shopping data from Whole Foods, improving its knowledge its own and of Whole Foods Shoppers.
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