Amazon’s Rounding Error

Paris Market [Photo: R. Wottrich]

Amazon announced the acquisition of Whole Foods this week, the organic grocery food chain, for $13.7 billion. In Amazon’s world, with a market capitalization of $460 billion and a P/E ratio of 185, this amounts to a rounding error. But Amazon’s annual revenues of $136 billion pale beside Walmart’s $486 billion in global sales. Walmart accounts for 25 percent of total U.S. grocery sales. Average sales per U.S. Walmart store, of which there are 4,692, are $66.7 million.

Whole Foods by contrast had 2016 annual sales of roughly $15.72 billion, just 2.3 percent U.S. grocery sales. Whole Foods’s average sales per store, of which there are 430, are $36.6 million. Amazon already has roughly $15 billion in on-line food and beverage sales, so the purchase of Whole Foods could take Amazon grocery revenues over $30 billion, which puts them in the top five of the fragmented U.S. grocery market. But at what cost?

Amazon’s primary focus is the Whole Foods chain of 430 stores, which brings an established grocery distribution network to the Amazon on-line juggernaut. Whole Foods stores are in upscale demographics that match many of Amazon’s targeted demographics. From this perspective, Amazon is plugging the Whole Foods bricks and mortar stores, plus its database of customer preferences, into Amazon’s well-established on-line empire to gain market share in the grocery industry. Using the Whole Foods distribution network in conjunction with Amazon’s on-line scale should drive costs and price points down and capture market share.

Is this a smart Amazon acquisition from that vantage point? The average cost to open a new Whole Foods store is roughly $7.5 million. Amazon’s purchase price works out to about $32 million per store; a premium of $24.5 million per location. Amazon could open its own store/distribution centers of course and they probably could build them for far less than $7.5 million each.

If Amazon’s main premise in acquiring Whole Foods is to expand its distribution network to drive its online grocery business, the $25 million premium per store would appear to be much more than a rounding error.

A recent report by Food Marketing Institute and Nielsen Online projects that American consumers could spend $100 billion on food-at-home items by 2025. Just how much of this $100 billion can Amazon capture? And how much of this captured revenue will be cannibalized out of its own Whole Foods chain?

Conclusion: Amazon overpaid for Whole Foods. But then, they can.

Blog author: Richard Wottrich