What Can Target Do To Combat Competitive Pressure From Amazon-Whole Foods?

Recently, Amazon (NASDAQ:AMZN) announced that it has agreed to acquire upscale grocery chain Whole Foods for $13.7 billion. With this acquisition, Amazon expects to gain access to a strong brand, a network of more than 450 stores and also an immediate expansion of its distribution network, which could lead to a rapid expansion of the AmazonFresh delivery service.

This intersection between food and technology companies has been playing out for years now, allowing companies to experiment with omni-channel retail, so that they do not miss out on the next wave of growth. Target (NYSE:TGT), has also been investing heavily in its e-commerce initiatives of late. However, it is going to take a lot of effort on its part to keep up with Amazon (not to mention Wal-Mart, which has spent billions on e-commerce initiatives and acquisitions). With Amazon acquiring Whole Foods, Target’s grocery business is going to face a lot more competition in the coming years.

The Whole Foods-Amazon entity is going to have significant e-commerce capabilities and a presence in cities and affluent markets, where people are generally more likely to take advantage of innovative e-commerce offerings. Amazon has made its interest known in the grocery space for a while now. The company has launched its grocery delivery service Amazon Fresh in several markets, and is currently testing Amazon Go, an app-based, checkout-free grocery store. Although Amazon captures a very small percentage (<1%) of the highly fragmented online grocery market, it is expected to command approximately 3% (third largest grocery share behind Wal-Mart and Kroger) of the total estimated $903 billion grocery market by 2021, according to Cowen & Co. To add to that, Amazon will further boost its share following the Whole Foods acquisition.

Amazon mostly caters to the middle and higher ends of the market with its Prime service, which has an estimated 65-80 million members according to recent data. The acquisition of Whole Foods should allow it to sell more groceries, on an even more convenient basis, to its Prime members. It will be interesting to see how traditional retailers such as Wal-Mart and Target address this problem. In order to compete with the growing threat from Amazon, Wal-Mart plans to accelerate efforts in its technological capabilities and leverage its wide network of 4672 stores in the U.S. Wal-Mart has already spent billions on e-commerce initiatives and acquisitions such as Jet and Bonobos.

Target’s grocery sales represents about 20% of the company’s total sales. However, groceries are important because the retailer continues to witness pressure on comparable sales growth, driven by declining traffic and lower average transaction amounts at brick and mortar stores. The company generates higher overall sales in stores that offer groceries, and plans to make itself a more compelling destination for grocery shopping with several initiatives such as adding organic and gluten-free brands, more localized fresh products and better distribution to boost the grocery business. In fact, the company’s strategy includes renovating stores, supply chain improvements and increased promotions, all at an estimated cost of $7 billion over the next 3 years. But Amazon’s Whole Foods acquisition could complicate Target’s re-modelling strategy, as there is a considerable overlap of customers between Amazon Prime subscribers and Target.

Target’s online sales accounted for 4.3% of the company’s total sales in 2016, up from 3.5% last year, compared to around 3.2% for Wal-Mart for the same period. Although Target is grappling with declining comparable store sales, that can be offset through effective e-commerce initiatives given the growth in its online sales. The company has been testing next-day shipping on essentials to compete with Amazon Prime and Wal-Mart’s free shipping offering.

However, if Target doesn’t make substantial progress with its e-commerce offerings and its grocery business, it could see a lot of pressure in the long term due to declining overall store traffic.

 

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