How Amazon Surprised Everyone With Its Official Debut in Brick-and-Mortar Retail

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Late last year, buzz was building that Amazon (NASDAQ: AMZN) would be diving headlong into a brick-and-mortar store network that would eventually add up to as many as 2,000 locations. And on Industry Focus: Consumer Goods, Vincent Shen and Motley Fool contributor Daniel Kline were among those who believed this major investment could be a logical next step for the retailer.

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As we now know, that's not even close to what happened. In this video, the pair revisits this story to better understand the surprise strategy that Amazon ultimately opted for instead.

A full transcript follows the video.

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This video was recorded on Aug. 22, 2017.

Vincent Shen: So looking back now at Nov. 2016, we talked about Amazon and its potentially massive brick-and-mortar expansion. There was buzz at the time about some of the pilot stores and the positive results that the company had seen, that it was ready to really hit the gas and aggressively expand, as Amazon is known to do. Austin, can you play back the clip for us?

(Shen): Just to give everyone a little bit of detail, you mentioned 2,000 locations. Based on the current planning, the company sees, if the tests are successful ...

(Kline): And this is wildly speculative in terms of where we are.

(Shen): Yeah. The company sees a potential rollout of 200 store openings per year.

So, we threw some caveats in this episode when we first discussed the idea of 2,000 Amazon stores being opened, with potentially 200 store openings per year. Obviously, in the year since, Bezos and his team have taken a pretty different approach. They would rather cut a $13 billion check for an established brand instead. The Whole Foods Market (NASDAQ: WFM) buyout --

Dan Kline: I got this spectacularly wrong! Yes, we had caveats, but my exception was, I thought they were going to buy something else. I really thought Amazon was going to go out there and buy Radio Shack and have thousands of stores and that great retail footprint, and the whole reason they were testing all this stuff was for that. And that, of course, proved to be horribly wrong, and I did not see Whole Foods coming at all.

Shen: The Whole Foods Market buyout, for you and for me and for most of the market, was a huge surprise. But what do you think about that strategy? They're buying about 500-plus stores outright that are ready to go vs. what we had talked about during the show, this idea of building out your store network more gradually, at least you're building it out exactly the way you want it. What do you think?

Kline: I think they could use a hub-and-spoke model. They have these stores, and you've been in a Whole Foods, they're not small. They also already cater to an Amazon-like customer base. So it's reasonable to think, if they're going to add what they call the Amazon Go store, which are these little convenience stores, that having these distribution centers, these larger locations, can help not only serve Amazon customers but also these smaller stores. So I think this is a smart step to jump-start their pipeline and buy a company that is making money that jives really well with their customer base and gives them a foothold and lets them experiment. They can try out new technology much faster, they can really be in the space, instead of having to reinvent the space.

Shen: Yeah. The deal is expected to close in the second half of this year. Whole Foods actually reported its latest quarterly results, and it might be its last quarter of results as a public company. This was about a month ago when it released its earnings. Signs of improvement in that report, but overall, comparable sales were still negative, profitability is still getting squeezed. That's been the story for quite a few years now, and why the stock was down about 50% from previous highs. The net margin, for example, for the last 12 months, is down to 2.4%, which is much closer to what is seen by the company's peer group, whereas in the past that net margin was at 4% or higher, kind of the premium that Whole Foods was able to command and enjoy. But in terms of changes we might see -- let's say it's this time next year, and the Whole Foods acquisition is closed, they're well into the process of integrating the stores -- what are some things that you think you might see, as a customer in stores?

Kline: Well, you're not going to see it, but Whole Foods is going to lower its costs just by having the added buying power of Amazon. I think you'll see a slight shift in merchandise. Amazon has an enormous database, they use this to staff their regional warehouses to know what you want in each market. So if they realize that the customers at a Whole Foods in Seattle are buying a lot of, I don't know, iPhone chargers, well, they're going to stock iPhone chargers in that store, even if they didn't previously. So they're going to be able to use data to refine what they sell, and that's going to be noticeable. I think you're also going to see integration with Amazon ordering and delivery. It might not be like Wal-Mart, it might not be full returns and pickups, but you'll see Amazon lockers or some other ability, especially in city locations where there's a lot of Whole Foods, where if you don't live in a doorman building it's hard to get an Amazon delivery. And I think you're going to see Whole Foods fill some of that gap.

Shen: Yeah, I can definitely imagine, as this integration happens, making use, as well, of all the information on customers that Whole Foods will be able to offer, and at the store locations themselves. And then, the brand power too, I think, despite some of the decline the company has seen in terms of its share price and the business overall. Whole Foods still has that strong reputation and following among its loyal customers.

Kline: Yeah, and I think Amazon can cut into some of the "whole paycheck" argument. If they start bringing in some of the Amazon Basics products, some more house lines, and really work to not have some of the really dumb overpriced things that get people mad at Whole Foods, I think they could smooth some of that out and loan some of the Amazon sheen to Whole Foods while taking some of the Whole Foods upscale and giving it to Amazon. So it really is a nice marriage.

Shen: Yeah. Last point I'll make on this is, with those 500 or so Whole Foods locations to work with, probably enough for Bezos and his team to experiment going forward. But there's still the potential with some of these other pilot stores that they have, in terms of the bookstores and convenience stores that you mentioned, the automated stores where there's no checkout lines, those are still things that could come up further down the line. I just think --

Kline: I think you're seeing the bookstores already. There's a handful of them out there. There's another group of malls that have Amazon kiosks, interestingly enough, where Microsoft kiosks used to be before full-on Microsoft stores went in those malls. So I don't think they're going to roll out in a thousand malls, because I don't think you know which malls are going to exist in a few years from now, but you are going to see a lot more Amazon bookstores, and I think you're going to see convenience stores located in markets where Whole Foods is maybe a once a month drive instead of a once a week stop, and they're going to use the two to support each other.

John Mackey, CEO of Whole Foods Market, is a member of The Motley Fool's board of directors. Teresa Kersten is an employee of LinkedIn and is a member of The Motley Fool's board of directors. LinkedIn is owned by Microsoft. Daniel B. Kline owns shares of Microsoft. Vincent Shen has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Amazon. The Motley Fool owns shares of Whole Foods Market. The Motley Fool has a disclosure policy.