What Amazon Needs Most From Whole Foods

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It's been two weeks since Amazon.com (NASDAQ: AMZN) took over Whole Foods, and there are already several signs of progress. 

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As widely expected, Amazon has lowered prices, targeting staples such as milk, bananas, and avocados.  However, some customers didn't even notice the price cuts or said they weren't lower enough to make a difference, as they seemed to be focused on specific items rather than being implemented across the board. 

Still, the news attracted an increase in customers, as JPMorgan Chase analysts said traffic trends at stores they studied were the best in three years. Foursquare found that traffic jumped 25% in the first two days, though much of that boost is likely to be related to the hype around the takeover. Amazon said it will continue to lower prices at Whole Foods, but improving performance at the organic grocery chain is only a small part of Amazon's ambitions in the supermarket industry.

Grocery sales in the U.S. total around $800 billion, but Whole Foods brought in just $15.7 billion last year, or only about 2% of nationwide grocery revenue. In other words, despite its well-known brand name, the company is dwarfed by industry leaders Wal-Mart (NYSE: WMT)Kroger (NYSE: KR), and Costco Wholesale, which control more than half of the market.

That means the threat from the Whole Foods stores themselves to larger competitors is probably less than Wall Street has feared. Kroger shares, for example, fell by double digits when Amazon announced it would acquire Whole Foods, but the company has more than six times as many locations as Whole Foods. Sixty percent of Whole Foods stores are located within 10 miles of a Kroger market, but that means only about 10% of Kroger stores compete directly with Whole Foods. For Wal-Mart, which dominates rural America, the overlap is even smaller.

Playing the online game

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For the Whole Foods acquisition to be truly successful for Amazon, it needs to find a way to take grocery e-commerce mainstream as it's done with so many other categories, from books to electronics to the odds and ends that make up the tens of millions of items available on its website.

Amazon's inability to break into that market on its own seemed to be the impetus for the Whole Foods takeover, but there are signs that the deal is boosting its online sales as well. Following the closing, Amazon immediately put 2,000 Whole Foods 365 items on its website, such as canned beans and tomato paste, and sold out of many of them.   Research firm One Click Retail estimated that Web sales of Whole Foods items totaled $500,000 in the first week.

While those are positive signs, the biggest opportunity for Amazon may be in using Whole Foods locations as staging areas for grocery deliveries, or as pick-up locations. Since many of the stores are located in high-income neighborhoods in large cities, the demographic that is mostly likely to be an Amazon Fresh customer, the stores could also help make delivery more efficient.

It's clear that the supermarket industry is moving away from the traditional brick-and-mortar model. Wal-Mart has scaled back on new store openings and is instead investing in improvements such as grocery pick-up kiosks, which are now available at 1,000 stores.  The service allows customers to place orders online and pick them up at a time of their choosing without their car for no extra cost. The program appears to be popular based Wal-Mart's recent U.S. e-commerce revenue growth at 63% and the speed with which it's expanding it.

Kroger has over 500 of its own pickup locations, though it charges $5 for the service. The hybrid pickup model appears to be the most efficient way to use the internet to sell groceries, but there's no question that delivery would be more convenient.

Wal-Mart has a store within 10 miles of 90% of the U.S. population. Kroger has nearly 3,000 locations across the country. Even with Whole Foods under its umbrella, Amazon will never match the brick-and-mortar presence of its top rivals. For the company to disrupt the grocery market, it has to do so online, by making grocery delivery as normal as any other kind of online shopping. That remains its biggest challenge as it experiments with its new shiny toy.

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Jeremy Bowman owns shares of Kroger. The Motley Fool owns shares of and recommends Amazon. The Motley Fool recommends Costco Wholesale. The Motley Fool has a disclosure policy.