Amazon Doesn't Need to Make Money on Groceries, Putting Pressure on Wal-Mart, Kroger

Amazon.com Inc. will bring lower prices to its new Whole Foods Inc. division Monday. It also will bring a new rule book.

While Amazon doesn't need to make money from its grocery division yet, food sales are crucial for traditional players like Kroger Co., Wal-Mart Stores Inc. and Target Corp. The extremely competitive food-retail business demands high capital investments for low margins. Supermarkets' success has mainly relied on getting customers into conveniently located stores with deals.

"Amazon's using the same playbook they always have when competing with booksellers and other retailers," says Chris McCabe, a former Amazon performance evaluation and policy enforcement investigator who now works with sellers on the retailer's marketplace. "They take out their revenue stream by killing them slowly on price."

Amazon and Whole Foods declined to comment.

The Amazon-Whole Foods deal, sealed about 10 weeks after its announcement, has weighed on the grocery sector, pushing food-retail stocks down 20% this year. Consumer-packaged good shares have fallen about 7% as legacy brands struggle with American consumers' increasing interest in the fresh and natural foods sold at stores such as Whole Foods, along with Kroger, Wal-Mart and a growing number of traditional supermarkets.

Wal-Mart, no stranger to Amazon's rivalry, is confident in its strategy and is spending billions of dollars to lower prices, spokesman Randy Hargrove said. The retailer is working to spruce up its stores and offer e-commerce pickup options at 1,100 of its roughly 4,600 stores by year-end. Wal-Mart in the past has moved quickly to meet challenges from Amazon, most recently acquiring a string of e-commerce startups -- including a $3.3 billion deal for Jet.com -- and testing same-day deliveries.

"Amazon is really good. We certainly have respect for them, and we have experience competing with Whole Foods," said Steve Schmitt, Wal-Mart's vice president of investor relations, when speaking to shareholders earlier this month.

Executives at Kroger, whose shares are among the hardest hit in recent weeks, say they haven't changed their strategy following Amazon's push into grocery, but now feel a heightened urgency to invest in technology to better tailor promotions to shoppers and expand online-grocery pickup.

The U.S.'s largest traditional supermarket chain is also sacrificing profits in select markets. "If we have to sell a can of corn for 40 cents, we'll figure out a way to sell a can of corn for 40 cents," said Mike Schlotman, Kroger's chief financial officer, during a recent interview.

Kroger, which reports earnings next month, has lost more than $7 billion in market valuation since it reported a disappointing financial outlook in June. Its stock is down by 36% since the start of the year.

News of the Amazon deal has also hurt Target's stock, and the retailer is putting renewed focus on its grocery business. Target has hired a number of food-retail executives and put more attention to its assortment this year after grocery had declined in sales.

Amazon has focused on the long term when it enters a new business, with a pledge to make bold investments to gain market leadership. While Amazon's grocery plan is still unclear, the company wants to draw customers into stores with lower prices and more convenience, adding perks like Amazon pickup lockers and Prime membership benefits, according to former executives.

Online grocery sales remain small, but they are growing fast. Same-store sales for online ordering at supermarkets are growing 26% year-over-year, with an average online transaction size of $148 -- much higher than the $35 average for in-store purchases, according to internal market research by consultancy Brick Meets Click.

Whole Foods had one of the poorest price perceptions among 13 national food retailers, according to a Morgan Stanley survey of 2,900 U.S. grocery shoppers last month, which also found its customers were nearly twice as likely to earn upward of $125,000 a year than Kroger shoppers. Whole Foods began to lower its prices in 2015 as its sales slipped, but the promotions did little to woo back customers. Those cuts weren't as extensive as analysts expect to see this week.

Still, Americans increasingly want to eat better, and the Whole Foods name continues to symbolize quality. "The brand is incredibly aspirational. Amazon knows this," said Scott Mushkin, managing director at Wolfe Research, LLC.

Slashing prices is an easy first move, but more telling will be if Amazon can determine how to use data and algorithms for real-time price matching and better identifying what consumers are willing to pay in store, said Greg Portell, lead partner in the retail practice of A.T. Kearney.

If Amazon can figure out what Whole Foods shoppers are willing to spend for organic tomatoes and grass-fed beef, it could result in more regular visits from customers including Elizabeth Alderman, a 37-year-old senior product manager and Amazon Prime member from Chicago.

"We don't buy their meat all the time, because it is really expensive and we have other options," she said, something she's willing to change if prices drop.

Write to Heather Haddon at heather.haddon@wsj.com and Laura Stevens at laura.stevens@wsj.com

(END) Dow Jones Newswires

August 27, 2017 19:07 ET (23:07 GMT)