By Alex Pollak, Chief Investment Officer, Loftus Peak
Amazon in the past 24 hours has confirmed it will launch a full scale retail offering in Australia – it is now calling for local retailers to join its global marketplace as part of the launch, having already briefed CB Richard Ellis for warehouse space earlier this year.
The Coles and Woolworths share prices will be off today, or at least should be.
The problem for the big Australian retailers is that Amazon’s retail model doesn’t just focus on groceries – it uses a broader, whole of wallet approach to attack every part of the retail chain, leaving the big supermarkets scrambling for a competitive response.
It does this by building feeder businesses which bring in new customers in one area and then cross selling them stuff in another. Bezos refers to it as his ‘flywheel’.
For example, by signing up with Amazon Music, which is about the same price as Spotify, a customer may qualify for a Prime Membership, which provides free shipping. So low prices and home delivered groceries thrown in with the complete Bee Gees collection.
The company is also building a large presence in a Netflix-like service called Amazon Video. This video offering may be coupled with a Prime membership – for example Prime customers will get Season 1 of American Playboy, the Hugh Hefner show, for free.
The Playboy show isn’t a one-off: Amazon will this year spend US$3.2b to become the fifth largest US TV content producer after ESPN (US$7.2b, but that’s mostly sport) Netflix (US$6b) and CBS and NBC (at just over US$4b each.)
Or the Amazon Go stores, which are mostly there to learn about you and your buying habits in order to better fleece you later.
All of this creates more pressure for competitors, who are already under pressure because of an ageing retail mall model.
Amazon understood that by siting its distribution centres outside traditional shopping districts, the company was able to reduce a significant cost – its rent – and then share the benefits of the lower costs with couriers, customers and shareholders. This has worked – Amazon sales are US$136b, and its Prime membership base in the US is up 20% to 65m customers, who by paying US$99 annually enjoy free delivery within two hours. The Amazon price is now over US$900, having tripled in under three years. It is bigger than Walmart.
This is the problem for Woolworths and Coles. If it were just about competing with them on their own terms in malls, Amazon would fail since it would never get the same locations and the same space. In Australia Aldi has had some success in second tier locations, but hasn’t really hit scale because of the lack of range. Costco has done OK as a novelty, but it’s really just a warehouse for oddments and relies on people driving themselves across town for a bargain. By contrast, Amazon has 369m SKU (stock keeping units) which it will deliver.
There is no comfort to be had in the majors’ competitive response. For example, Woolworths trumpets that it focused on fulfilling on-line demand, estimated to be growing at 25% pa, from its “dark stores’ ie distribution centres that don’t offer retail customer access. If thought through, it is apparent that this is simply cannibalising existing sales, which if it is to compete with Amazon will require discounting. Lost and discounted sales on a fixed cost base inflated by mall rents will hurt profitability big time.
The ‘cannibalise yourself’ strategy is now shaking out as one of the older tricks which catch companies out. They see how they must disrupt their business models through lower prices or a better offering, but in doing so fail to adequately address the existing high cost base (in this case the stores). The resulting rear guard action is the stuff of corporate boardroom nightmares.
Supermarket boards in Australia will point to the failure of Amazon in China and say success isn’t a given. This is true to a degree – Amazon failed in China, but it had help: the Chinese government effectively kicked it out in favour or Alibaba, which is its own success story.
Amazon bears will chime in with the predictable comment about low profits, but that view isn’t compelling. Amazon’s total balance sheet shows assets of US$83b, of which US$29b is property and equipment at net values (after amortisation). Only US$17b is paid in capital – ie put in by shareholders. Thus, the company has financed its growth to US$83b from its US$17b in paid capital, supported with cashflows coming from the business itself, as well as borrowings and leases, of course.
Banks have done their numbers – they are lending this because they see these underlying cashflows. It is the charges on this prior year balance sheet growth that reduces Amazon’s earnings in each subsequent year. Were Amazon to stop expanding, these charges would quickly roll off and earnings would zoom.
(Separately, it is a matter of some interest that the Netflix price was up 3% last night to close just below its all-time high at US$147, given that the only barrier to entry is a commitment to produce content, which the US studios have done. Technological barriers for distribution are effectively non-existent, as Stan, Tenplay and ABC iview have shown. In time, US film studios will get their heads around the Netflix model, and compete in just the same way – as an app on your phone, Apple box or computer.)
For TV, Netflix shareholders should be watching Amazon carefully. But in Australia, it’s very definitely Coles’ and Woolworths’ problem.
Loftus Peak featured in Financial Newswire01 Jul 2022
Responsible Investment update: reducing the world’s carbon footprint19 May 2022
Loftus Peak’s Alex Pollak sticking by his firm’s holdings in Netflix26 Apr 2022
Companies spearheading disruption hit value territory; plus Geopolitics Matters22 Apr 2022
Share this Post