Amazon (not so) Fresh

Written By:

Stephen Springham, Knight Frank

02 Sep 2022

10 minutes to read

Categories: Property Sector Retail World Regions UK London

Key Messages

• Amazon reportedly pausing expansion of Fresh in the UK.
• Currently 19 Amazon Fresh stores, mainly in London,
• Only already committed sites will proceed.
• A major U-turn on roll-out.
• As many as 260 new stores touted as recently as Nov 2021.
• U-turn very little to with ‘cost-of-living’ crisis.
• Inference is that stores are under-performing and not achieving acceptable returns.
• Format is not flawed, but operates in a very competitive and challenging market.
• Jury is out as to whether checkout-free technology is help or hindrance.
• Not necessarily end of the road for Amazon Fresh.
• But it does need scale if it is to succeed.
• Questionable whether scale can be achieved organically.

Another set-back in Amazon’s supposed imperious rise to global domination. Reports in last week’s Sunday Times suggest that the business has abruptly called a halt to further roll-out of its checkout-free Fresh format in the UK. It will still open a handful of new stores this year at sites where it has already committed, but previous plans for expansion beyond this have been put on ice.

Shock horror for many, especially the Amazon-sycophant analysts. But for others with a more rounded view, much less a surprise.

Background

After what seemed like years of frenzied speculation, Amazon finally opened its first Fresh store in Ealing in March 2021, to predictable media and analyst fanfare. Most waxed lyrical about the new format, not least its ‘Just Walk Out’ technology which many believed would turn the grocery industry on its head. Shoppers just need to have an Amazon app on their phone and scan a QR code at the entrance to gain access to the store and once they are done, simply walk out without having to negotiate a check-out (staffed or otherwise). Frictionless shopping was the watchword. Genius. Enough to for Big Four grocers to be supposedly quaking in their boots. So great that Amazon is even able to license the technology to them,

A further 18 Amazon Fresh stores have opened in the intervening period, all within London (with the one exception of Sevenoaks). As recently as last November, the press were reporting that expansion was going to be ramped up, with a further 260 sites reportedly in the offing.

And then the brakes have unceremoniously been slammed.

Why the U-turn?

Some sections of the press were predictably quick to point to the ‘consumer squeeze’ and ‘cost of living crisis’. Simply because they have a lazy habit of pointing to these for absolutely every turn of event. For all the myriad reasons Amazon has called a halt to expansion of Fresh, this is likely to be way down the list. Even if we were in an economic boom period, I doubt any decision would have been materially different.

Others have questioned whether this is a wider reaction to price hikes introduced to Amazon Prime, with an annual subscription increasing from £79 to £95 in September (that’s 20% vs 10% CPI, just saying). Indeed, data from industry regulator Ofcom found that UK subscribers to Amazon Prime dropped by 590,000 in the second quarter of 2022 alone. Again, I would question this is as a factor. Such is the loyalty of Amazon’s customer base that Prime is surely one of the most inelastic features of the consumer economy. Consumers perceive it as life-critical and would pay for it whatever the price.

The reason for the U-turn is far more fundamental: the stores themselves are not cutting the mustard and achieving the necessary levels of performance. Of course, we have no transparency on this, but it doesn’t take much to realise that sales are lower than they need to be and this is affecting profitability and viability. I would go as far to venture that the format is highly unprofitable and indeed question marks are being raised as to whether Fresh could ever hit break-even.

To the ‘why now?’ question.

A flawed format?

I may not be as gushing in my praise for Fresh as other commentators have been, but there are many elements of Fresh that are good, even very good. The stores are extremely well-curated and presented, the range is good, the product mix right, the price point competitive. All big ticks in key boxes in a checklist of convenience store retailing fundamentals.

As a convenience store format, Amazon Fresh is not flawed. But in a very crowded and challenging convenience market, not being flawed and simply being good rather than great may not be enough to succeed.

‘Just Walk Out’ – a questionable USP?

USPs are important in any retail market and Amazon Fresh has the luxury of have two 1. The Amazon brand. 2. Its ‘Just Walk Out’ technology.

The Amazon brand is unquestionably one of the strongest globally in any walk of commerce. It now extends far beyond its retailing origins. But it is still not readily associated with food and despite owning Wholefoods, Amazon is still a relative minnow in the grocery market. Expressed another way: given the choice, would more UK consumers opt for a Tesco/Sainsbury’s/M&S sandwich or an Amazon one?

It is admittedly a unique experience to walk out of a store seemingly without having to pay (or at least pass through a check-out). But, in all honesty, how much of a hardship is it really go to a check-out and in all likelihood pay through self-scanning? Is that any more ‘frictional’ than having to fiddle around on your phone to get the app working and scan the QR code (or download the app if you don’t already have it). ‘Frictionless’ is a relative term.

What of the cost implications? Do Amazon Fresh really have lower staffing costs than a ‘mainstream’ c-store? Both presumably have the same staffing requirements in terms of delivery management and shelf replenishment. And despite there being no check-outs at Amazon Fresh, their ‘front of house’ staffing is broadly the same. Instead of a couple of check-out staff, Amazon Fresh has the same headcount allocation (and cost) deployed to explain how the app works to customers.

The upfront cost of the technology itself is huge. A property director of one of the major grocery retailers recently flagged three key misgivings to the ‘Just Walk Out’ technology. 1. It only works in stores configured a certain way. 2. It is expensive and dramatically reduces profitability (especially ROIC, to be precise). 3. Many consumers don’t actually like it.

To add a bit of transparency on the second of these misgivings. As a very general rule of thumb, the average fit-out costs of a standard c-store are ca. £500k. The cost of installing ‘Just Walk Out’ technology is apparently ca. £500k. So, basically having it doubles the initial outlay and significantly lengthens the pay-back period.

The third misgiving is much more fundamental. Ground-breaking as the technology may be, it is not much use if it meets resistance amongst those that matter most – shoppers. Market research undertaken by Mintel for their Convenience Stores 2022 report showed that 32% of consumers said that the surveillance needed in checkout-free stores makes them less appealing, while 50% said having to download an app to enter such stores is a barrier. Both are applicable to Fresh.

C-store retailing – much harder than most appreciate

The fact is that Amazon Fresh is a new entrant and debutant in a highly competitive sector that is much harder to master than most appreciate.

The four leading c-store operators (Tesco, the Co op, M&S and Spar) collectively operate more than 16,500 stores across the country. Tesco alone operates over 8,750, with nearly 2,700 Tesco Express / One Stop sites supplemented by a further 6,000 c-stores made through the acquisition of Booker (trading as Premier, Londis, Budgens). Tesco is very much the trailblazer in c-stores, having launched Express way back in 1998 (if memory serves me right). It pretty much had free rein to establish its c-store business while the rest of the Big 4 grappled with other operational issues. Sainsbury’s joined the c-store fray much later, not really pushing the button on Local until the late 2000s. And it remains a much smaller player (with ca. 800+ sites).

Tesco has been scouring the country for the best c-store sites for more than 20 years. Sainsbury’s M&S, Coop et al have all been doing exactly the same over the last 10 years. High quality convenience store sites have been in huge demand for many years, most of the best ones have gone. Amazon Fresh joined this particular party very late in the day. That is not to say that there are not opportunities out there, nor that their store locations are necessarily wrong. But the pickings are significantly less rich than they were a decade ago.

On the more general point of c-store retailing being tougher than most appreciate, profitability is much more hit and miss than in big box supermarkets. The latter benefit from huge economies of scale and a much lower cost base. Contrary to popular belief, c-stores are not simply scaled-down versions of supermarkets, they have a totally different operating model. C-stores must work very hard and there are very fine lines between balancing volume and margin. In basic terms, the margin mix needs to be skewed to high margin items (fresh, ready-made meals, food-to-go) with low margin items (milk, alcohol) stocked out of necessity. And they need to shift huge volumes to make them viable.

To understand how difficult c-store retailing is, just ask Morrison’s and Asda. Both have tried to enter the c-store arena in the past and failed. Only now are they firmly establishing themselves in the convenience arena, tellingly more through acquisition than organically.

Amazon Fresh is new to the c-store game and the past 18 months have undoubtedly been a steep learning curve. Another probable reason for the current pause for breath.

Where now?

This is not necessarily the beginning of the end for Amazon Fresh in the UK. But, at the same time, it just might be.

The Amazon sycophants are predicting that this is just a temporary blip and rightly point to the fact that it is merely pausing roll-out rather than walking away completely. The consensus seems to be that after a period of reflection and strategic tweaks to the format, normal service will resume and Amazon Fresh will once again embark upon aggressive expansion.

But there are precedents that suggest otherwise. This is not the first time that Amazon has undertaken a U-turn on a store format. In March, it shuttered its 68 bookstores worldwide and also ditched its 4-star store format, just months after launching the concept in Bluewater. It clearly isn’t afraid to make big decisions on ventures that don’t deliver the required returns.

It’s worth stressing that both Tesco and Sainsbury’s had significant teething troubles with their respective c-store formats and took considerable time ‘to get it right’. Again from memory, I believe it took around two years for Tesco to fine-tune Express before it was ready for wider roll-out. For Sainsbury’s, I believe the gestation period for Local was even longer. That should provide some comfort for Amazon, the question is whether it has the patience to persevere.

And I would question whether it can achieve this organically. Even if the touted 260 new stores were to materialise, a network of only <300 stores would still make it a small player in the market (about the size of Budgens). And with Morrison’s taking over McColl’s and Asda this week paying £600m for the Coop’s petrol forecourt, the ship is slowly sailing on acquisition targets.

In retail, state-of-the-art technology can only take you so far.