These 2 chilling facts about Amazon show how it can unleash chaos in Australian retail

He’s coming. (Photo by Drew Angerer/Getty Images)

Amazon will this week start offering lower prices at Whole Foods, the US grocery chain it bought for $US13.7 billion.

With the deal now complete, not only will Amazon immediately start offering reduced prices at the much-loved grocery chain, but even more rewards and discounts will be available to members of Amazon Prime, the $US99-a-year service that includes free two-day shipping and cheap rushed shipping.

Amazon is building its Australian capabilities right now, and the service will start with basic online shopping through its Marketplace. It’s not clear what Prime will look like in Australia or where it will be available, but the service is so central to the Amazon growth model that you have to expect it to roll out at some point, at least in Melbourne or Sydney.

Prime acts like a gateway drug. It opens up cheap prices and access to discounted rush deliveries, but also other services like music streaming, photo storage, and Prime Video. By providing all those peripheral services, Amazon is able to keep accumulating customers who will then be able to buy anything and everything through its platform.

The debate about which Australian companies face the biggest threats from Amazon’s arrival is a favourite sport in business and financial markets at the moment. The reality is there are many variables in play. What suppliers will Amazon be able to lock up? What will discounts be like for Prime members? What geographical areas will it reasonably be able to serve?

But equally important is the response from local retailers. These are the things that they can control. What will they do to compete? How will this affect their margins?

With Amazon so secretive, trying to figure out who will be hurt most is largely guesswork. But we do know Australian retailers look woefully ill-prepared.

A somewhat disturbing survey of around 500 retailers, conducted by the Commonwealth Bank back in March shows a widespread complacency — and even ignorance — among Australian retailers on what’s about to happen to them. The survey found 30% of Australian retailers were unaware Amazon was coming, and of those that are aware, only 14% had a plan to compete in response.

Half of the retailers surveyed found they were unfazed by Amazon’s entry and only 11% said they saw Amazon as a significant threat.

Granted, that survey was taken several months ago, and some retailers may well have adjusted their views and started working on plans by now. But for anyone still unconvinced about Amazon’s scale and capability — and how much customers love the service — the following two simple points should cast some light on the scale of Amazon’s power.

1. Amazon runs its shipping services at a loss of more than $US7 billion

The chart above is from a recent research note by Deutsche Bank and highlights just how aggressive Amazon is when it comes to building scale and customer transactions. It underlines how the Prime service works as a hook for getting customers into the platform.

For perspective, on current exchange rates that’s around $A9 billion Amazon is prepared to lose just on global distribution. Compare that with Australian supermarket giant Woolworths — one of the real success stories in the Australian retail landscape at the moment — which reported a full-year profit of $1.53 billion last week.

2. When a US department store announced it was selling its electronics through Amazon, its shares exploded 20%

Sears is a department store in a lot of trouble as a company. It has closed almost half of its stores across the US in five years, down from 2,073 to 1,140, and with hundreds more scheduled for closure. Some of the decline has undoubtedly been driven by Amazon’s convenience, with online ordering and delivery replacing the convenience of a single trip to a physical department store.

However, Sears did have a very popular line of home electronics — kettles, toasters and so on. When it announced it was going to distribute these through Amazon, the stock exploded in after-hours trading.

What’s astonishing about this is that the market sees the potential for increased earnings from Amazon distribution far outweighing the element of the announcement that Sears was giving people yet another reason not to visit its physical stores.

Some retailers spotted the opportunity here a long time ago. Retail entrepreneur Ruslan Kogan, for example, has been bullish about the impact Amazon will have on his business because it will mean more distribution and more online retail activity generally.

“Unlike many retailers, we have a strong private label business and Amazon provides another large distribution channel to sell our products and deliver our value proposition of price leadership and digital efficiency to customers,” Kogan said last year.

But the Sears story shows Amazon can destroy one element of a competitor’s business model at the same time as helping another.

And the mind-boggling size of its investment in shipping shows how prepared it is to fund its goal of building vast scale and customer loyalty.

All of this underlines the unpredictable nature of Amazon’s impact on Australian retail and the need for companies to review their strategies. For companies that partner effectively with Amazon, especially for distribution, there is a great deal of opportunity.

But who those companies will be, and the net impact on their margins, remains an open question.

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