How Amazon is Changing Everything Within the Natural Products Industry: Why Antitrust Law Matters

This article will look at Amazon’s private label strategy within the grocery category, the Whole Foods 365 stores, and how the Amazon grocery strategy has unfolded over the last year.  I point towards news that indicates another Amazon grocery merger may be coming via a transportation acquisition. I go on to present the initial constructs for a case around which I believe economists, members of the judiciary, and legislators may be able to move forward current discussions around why companies using Amazon’s business model at a large scale have the potential to become (or already be) monopolists.

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Before the Whole Foods brand was acquired by Amazon, Whole Foods seemed to have identified its core problems. The distribution network was creating pricing inefficiencies further complicated by expensive, externally sourced brands.  Whole Foods’ singular advantage, outside of solid branding and a great culture, was a solid set of data about every product sold. Whole Foods had come to the conclusion that a store full of private label products was the answer to their revenue problem.  Trader Joe’s was winning. Walmart had private label products next popular products on store shelves. Target was doing the same.

Photo of the spaghetti sauce section in a Whole Foods store. This photo was taken in a Whole Foods store in St. Louis, Missouri on September 24, 2018. Of particular interest was the floor level positioning of the Newman’s Own brand at the bottom of the fixture. The 365 products had identical titling and were positioned at eye level.

Whole Foods chose products, developed necessary chemistry, and prepared plans for the launch of a new store format. In June of 2015, Whole Foods announced the plan for a new store concept perhaps with the intention of placating shareholders for a fiscal year ending in September.  One year later, in June 2016, headlines announced the opening of the first concept store. Shortly thereafter, Goldmans downgraded Whole Foods stocks from “neutral” to “sell”. Whole Foods showed a total sales growth of 2%, but their earnings per share dropped by 17% YOY after a less than hopeful shareholder meeting.  In a July, 2016 Forbes article,  Whole Foods CEO, John Mackey is quoted in a statement accompanying that years earnings release, “Through lower capital and operating costs, [365 stores] are able to offer great values to our customers, and the response has been overwhelmingly positive. Our 365 stores are firsts for us in so many ways, from a streamlined operating model, to centralized buying, to auto-replenishment of inventory.”

When the sale of Whole Foods to Amazon was announced 12 months later, in August of 2017, the focus of the initial acquisition announcement was kept remarkably simple.  As the week evolved, analysts began to look at other potential advantages of the merger like branding, fulfillment, real estate, grocery, Prime Now, etc.  Interestingly, the 365 store strategy was rarely mentioned. In fact, it seemed as if the 365 store strategy may, in fact, be abandoned.  In my research, I’ve found that the opposite is true.  Amazon has quietly continued to open 365 stores over the last twelve months. There are approximately ten 365 stores open across the United States. Each store is an interesting mix of locale, demographics, signage, and branding. Amazon hasn’t publicly committed to a singular strategy with the 365 stores. In fact, they have openly stated that they are using the store formats to test pricing and other strategies.

Using the Census Bureau’s website, the following information was located regarding the zip codes where each of the new 365 stores is located:

  • The store location in Akron, Ohio (44313) has an average income of $55k.
  • The store location in Cedar Park, Texas (78613) has an average income of $65k.
  • The store location in Concord, California (94520) has an average income of $34k.
  • The store location in Brooklyn, NY (11217) has an average income of $35k.
  • The store location in Houston, TX (77018) has an average income of $25k.
  • The store location in Lake Oswego, OR (97034) has an average income of $18k.
  • The store location in Santa Monica, CA (90404) has an average income of $97k.
  • The store location in Los Angeles, CA (90039) has an average income of $77k.
  • The store location in Upland, CA (91784) has an average income of $102k.

Photos of each 365 store (along with its varying branding) are available on the Whole Foods Market website.

What are the potential economic implications to the brands within the natural products industry as Amazon uses their formulas, recipes, and chemistry?

For natural products industry brands, the impact was immediate.  Amazon wasted no time getting the 365 branded products available on Amazon.com after the acquisition of Whole Foods was complete.  From an article in Supermarket News published on December 20, 2017, four months after Amazon purchased Whole Foods,  “The 365 Everyday Value brand was consistently the No. 2 performer in sales volume behind Amazon’s main private label, AmazonBasics, during the short time it was available, and was the fourth most popular brand for the full year.” Amazon is credited with over $10M in sales of its 365 brands on the Amazon platform in one effective selling quarter.

In March of 2018, three months later, Amazon/Whole Foods announced that their buyers wouldn’t be attending Expo West, the nation’s largest trade show for natural products. Whole Foods is the industry’s largest buyer of “natural products”. Vendors exhibiting at Expo West would have been hoping for exposure to those buyers.  The same week, Amazon implemented mandatory merchandising fees for traditional brands on store shelves in Whole Foods.  Brands who pay the merchandising fee would lower their margins, increasing Amazon’s profitability, and effectively decreasing their ability to compete in other markets. An attorney might want to look into a possible interpretation of this behavior as an abuse of dominance, or exclusionary pricing abuse. If, as another article theorized, brokers were also moved out of the way, a layer of the grocery supply chain may be removed and Amazon’s costs further reduced.

Private label Amazon grocery items can be purchased directly from a local Whole Foods, 365 Store, or on Amazon.com. If “Prime Now” shipping options are available in an area, many Amazon private label grocery items are available for delivery within a few hours.

Amazon’s private label grocery items are available across multiple sales channels:

  • food
  • pet
  • baby
  • health
  • beauty
  • snacks
  • frozen foods
  • meat
  • dairy

Consumer behavior is difficult to anticipate. When presented with two products that appear to be similar with varying price points, some consumers may purchase their preferred brand. However, many consumers are price driven and may believe the lower priced products are equivalent to the more expensive product. Prices of Amazon-owned private label grocery products are lower than the comparable brand and generally positioned near the comparable, more expensive item.

While the economic impact of alternate consumer buying decisions wouldn’t be difficult to calculate for a single item, on a single shelf, in a normal store with normal barriers to entry, it may be more challenging to calculate on a larger scale as that same behavior is applied to an entire store of private label grocery items made immediately available to all consumers with access to an Amazon app and an Amazon Prime shipping benefit.

Natural grocers are also consumers of these products on their store shelves. As grocers feel the impact of the store changes, brands will have a transition in their supply chain. These changes will take time.  Some things that may impact these changes include, unanticipated transitions with Whole Foods stores.  If these 365 stores work well for Amazon, existing Whole Foods markets could become 365 stores with some remodeling and re-merchandising. As those changes are realized, the shelves will transform in Whole Foods stores as old brands move off of shelves and private labels take their place. Independent natural grocers may become more of an exclusive local resource for those items as time moves forward.

Perhaps more interestingly, at the end of July, UNFI, the exclusive distributor for Whole Foods stores, announced the acquisition of Supervalu for $2.9B in cash. Supervalu is a discount network of wholly owned grocery stores, a transportation network, and a wholesale provider of private label food to independent grocers. Their private label food line was not unlike what you might find in Aldi.

UNFI has previously held an exclusively natural and organic position in the market.  With their purchase of Supervalu, UNFI now also owns ALL of the *non-organic* food science previously owned and sold within the SuperValu food stores, along with several chains of non-organic grocery stores with 114 physical locations, over 3,000 wholesale relationships, and a large associated distribution network. The placement of those non-organic grocery stores is in lower income neighborhoods, not unlike the neighborhoods where the new 365 stores are being placed.

Amazon did not acquire the UNFI transportation network when they bought Whole Foods. With UNFI’s new position in the market, Amazon could decide to purchase UNFI to expand their own  transportation network. The purchase would give Amazon access to the Supervalu-owned leases along with the expanded discount grocery store positioning, the non-organic food chemistry, and the ease of expansion for it’s 365 grocery strategy. Although, if Amazon wants to purchase these stores, they should move quickly as UNFI is rapidly divesting itself of the chains.

Looking further at UNFI as a distributor without Whole Foods as a customer, the UNFI business is in a precarious position should Whole Foods change its distribution strategy.  UNFI stock continues to fall.

Should Amazon not purchase UNFI, the acquisition of Supervalu puts UNFI in a much stronger competitive position. The investment and grocery industry should pay close attention to next moves for both companies.

Is Amazon a Monopoly?

Concerns about monopolistic power usually focus on businesses that have become so large within an industry that its position becomes singular or nearly singular.  Within retail, 49% of searches start on Amazon.com. This isn’t true for grocery.  Yet.  However, given Amazon’s growth trajectory within its private label consumables, within a few years, their market position will change to one resembling a singularity. Here’s how the story started.

When Amazon acquired the Whole Foods 365 chemistry, it enabled Amazon to essentially “copy / paste” an entire organic grocery store into an app, and immediately place private label grocery products alongside comparable brands at lower prices.

Amazon acquired the formulas and chemistry for many products sold in Whole Foods along with the sales data about those products. The formulas and chemistry represent products across the entire natural products industry. The new lower-cost products are being sold by Amazon next to the comparable products, for which the both cost of online fulfillment through Amazon.com and the cost to be in Whole Foods store has been recently increased by Amazon.  Unlike traditional stores, there are few constraints for consumers who want to acquire the new products in any market nationwide. Consumers may begin to immediately choose the lower-priced substitute products, available both in-store and online on the Amazon app, over brands being replaced. As this plays out over time, we may see a number of changes as the market consolidates and the supply chain within the natural products industry begins to flatten.

Today, the 63% of U.S. consumers who have Amazon Prime are being presented with private label grocery items  in an app beside the more expensive original product, nation-wide, where, according to updated survey data from Survata and published on Forbes, over 49% of all retail searches start.

When regulators looked at Amazon’s acquisition of Whole Foods, analysts were focused on why Amazon might be interested in an organic grocery store. Amazon didn’t talk about why they might want food, health, and beauty chemistry and apparently, the right long-range thinkers weren’t in place to draw the predictions for the industry as a whole.

Porter’s Five Forces provide a standardized method to evaluate the competitive strength and competitive position of a business in an industry.

  • Threat of Substitutes is determined based on an ability for substitutes to be easily created within an industry.  Formulas and chemistries are easily replicated. The cost of creating a single formula or recipe is low.  The cost of creating an entire store is very high.  In this case, 365 products and other private label brands are the substitute to the brands being replaced.
  • Buying Power within the natural products industry is based on volume and demand. Amazon covers a world-wide market and will have significant buying power influenced by knowledge and insights gained through the consumer data and the business data hosted in their tech centers. Amazon gains additional marketing power through their terms of service that keeps businesses from utilizing data to market to consumers post sale. Amazon has an ongoing practice of using data to compete with the very businesses they are serving through other channels.  Data shows that 49% of retail searches start on Amazon.com and 2/3s of American households have and use Amazon Prime. Amazon controls the a primary sales channel in the United States, which also means that there is minimum threat of new entry without a whole new sales channel that appeals to consumers differently or “more” than Amazon does right now.
  • The Bargaining Power of Suppliers is dependent on their willingness to walk away from Amazon as a sales channel.  If Whole Foods was their entire sales channel, which, in this case, may have been true, the bargaining power of suppliers, the brands within the natural products industry, may be low.
  • The Bargaining Power of Consumers is currently high. I predict the bargaining power of consumers will become lower as product selection narrows. In July of 2018, Whole Foods increased the cost of being on the shelf. In March of 2018, Amazon raised the price of fulfillment. If grocery brands choose to sell through alternative distribution methods, they may find new barriers as independently owned natural grocery chains face increased competition from falling prices at Whole Foods and close. Alternatively, brands may bypass the entire grocery supply chain and open their own sales channels, marketing directly to consumers at lower prices.
  • Rivalry within the natural products industry is high, the firm concentration ratio is high, the firm turnover rate is high, and, generally speaking, true innovation is low. The FTC requires a high degree of transparency in labeling making it easy to replicate formulas and recipes.

All of these indicators point to Amazon as a future monopolist within the natural products industry.

It’s clear that Amazon acquired, built, and quickly deployed a mostly organic private label grocery store on their platform.  Their private label consumables growth is substantial and on track to have significant impact on the grocery industry in the next few years. The pace of this implementation and growth is of note and some concern.

There is a strong push by some academics and industries for legislators and the judicial system to consider making changes that would limit Amazon’s ability to expand its reach into other industries.

I will spend the next few paragraphs outlining some thoughts that may provide the initial constructs for a conversation around which I believe economists, members of the judiciary, and legislators may be able to reconsider the court’s current position around the benefits and advantages of what has come to be known as efficiency theory and how a monopolist without constraints might leverage that theory to boundless advantage.

For the purposes of this argument, a “constraint” should be considered an unseen limitation or restriction governing the behavior of the participants in commerce. A psychological constraint should be considered anything influencing the psychological behavior of a consumer as they participated in the act of buying and a limitation affecting the ability of a business to sell to the same consumer.  A functional constraint should be considered anything influencing the physical behavior of a consumer as they participated in the act of buying and a functional limitation affecting the ability of a business to sell to the same consumer.  Implicit should be defined as “implied, but not plainly expressed”.  Bias should be defined as “prejudice in favor of or against one thing”.

Anti-trust laws were originally written in 1890 and 1914 to ensure that no single business could have too much power in any single industry. Over the years, many cases have been brought before various courts under The Sherman Act, The Clayton Act, and The Federal Trade Commission Act resulting in extensive case law that has refined our understanding of those laws. In 1890 and 1914, when the original language around anti-trust law was developed, barriers to growth included inefficient manufacturing, no applied business computing technology, long transportation timelines, an inefficient communication system, and a non-digital monetary system. Cars had just been invented and airplanes had not yet taken flight. The internet did not exist.

Certain theoretical psychological and functional constraints governed competition.  Cultural context based on these constraints created implicit understanding in the language, the construction, the interpretation, and the case law built around anti-trust laws. The law was constructed around the foundational existence of these constraints, constraints that have existed since a modern understanding of business was established. This implicit understanding about how business could occur governed the way anti-trust laws were written, and how those laws have been interpreted by economists, legislators, and the judicial system throughout memorable history.

Throughout recent economic history, our understanding of competition and economic law (a general understanding of economics) has been, in part, governed by the IMPLICIT difficulty in changing WHY people chose a BUSINESS or a PRODUCT and a base assumption that the customer MAY BE WILLING TO WAIT OR TRAVEL to purchase from an alternative supplier.

Today, many of these constraints affecting transportation, communication, exchange of monetary value, and delivery timelines have been removed. Business is done nearly instantly within the current economy. Instead of getting on a horse and riding into town to buy a loaf of bread, a consumer opens an app on their phone and that loaf of bread is waiting in the refrigerator at home an hour later. Interestingly, as these constraints have been removed for some businesses, several things have changed.  The psychological constraints governing how that loaf of bread is purchased are different. The physical constraints governing how that loaf of bread can be purchased are different. Even the language governing how we discuss how that loaf of bread should be purchased is different than it might have been in 1914.

That said, for some retailers, the boundaries around these theoretical constraints are still very real.

For example, when a consumer shops at Walgreens, there are psychological constraints in place for “how” they shop and use Walgreens both online and in store.  Consumers go to Walgreens for prescriptions, snacks, gum, tampons, emergency shampoo, condoms, nail polish, pregnancy tests, and maybe food forgotten on the way to a holiday dinner.  Walgreens understands these constraints, and that’s what is stocked in stores.  To overcome those psychological constraints, Walgreens would have to change something fundamental about the core business.  It’s not IMPOSSIBLE to change those constraints, but it would be very DIFFICULT.

The same theoretical constraints are in place for Target. For example, consumers don’t go to Target to buy a washing machine or a machine that shoots tennis balls. Consumers go to Lowe’s for lumber and paint. These behaviors are psychological constraints around consumer behaviors.

While psychological constraints aren’t “real” constraints, they are theoretical barriers that are difficult for any business to actually change.  For example, it would be very, very difficult to convince many, many people that they could go to Walgreens to buy a machine that shoots tennis balls, so, in practice, this is a very “real” constraint Walgreens would struggle to overcome. In the same way, Target would struggle to convince consumers to purchase a washing machine in their store.

Over time, Walmart and Target began to break through the boundaries of “psychological constraints” as the cultural concept of a department store was expanded but even within the department store concept, sales patterns within both stores became somewhat predictable as Walmart and Target raced towards similar price competition while only being somewhat differentiated around brand presentation.

Today, both Walmart and Target have a presence in grocery, but only Walmart is truly competitive in the segment. In 2016, Walmart reported holding over 17% of the grocery market. According to one Washington Post article, food sales at Walmart today represent over half of it’s total earnings.  It took time for Walmart to scale a grocery concept nationwide. Walmart started moving towards a full grocery concept in 1988. It wasn’t until thirteen years later, that Walmart became the largest food retailer in the United States when its food sales reached $56B. To expand it’s footprint, Walmart had to physically build new stores in new regions. As it did so, it acquired new customers through everyday low price strategies and by building locations in areas that routed customers away from competitors. Walmart’s ability to compete within grocery as a full grocery store was limited to Walmarts ability to physically expand or modify space to include that full grocery store. Walmart did not struggle as much to convince consumers to buy food in their stores because Walmart stores already sold food to consumers. However, Walmart could not scale the sales of food in their stores beyond a consumer’s willingness to drive to purchase food from a Walmart store. Growth required time and monetary investment in physical real estate.

In comparison, Amazon did not have the same functional constraints in place. Amazon was able to purchase an entire natural grocery store and scale it to consumers across the entire United States within a few short weeks, compared to Walmart’s 13 years of building physical grocery stores.

Theoretical functional constraints work the same way.  Walmart was not psychologically constrained in their ability to sell groceries, but, in 1990, they were functionally constrained in their ability to sell groceries based on how physically close a consumer was to a store that provided a full grocery service.

A firm who cannot deliver their goods, provide in-person local service, as well as online ordering with a short delivery timeline, in every market possible has a functional constraint that limits their revenue growth.

To remove all physical and psychological barriers to revenue growth, a firm should be physically present in all parts of the world, offering all products and services desired by any business and consumer in that part of that world. All products and services would be shippable to all addresses within a period of time that the business or consumer is reasonably willing to wait.

As Amazon has expanded their product base, and moved towards a physical presence in many cities, they have shown the ability and the desire to remove all physical and psychological constraints to growth in any and all industries. They have further proven that people can will buy anything, anytime through Amazon. 

The removal of psychological constraints and physical constraints for some competitors in the business world has fundamentally changed the way business is done.

It has substantively altered economic forces in a way that should cause us to evaluate and perhaps, once-again, evolve anti-trust law.

Originally, anti-trust law was written to prevent the consolidation of firms.  The law was designed to practically insist upon a singular selling focus within an industry.  As anti-trust law has evolved based concepts like The Antitrust Paradox by Robert Bork and other legal concepts that were driven by efficiency theory, case law has evolved around something between the avoidance of firm consolidation and the prioritization of a consumer-focused, low-price, efficiency strategy. Both are important.

Low Prices: A Short Team Deal

The branded (organic) dried blueberries had almost identical packaging to the 365 product. The branded product was also almost exactly double the price of the private label 365 (non organic) blueberries in my basket.

When prices are lower, consumers benefit. When prices are too low, players are artificially removed from the market.  It is impossible to buy, warehouse, pick, label, pack, ship, deliver, and support a bottle of organic spaghetti sauce or shampoo with low cost or free shipping to a customer for $1.99 or $4.99. In court, a lawyer might argue theoretical circles around the real cost of those products, but, a panel of business owners would tell you that it is not plausible or reasonable for those products to remain at those prices after all competitors are removed from the market.

There is no outcome in this scenario where at least one person is better off without making any other person worse off (Pareto). There is no zero profit outcome in this scenario. There is only a negative profit outcome for all business players and a low price outcome for the consumer until all but one business player have been removed from the game.

Pricing at this level, next to competitive brands is designed to remove competitors.  As competitors are removed, prices will almost certainly go up to either equalize costs or move to profitability. Amazon has proven that it will continually lose money for long period of time to gain power in an industry. It can and will out-wait competition. This is how monopolies work.

According to retail trends published by the USDA, “The Nation’s 118,812 traditional food stores sold $648 billion of retail food and nonfood products in 2016.”  The same report credits Walmart with being the largest grocer in the United States and $136.2B in sales, over half of Walmart’s revenue. In 2017, Whole Foods reported revenue across approximately 225 stores, with no online sales, as $15.72B.

Grocery is a massive category. Currently, Walmart owns most of that category.  This is a bold strategic move by Amazon to capture a new industry in the United States. Unlike Walmart, who had to work to gain the category, Amazon moved into the category without the functional or psychological constraints that have limited their competitors.

Amazon is scaling a grocery category using an organic brand and a low price strategy with relatively immediate delivery to a significant percentage of the population.

The new category has been placed next to competitive brands that were copied by the platform en masse. Compared to Walmart’s thirteen year step into national grocery, the first wave of the Amazon grocery strategy was effectively played out in one financial quarter. Amazon has arguably become a monopolist within retail, owning most of the purchases made within the retail sector.  Within a few short years, the same could predictably happen within grocery given their ability to get to scale nationwide within such a short timeframe. If Amazon can take such big steps in such a short timeframe within grocery, what stops them from doing it within other industries?  While Amazon is truly not a monopoly within grocery today, we must recognize that Amazon is or has the potential to become a monopolist within the industries it occupies.

Over time, anti-trust laws have been continually re-interpreted by the courts based on the context of trade practices at the time new cases are presented. Courts are looking at trade law within the context of constraints informed by social constructs that just aren’t reality today.

Paradox Rainbow

Perhaps we have reached a the end of the efficiency rainbow proposed by Robert Bork in The Antitrust Paradox. The end of that rainbow is, in fact, a growing monopoly named Amazon that can readily take over entire industries using the powerful leverage gained by the steep slope of an ever increasing EBITDA, a consumer database constantly mined for information about new industries to target, an expanding international distribution network, a carefully guarded “buy now” button, and an app that sits on a device in everyone’s pocket.

Friends, it is not my job to write new laws. It is not my job to interpret old laws.  I don’t create new theories. I simply read and ask what I hope are good questions.  As I’m sure you can see, there are many, many questions.

Action Items

This topic really belongs in the hands of people who can bring change.

  1. Consider sharing this article on Twitter.
  2. Please share this article with your State Representatives and Senators in Congress.

Together, we can bring change. Thank you so much for reading.

Jenn is the Founder and CEO of Cotton Babies. She holds an Executive MBA from Washington University. She was awarded Ernst & Young’s Entrepreneur of the Year award in the Emerging Category for the Central Midwest Region in 2011. Among many other awards, she recently received a 2017 YWCA Leader of Distinction Award for Entrepreneurship. Jenn holds many patents on various inventions in a number of different countries and is listed as one of 50 Missourians You Should Know. She is particularly fascinated by languages, chickens, and children (she has four) when she’s not reading economics journals.

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