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Spread bets and CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 71% of retail investor accounts lose money when trading spread bets and CFDs with this provider. You should consider whether you understand how spread bets and CFDs work, and whether you can afford to take the high risk of losing your money.

How will Amazon disrupt the UK grocery market?

Amazon is capitalising on the shift to online grocery shopping during the coronavirus pandemic and taking another big step into the market. But what does this mean for incumbents like Tesco, Sainsbury’s, Morrisons and Ocado?

Amazon Source: Bloomberg

Amazon takes another big step into the UK grocery market

Amazon has announced that it is adding its online grocery service, Amazon Fresh, to its monthly Prime subscription service and said it intends to expand across the UK so ‘millions of members’ can access the service by the end of 2020. Customers in 300 postcodes stretched across London and the South East already have access to Amazon Fresh.

Amazon is looking to immediately outdo traditional incumbents, particularly with its offer of same-day delivery within just two hours on orders over £40, and they can be made up to 9pm. Customers can even opt for a one-hour time frame for an additional fee of £3.99.

The company has said it intends to offer a big enough selection for customers to complete a weekly shop, thanks to its relationships with a slew of suppliers. Unlike most other supermarket chains, Amazon doesn’t produce any of its food and instead sources its products from others.

This includes supermarket Morrisons and several individual food and drink brands, such as Pepsi, Warburtons and Britvic, as well as other independent chains and artisanal product makers. Its ownership of Whole Foods, which it acquired in 2017, also helps as it already has seven UK stores centred in London that offer local same-day delivery.

Will Amazon Go stores be opened in the UK?

The Times has also reported that Amazon is looking to start introducing its new grocery store format into the UK in tandem with its expanded online offering. The company has already rolled out 26 Amazon Go stores in the US since launching the first one in Seattle in 2016.

It is reported to be in the process of opening ten stores in and around London this year, with the first to open before the end of 2020. Many of these are expected to be situated near busy public transport hubs and Amazon is thought to be considering 20 more locations beyond the original ten. Amazon has not confirmed the roll-out in the UK.

The Amazon Go store format is revolutionary. There are no tills and customers can immediately place products in their bags as cameras and sensors tally-up their shopping totals before deducting it straight from their Amazon account once they leave the store. Tesco and Sainsbury’s have both trialled their store formats that have tried to cut out the till but neither have been able to introduce it successfully or at scale.

Amazon looks to capitalise on the grocery industry’s structural growth problems

Amazon has been a bit-player in the UK grocery market for many years, but it has been widely expected that the behemoth would eventually make its big push into a sector that it believes is ripe for the taking.

The coronavirus pandemic has rapidly changed the landscape for the UK grocery industry, particularly in terms of demand for online shopping. Consumers bought less food and groceries online compared to other non-perishable items before the lockdown, so online penetration for the industry has been relatively low compared to other retail sectors.

But this attitude has changed as more people tried online shopping whilst they isolated themselves from others and avoided going to the shops.

Estimates from Mintel suggest the UK’s online grocery market will be worth £16.8 billion in 2020, jumping 33% from £12.7 billion in 2019. That surge in value comes after four consecutive years of growth slowing down, with online sales growing just 2.9% between 2018 and 2019.

It is anticipated that the industry could be worth almost £18 billion by 2024, suggesting that online grocery shopping will maintain some of this momentum even once social-distancing and other measures ease. Kantar Worldpanel, which tracks the UK grocery market, said one in five UK households purchased groceries online in June, equating to around 5.7 million shoppers.

But this is not good news for most of the industry because supermarkets do not make money by delivering goods to the customer’s front doors. Most major supermarkets only make a slim margin of somewhere between 2% and 5% on a typical shop in-store but can lose up to 15% on an online order.

The coronavirus pandemic has shifted many of their customers from money-making trips in-store to heavy loss-making orders online. Management consulting firm Bain & Company said a two to five-year acceleration in online grocery sales could ‘massively dilute retailer profits without action to improve the poor economics of the channel’.

One reason the industry finds itself in this position is that it made some mistakes in the early days of online grocery shopping that have been left unaddressed. They have largely applied their same in-store format to their online platforms, all at the same cost for consumers but with huge additional costs for the stores themselves – whether that be for the facilities and space needed to store goods, the staff that must pick the orders or the ones that have to deliver the items to the customer.

Plus, the industry has taught customers to expect free delivery even though this is unsustainable. Supermarkets appear to be fearful about introducing delivery fees to cover the additional costs of their online services and seem reluctant to be the first to charge. That is despite the fact that this model has proven successful with other companies such as last-mile delivery firms Uber Eats and Deliveroo, which put their fees on top of their partners'.

For example, Uber Eats charges £3.99 on top of customer’s McDonald’s orders, and customers appear willing to pay extra to have the goods they want to be delivered to their door quickly and efficiently.

Read more about the top UK supermarket stocks to watch in 2020

How will UK supermarkets respond?

Most of the UK supermarkets have been caught off guard and unprepared for such a dramatic change in shopping habits. They were expecting a more gradual shift to online, but now find themselves racing to find a sustainable solution to their problem.

While some companies like Ocado have invested heavily in automated warehouses and technology in the knowledge the market was shifting online, most of the traditional players are stuck with more simplistic but costly operations involving staff manually picking items in-store, or from a ‘dark store’ that isn’t open to the public.

Traditional supermarkets will have three choices. The first would be to avoid the online grocery industry altogether, which would minimise expenditure and prevent margins being eroded over the short term but reduce competitiveness over the long term.

The second is to develop their own online operations and distribution systems, which could prove beneficial over the long term but prove costly and complicated to develop.

The third is to partner with a firm that has the technology they need, like Ocado, which would be a quicker and more effective solution but one that relies on a third-party.

Why is Amazon making its move now?

The problems facing traditional players will also apply to Amazon, but the company’s sheer size, expertise in e-commerce and logistics, and its technological prowess means it is in a much better position to tackle them.

The fact it is building its grocery operations from the ground-up, rather than trying to overhaul huge networks of stores, means it can adapt to the changes occurring at a much faster pace than the incumbents.

Amazon, as the market leader in e-commerce, has reaped the rewards of more people buying online and sees an opportunity to add groceries to its offering. It adds another dimension to its Prime subscription and introduces another aspect to the ever-growing Amazon ecosystem.

It always prioritises gaining market share over making a profit when it enters a new market, therefore, it will be able to absorb the burdensome delivery costs that traditional players struggle to swallow. The fact the UK competition watchdog has just given the all-clear for Amazon to buy a 16% stake in Deliveroo will also bolster its ability to deliver more goods to people quickly and efficiently.

Amazon will still have a task on its hands. For one, existing players have a head start, with figures from Mintel suggesting Amazon currently holds just 3% of the online grocery market compared to Tesco, by far the largest online operator with over 30%, and the likes of Ocado that has around 14%.

It will only initially appeal to Prime members that can access the service for free, and there are fears that if it becomes too popular that Amazon could find itself in the same position as many of the existing players – left with an unprofitable and unsustainable service that consumers have become accustomed to.

If Amazon is successful, both with its online service and till-less stores, then it could radically change the industry with a new model. This could lead to other major changes, such as creating new revenue streams by redefining the relationship between suppliers and supermarkets.

Virtually all of the major supermarket chains currently compete on just one front – price – and the entry of Amazon will only exacerbate this. Customer loyalty has been eroded over the years and most customers base their decision of where to shop solely on price, driven by the rise of discount chains like Aldi and Lidl.

But a shift online could present the opportunity for companies to monetise customer data, and leverage this with suppliers that may be willing to pay for their products to get a prime position on websites or to be recommended to prospective shoppers. It is new concepts like this could help supermarkets get their online operations into the black.

What stocks could benefit from Amazon’s grocery expansion?

Amazon has the potential to dramatically disrupt the UK grocery market, but it will not be achieved overnight and there is no guarantee that the company will be successful. Amazon has tried and failed with ventures into the grocery space before.

Amazon has previously closed its grocery delivery arms in parts of the US as it struggled to expand outside of major cities, shut certain Whole Foods stores (including in the UK) and had to temporarily suspend its Pantry service earlier this year when it couldn’t cope with peak demand. Regardless, groceries will remain a small segment of the behemoth for the foreseeable future.

Will Ocado benefit from Amazon’s push into groceries?

There could be other winners from Amazon’s move. For example, it could encourage more grocers and other retailers to improve their operations by using Ocado’s automated warehouse technology.

The number of major international retailers licensing Ocado’s technology and building new automated fulfilment centres has surged in recent years as they look to unlock more value and better compete with Amazon, and a similar trend could happen in the grocery market now that Amazon is taking another big step into the market.

Plus, Ocado’s purely online grocery service has benefited the most out of any player in the UK during the coronavirus pandemic. Although Ocado’s grocery arm has struggled to cope with the level of demand at times it has still outperformed the wider market.

The latest figures from Kantar Worldpanel showed Ocado delivered ‘industry-high sales growth’ of over 42% in the 12 weeks to June 14, which resulted in the company earning its highest share of the market to date. That compared to the 12.1% growth delivered by Tesco, 10.2% at Sainsbury’s and 10.5% at Morrisons. However, all three of them reported strong growth in online orders, as well as in ‘click-and-collect’.

Read more on how to buy, sell and short Ocado shares

Will Morrisons benefit from Amazon’s push into groceries?

The other main player that could benefit from Amazon’s push into the market is Morrisons. It is the fourth largest supermarket in the country, but it does have an edge over its rivals because it produces much more of its own-label food.

Morrisons supplies food to Amazon under a deal that has been steadily growing for years and could benefit as Amazon Pantry expands this year. Morrisons said in May that 40 of its stores were now helping to serve Amazon Prime customers, up from just 17 in March.

Although Amazon will aim to compete with all the supermarkets, Morrisons is the only one that could benefit from the US giant’s success. The fact Morrisons also partners Ocado should add a further layer of confidence to Morrison’s prospects.

The relationship between Amazon and Morrisons has been gradually intensifying over recent years and is currently underpinned by a new deal signed last year that involves both companies ‘exploring new opportunities together to improve the shopping experience for both Morrisons and Amazon customers.’

The partnership has also led some to believe that Morrisons could be a takeover target in the future if Amazon wanted to quickly enter the market and acquire a large network of stores or food manufacturing capabilities.

Read more on how to buy and trade shares

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