Amazon’s acquisition of Whole Foods

Amazon’s acquisition of Whole Foods is an entrance to the new market for the company – an M&A that is, in financial terminology, distant from the core business of Amazon.. Previously, online-only retailer of non-perishable items and services, Amazon now has 464 retail stores around the world, and a supply chain management system that supports these and is distinct from the Amazon’s core business. The company is also stepping into a different retailing business – food – involving perishable and highly regulated goods. Question 1: (70 points out of 100) As a discounter, Amazon built its brand on lower price, faster delivery model. As its first move as the WholeFoods owner, Amazon came up with two key strategic approaches to integrating WholeFoods business into broader Amazon business model: the price cuts which were aimed to draw more customers and the technological and service innovation. The strategy, however, can be of dubious advantage as the most appealing aspect of WholeFoods is the grocer’s upscale demographics, generating higher profit margins, but limiting size of the market. Whereas lower prices do the opposite – expand market size, but threaten loyalty of luxury segment shoppers and reduce profit margins. If Amazon is targeting the households with mid-income, will price0cutting lead to a significant increase in the new customers purchases or decrease in current customers purchases? Note: store locations may be inconvenient to mid-income earners; shopping habits of mid-income earners can be quite ‘sticky’; etc. QUESTION 1: A. Using the model of monopolistic competition, consider two companies: Amazon and WholeFoods as separate entities operating in two different markets. Amazon is trading inthe market with high price elasticity of demand, and WholeFoods operates in a market with low price elasticity of demand. Compare and contrast the two companies’ pricing and supply (quantity) decisions in the market, assuming both face the same technology (identical variable and fixed costs structures). (15 points) B. Now, suppose Amazon has lower cost technological advantage over WholeFoods. Model this using the analysis framework in (A) above. What will be the two companies’ decisions in terms of pricing and output? What profits will be earned by each company? (25 points) C. Suppose the two firms merge and Amazon’s technology is now available to WholeFoods, allowing the latter to lower its operating costs, without lowering its fixed costs. However, Amazon’s ownership of WholeFoods erodes the latter company’s market power by increasing the price elasticity of substitution in demand for WholeFoods groceries. How will profit of the combined firm change when compared to profits of individual firms as discussed in (B) above? (20 points) D. What do you expect to happen to Consumer Surplus and social gains/benefits as the result of the two companies merger? Explain your answer. (10 points) QUESTION 2 : Some rivals have already reacted to the kickoff of what could become a new era of selling food in the US. For example, Wal-Mart, the world’s biggest retailer, has already invested billions into lowering prices across the board. The conventional supermarket has not evolved much in decades, but Amazon entry will likely drive drastically different shopping behavior in grocery business. Suppose the market reaction leads to two things happening: 1. The market for grocery retailing becomes competitive; and 2. Amazon’s competitors are successful in replicating the core propositions of the WholeFoods brand. In your opinion, can WholeFoods sustain its dominance of the luxury grocery business market niche? Can WholeFoods-Amazon sustain price discrimination powers associated with the differences between on-line shopping channel (low price, low cost model) and physical retailing channel (high price, high cost model)? Explain your answer. • Amazon-WholeFoods merger is an interesting case of innovation, brand differentiation, learning-by- doing and technological innovation deployment • Amazon wishes to expand its grocery business – not simply by adding bricks-and-mortar supermarkets, but by expanding its core e-commerce efforts in this category. If we look at Amazon as a service provider with the huge customer base, the Whole Foods acquisition wasn't an expansion into brick-and-mortar retail, it was an expansion of AmazonFresh. Whole Foods is going to become AmazonFresh's largest customer • The fundamental technological trends present more connectivity across sectors and more capability to analyze large quantities of data cheaply. Where do these trends lead and how does Amazon- WholeFoods link up fit into these? To prepare for this evolution, we must have strategies in multiple areas, at least: 1. Security 2. Innovation and funding 3. Learning, deployment, and competitiveness. The real gains will come from cross-pollination between sectors that will fundamentally change the economy.