Amazon Is Subduing Inflation and Frustrating the Fed

“World’s Greatest Price Wrecker” is a moniker that seems appropriate for Amazon, especially after the price cuts it announced earlier this week at its new subsidiary, Whole Foods.

However, the phrase actually dates back to the 1930s.

It was used in ads by Michael J. Cullen, who’s widely credited with having had the idea for supermarkets. During an era of mom-and-pop enterprises, the suggestion of “monstrous” stores, with plenty of parking, separate departments, self-service, discount pricing, and high-volume sales was revolutionary.

When Cullen’s idea was ignored by his then-employer Kroger Grocery & Baking Co., he struck out and opened King Kullen on Long Island. Ads for the new enterprise cried out: “King Kullen: World’s Greatest Price Wrecker.” King Kullen continues today as a family-controlled operation on Long Island with 32 locations.

Now King Kullen and other grocers need to evolve in response to Amazon’s arrival. We spill a lot of ink tracking Amazon because it’s disrupting so many different industries across the world of retailing (clothing, office supplies, food, etc.), entertainment, and technology (Alexa, Kindle, web services). Amazon is also affecting the broader economy, as the competition and lower prices it typically offers are helping to subdue inflation and preventing the Fed from achieving its 2% inflation target.

The most recent reminder of Amazon’s influence came last week when Whole Foods slashed prices on certain items. The move shook investor confidence in food retailers and suppliers alike. The S&P 500 Food Retail stock price index, which holds Kroger shares, has fallen 19.5% ytd through Tuesday’s close (Fig. 1). Likewise, the S&P 500 Packaged Foods & Meats stock price index, which contains General Mills, Campbell Soup, and others, has lost 6.9% (Fig. 2).

One related industry that hasn’t lost ground this year is Hypermarkets & Super Centers, which includes Wal-Mart and Costco. It’s up 8.3% ytd (Fig. 3). The gains are thanks to Wal-Mart, as the giant retailer’s shares are up 14.0% ytd, ahead of the S&P 500’s 9.3% advance.

Why would Sam Walton’s creation be faring so well in the face of growing competition? We have two possible explanations. In anticipation of Amazon’s arrival to the world of bricks and mortar, Wal-Mart has made numerous acquisitions and introduced new, competitive offerings that are having a positive impact on business. Another possibility:

The continued downward spiral of Sears and Kmart is helping Wal-Mart land new business. I asked Jackie to take a gander at why Wal-Mart’s shares have eluded the bargain bin.

Here are her findings:

(1) Hey, Google. Wal-Mart may not be the first to introduce a new technology, but it certainly knows how to copy a good idea when it sees one. Earlier this month, Wal-Mart announced plans to team up with Google to compete with Amazon’s Alexa. Wal-Mart will share its consumers’ purchase history with Google, and Wal-Mart customers will have access to Google’s online-shopping marketplace, Google Express. Google Express can be accessed by speaking to Google’s virtual assistant, which sits in phones and in Google’s voice-controlled speaker, Google Home.

As an 8/23 WSJ article explained, “The increasing importance of voice shopping suggests Wal-Mart and Google, part of Alphabet Inc., need each other to compete against Amazon. Voice-controlled ordering is a small but rapidly growing share of online sales, analysts say, and one of the top reasons to use Amazon’s virtual assistant Alexa and its Echo speakers.” Wal-Mart will be available on the service in September.

Wal-Mart is also introducing new functions that make shopping easier. It launched Easy Reorder, which lists a consumer’s purchases made online and in-store and makes them available for purchase. It has teachers’ school supply lists available on Walmart.com, and just clicking on the listed items puts them in your cart. The website also has a section dedicated to students shopping for college.

(2) Efficiency rules. In an attempt to keep costs down, Wal-Mart is introducing in-store kiosks from which customers can pick up goods ordered online. Customers access their order by scanning a barcode in the machine. “The massive orange towers stand 16 feet tall by 8 feet wide and deliver items through a conveyor belt inside the contraption,” a 7/6 AOL article explained. Packages are loaded into the kiosk by workers.

Wal-Mart is also experimenting with a kiosk for groceries that stands in a store’s parking lot. Consumers order in advance online, and Wal-Mart employees gather the items and store them in the 20-foot-by-80-foot refrigerated kiosk, according to a 6/6 Business Insider article. Customers walk up to the kiosk anytime day or night, type in a code, and their groceries are dispensed.

Other initiatives: Wal-Mart employees who opt into a program can deliver packages ordered online on their way home from work. The company is offering discounts to customers who ship purchases, especially large items, to Wal-Mart stores. And perhaps most importantly, the company introduced free two-day shipping on orders over $35 on more than 2 million items. Take that, Amazon Prime.

“We believe that we’re uniquely positioned to grow and delight customers by providing the seamless shopping experience they desire. Having stores within 10 miles of approximately 90% of the U.S. population allows us to serve customers in ways that are most convenient for them,” said Wal-Mart’s CEO Douglas McMillon, according to the company’s Q2 conference call transcript.

Wal-Mart has online grocery service in more than 900 of its US locations. In the US, there are 4,741 Wal-Mart stores compared to 444 Whole Foods stores.

(3) Winners and losers. The slow demise of Sears and Kmart shouldn’t be underappreciated in Wal-Mart’s success. Sears, of course, was the Amazon of the 1920s and ’30s. Its catalogs, offering a wide range of merchandise at low prices, dominated the industry. And when the automobile came along, Sears rapidly opened stores that ultimately overshadowed its catalog business.

These days, Sears and Kmart are shrinking. Kmart’s Q2 same-store sales declined 9.4%, and at Sears they fell 13.2%. Shoppers likely will head elsewhere as Sears Holdings continues shuttering stores. At the start of the year, the company had 735 Kmarts and 670 Sears. That’s down from 979 Kmarts and 709 Sears just two years prior. And the footprint will continue to shrink as the closure of 178 Sears and Kmart stores is planned for this year.

(4) Jetting higher. Wal-Mart’s Q2 online sales rocketed higher by 60% y/y, helped by the company’s September 2016 acquisition of Jet.com. Wal-Mart followed up with acquisitions of Moosejaw, Shoebuy, and Bonobos, as well as the rollout of online grocery delivery. Total sales rose 2.1% y/y to $123.4 billion, while the gross margin narrowed by 0.11pps, and adjusted EPS rose by a penny to $1.08. For the full year, the company is expected to earn $4.37 a share, basically flat from last year’s $4.38 EPS.

Here’s the rub: Wal-Mart doesn’t have a rapidly growing cloud service that throws off oodles of profit. As long as Amazon has Amazon Web Services (AWS), it can sell consumers bananas at a loss. And that’s a problem for everyone in the industry.

“AWS’s juicy operating profit margin of more than 25% gives Amazon a way to fund its new ventures and a retail business that has notoriously skinny margins. The cash and financial flexibility AWS provides ensures that Amazon will be a lethal competitor in the retailing industry for many years to come,” we wrote in the 3/30 Morning Briefing. It’s dilemma that we have no doubt Michael Cullen would understand.

Dr. Ed Yardeni is the President of Yardeni Research, Inc., a provider of independent global investment strategy research.