Amazon’s great conditioning experiment

Jeff Bezos has been very busy wreaking havoc in the retail space lately. His company, Amazon, recently announced that it will acquire Whole Foods Market for $13.7 billion. Amazon also announced the launch of Prime Wardrobe, a service that allows Prime members to try on clothes before they buy. Finally, news emerged that Amazon and Nike would strike a deal for the latter to sell its iconic shoes directly on the Amazon website. These developments together have crushed the share prices of grocers, department stores, and apparel and footwear retailers. Yet, Amazon itself has revealed very little about its intentions with these announcements.

The biggest development, and the one Amazon has been most silent on, is its announced acquisition of Whole Foods. This deal has spawned numerous theories from industry insiders to Wall St analysts as to what the company plans to do with Whole Foods and its network of 461 stores. Speculation has mostly centred on reducing Whole Foods’ prices to shed its “Whole Paycheck” image, and leveraging the store network as click-and-collect stations, local distribution centres, and shelf space to promote Amazon’s growing range of private labels and electronic devices. However, none of these strategies are distinctly “Amazon”, and incumbent grocery retailers are already pursuing them to some extent or other.

While I don’t profess to have any better insight into Amazon’s grocery strategy than the next internet commentator, I do not believe Amazon has spurned physical stores for two decades only to capitulate now and compete with incumbent grocers on their terms. Whole Foods has just over 2% market share of US grocery sales (compared to 16% for leading grocer Kroger), and it is unlikely that Amazon can capture a meaningful share of the $700 billion grocery market by competing on price and conventional measures of convenience alone.

If we look at what has driven Amazon’s exponential domination of the retail industry and summarise it in one word, it would be “conditioning”. Just as Sam Walton conditioned shoppers to expect the lowest prices every day when he founded Walmart in the 1960s, Jeff Bezos has meticulously conditioned consumers to be dissatisfied. This may sound bizarre, but consider this: Amazon’s overarching philosophy is “customer obsession” and a fervent belief that the customer is always dissatisfied, even if the customer doesn’t know it. To Bezos, the moment a business believes that its customers are satisfied, is the moment the business starts to decline.

This mentality can be seen at work throughout Amazon’s history. First it started with books – it wasn’t until Amazon opened its online bookstore did customers realise that they were dissatisfied with the prices and selection at brick and mortar bookstores. Then came free shipping over a certain basket size, followed quickly by the Prime two-day free shipping program. Bezos said that customers didn’t ask for Prime, but Amazon believed that customers would be dissatisfied without it. Now, the oft-referenced “Prime flywheel” is both the sword and shield surrounding Amazon’s retail business. Shoppers have been conditioned to be dissatisfied with paying for shipping, waiting more than two days for delivery, dealing with a limited selection, and even the time cost of leaving the house to go shopping. Competitors are thus forced to compete on Amazon’s playing field, and none have successfully replicated the Prime program – even if competitors could match Amazon on price, speed and selection, customers would be dissatisfied with the lack of free movies, TV shows, music and e-books offered to Prime members. Consider that Netflix built a $70 billion business out of streaming video, while Amazon gives it away for free.

For Amazon, competing on price and/or convenience (speed and selection) alone won’t be enough to condition customers to be dissatisfied with their existing grocery options, especially when German discounters Aldi and Lidl are also trying to expand in the US. Amazon would, at the very least, need to condition customers to expect a seamless, queue-and-checkout-free grocery shopping experience, one that would be hard for competitors to replicate. Even better if Amazon can leverage the Whole Foods stores to expand the Prime Now offering, and thus condition customers to expect two-hour free shipping even as two-day free shipping becomes industry standard a decade after Amazon pioneered it.

The same mentality also underpins the Prime Wardrobe service announced this week. By allowing customers to order 3 to 15 items of clothing to try on for a week, pay for what they like and then return the rest, Amazon is conditioning customers to be dissatisfied with not only the process of travelling to a store and trying on clothes for 30 seconds in cramped change rooms, but also with the process of paying upfront for clothes online, returning what doesn’t fit, and then waiting for a refund. It is also no coincidence that this service was announced two months after Amazon’s new Echo Look device was introduced. Not only will customers be ordering boxes of clothes from Amazon to try, they’ll also be asking Alexa whether they should buy. And as Alexa learns more about the customer, she can recommend better styles that should lead to higher conversion from tries to buys.

Thus, in quick succession, Amazon has barged its foot in the door of the US grocery market and firmly planted both feet at the top of the apparel retailing heap. Many already expected Amazon to overtake Macy’s as the largest apparel retailer in the US this year, and the launch of Prime Wardrobe will only help customers overcome one of the major pain points of buying clothes online. The deal with Nike to sell directly on Amazon may lead other brands to do likewise and improve the value of Prime Wardrobe. Finally, if Amazon can condition customers to be dissatisfied with their current grocery shopping experience, it might finally bring this category—which accounts for a third of US personal consumption—within the Amazon ecosystem and further accelerate the Prime flywheel.

Montaka owns shares in Amazon.

DH5_2155Daniel Wu is a Research Analyst with Montgomery Global Investment Management. To learn more about Montaka, please call +612 7202 0100.


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