Dan Raff and Amanda Nicholson on Amazon's Foray into Private-label Groceries

A huge market opportunity awaits online retailer Amazon as it plans to launch its own private-label brands of perishable groceries including milk, cereal and baby food. However, the e-commerce giant must overcome challenges in quality, the distribution logistics of perishables and customer preferences that the firm hasn’t previously faced.

“ … in a time-pressured society,” according to Amanda Nicholson, professor of retail practice at Syracuse University’s Whitman School of Management. Her optimism came with a crucial rider, however: With food items, especially private-label brands, “[consumers] need a sense of faith that this is going to be a good product, and that takes some time to build,” she said, noting that upscale supermarket chains like Wegmans have built that reputation over time. “I don’t think Amazon has that automatic advantage at all.”

According to Wharton management professor Daniel Raff, Amazon will benefit from the refinement over the years in the business model for home deliveries of online grocery orders. He pointed to two critical factors for success — warehouse locations that can guarantee freshness of produce; and sophisticated routing and planning of transit schedules to ensure timely deliveries. He noted that Amazon has been building warehouses on the outskirts of major U.S. cities.

Nicholson and Raff discussed the opportunity Amazon faces in private-label food deliveries on the Knowledge at Wharton show on Wharton Business Radio on SiriusXM channel 111. (Listen to the podcast at the top of this page.) Amazon’s plans were first reported by The Wall Street Journal in late May.

Amazon already offers private-label brands in products including cables and batteries, but this is the company’s first attempt to extend that to perishables. As part of its plans for private-label food items, Amazon sought trademark protection in early May under its Elements brand for products like coffee, soup and pasta, according to the Wall Street Journal report. The U.S. market for private-label packaged goods was worth $120 billion in 2014, the story said, citing research firm Information Resources.

“There is plenty of room for growth [in online grocery deliveries]… in a time-pressured society.” –Amanda Nicholson

The Quality Threshold

Ensuring quality will be the biggest challenge Amazon will face in food deliveries, said Nicholson. She recalled Amazon’s abortive launch last December of a brand of diapers under its Elements brand. Amazon had to withdraw the product from its site a month later after customers complained of quality problems.

Unlike with delivering books or music, the quality bar is set much higher for food items, said Nicholson. “When we are talking about melons or fruit or private-label yogurt, most of us have very specific likes and perhaps dislikes.” Also, in certain food categories like melons, avocados and other fruits that can easily become bruised, most customers may want to see what they are buying, said Raff.

“The secular change over the last dozen years or so in grocery merchandizing, and in the investments grocery store operators are making, has to do with the general shift in consumer preferences toward higher-quality fresh produce,” he explained.

“Vendors would be aware that customers who experiment with online grocery shopping would be very sensitive to the quality that is delivered,” Raff continued. “So it is probably worth it for the stores investing in the quality of such products in the beginning in order to generate consumer loyalty.”

Learning from Mistakes

Raff recalled the rise and fall of Webvan, an online grocery business based in Foster City, Calif. Launched in the thick of the dot-com boom in 1996, it went bankrupt five years later. Webvan became a part of Amazon in 2009 and focuses non-perishable groceries.

Webvan was “a great idea,” but it failed because of distribution problems, said Nicholson. Nevertheless, its experience inspired “entrepreneurial minded people,” said Raff. “It strongly suggested that once people figured out how to do the infrastructure properly, something like [Amazon’s latest move] might be coming. We know now that this sort of service is commercially feasible.”

Nicholson pointed to FreshDirect, an online grocer based in Long Island City, New York, that was founded in 2002 and serves markets in New York, New Jersey and Pennsylvania and appears to have gotten its business model right. “FreshDirect keeps its edge by focusing on its food route,” she said. She noted that the firm’s founders have experience in the supermarket and grocery businesses, “which is helpful.”

“Vendors would be aware that customers who experiment with online grocery shopping would be very sensitive to the quality that is delivered.” –Daniel Raff

Follow the Money

Customer satisfaction is key to online grocery deliveries — but the business also has to make money. “The crucial thing in home deliveries is [to ask]: Is it worth delivering?” said Nicholson. Clearly, each customer’s order has to cross a value threshold before it becomes worthwhile to the retailer, she added.

The arithmetic gets more complex with same-day delivery. Raff said that while “same-day delivery was cheap, prices [of products] were higher than they would otherwise be,” citing research by some stock analysts.

Raff also wondered how Amazon might use the customer data it collects. He recalled a controversy Amazon faced some years ago where it supposedly experimented with data on customer search behavior to adjust prices of goods “in a way that is [more] favorable to Amazon than … to the consumer.” He said that in the ensuing negative publicity, some found this to be “a somewhat more sinister side” of the company.

In any event, Amazon could be a winner with its grocery delivery business if it scores on two fronts, according to Raff. One is about persuading customers of the convenience, reliability and quality of its offerings, he said. The second aspect is about getting consumers “habituated with their orders arriving in hours rather than days later,” made possible with Amazon’s warehousing network and transportation infrastructure.

“[Eventually], all categories of consumer goods will fit into this general mindset — not just music or clothing or food,” Raff said, noting that Amazon “is really trying to be ‘the everything store.’”