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Last weekend was a momentous one for about 12 percent of the country. The state of California started requiring online retailers to collect state and local sales tax from residents. That means prices on Amazon.com (AMZN), the world’s largest Internet store, rose anywhere from 7.25 percent to 9.75 percent.
So how will Amazon react to this unwelcome jump in prices? Here’s one response that I believe is inevitable: by sending in the grocery trucks.
For the past five years, AmazonFresh, the company’s grocery subsidiary, has quietly been experimenting in Amazon’s hometown of Seattle. Residents there can order fresh produce, dry goods, meat, and seafood and have it delivered to their home anytime—day or night. The company owns a fleet of white and green trucks in the Seattle area and uses them to deliver orders that are carefully packed into green and blue plastic palettes. Seattle residents say it’s a marvel—you can place your orders until 11 p.m. and find the products waiting for you by the time you wake up.
But AmazonFresh has been slow to expand. One big reason is the sales tax issue. If the company started selling groceries and delivering orders in states where it claimed it didn’t have any physical operations, it would have been forced to start collecting sales tax. Well, as of this weekend, that’s no longer an issue in the country’s most populous state.
The service poses a number of challenges for Amazon and the traditional way it has done business. AmazonFresh requires the company to deliver multiple items, instead of just the usual one or two, and to make deliveries within a few hours, instead of after two days or more. Amazon has also used Fresh to try out same-day delivery of other products. Fresh customers who order a popular book or DVD often find it tucked next to that bag of organic fingerling potatoes.
Building a profitable service is also difficult because grocery stores have painfully low margins. Remember dot-com flameouts HomeGrocer and Webvan? Peapod, a pioneer in the space, still delivers in such cities as Chicago, New York, and Philadelphia, but recently it’s resorted to opening actual pickup locations to make the model work. FreshDirect has come as close as anyone to building a brand around home grocery delivery, but it remains small, operating primarily in the New York area.
Yet given those obstacles, Amazon has quietly worked to hone the service in Seattle. (It started AmazonFresh before it introduced the very first Kindle.) It has kept adding trucks, staff, and product, and internally, according to people with knowledge of these conversations, execs are constantly debating the wisdom and timing of expansion. The Fresh team is growing: There are currently a handful of job openings on the Amazon career site. And Doug Herrington, Amazon’s vice president of consumables, who oversees AmazonFresh, is clearly a believer in the grocery delivery business. He worked at Webvan from 1998 to 2001.
So I think Amazon’s likeliest next move is to expand Fresh into a high-density metro area like Los Angeles or San Francisco. The company is already working on two new fulfillment centers, a 95,000-square-foot facility east of L.A., and a 1 million-square-foot space east of San Francisco. Add some portable refrigeration units, and those two facilities could serve as bases of an AmazonFresh hub-and-spoke grocery distribution system for California’s two largest cities.
Delivering groceries is just the kind of thin-atmosphere climb that Jeff Bezos loves. Other competitors find it difficult to breathe at these altitudes, but Amazon can potentially make it work because a service like Fresh bolsters the core retail business—in this case, with quicker deliveries of the most popular products. Expanding grocery delivery also strengthens Amazon’s appeal with high-frequency female shoppers. Amazon’s founder likes to say he’s “stubborn on the vision, flexible on the details.” I suspect we shall soon see if that vision includes turnips and tomatoes.