Picture this: A long established direct to consumer business has committed to opening a significant amount of brick-and-mortar stores in 2021. Amidst the 2020 online fulfillment craze this company is rapidly expanding its physical footprint.
2020 had us believe “brick-and-mortar retail is a thing of the past.” But we fail to realize is this monumental statement can be true and false at the same time.
What gives? At a certain scale, DTC businesses realized the cost of a retail location is actually a cheap way to acquire incremental customers (especially in high-traffic locations). Here’s a great discussion on Warby Parker doing this, for example .
The same is true for the largest e-tailer, Amazon.
This post will dive into Amazon’s foray into brick-and-mortar and why it’s obvious that it will expand its footprint (hint, it compliments a significant driver of its moat, Prime).
Bear with me on some historical points in this post: It’s important to understand the history. And then we’ll all better understand why Dollar General is an attractive target for Amazon to gain retail footprint AND its logistics expertise.
The Importance of Prime
Doubted at First – Now the Moat
Amazon’s online retail business truly started to gain steam when it launched Prime 2-day free shipping. At the time, people forget many said something like:
“the cost of business just keeps rising, this won’t be that attractive to many customers… will they ever generate profits?”
I took these comments straight from a sell-side report at the time. But Amazon realized this would be attractive.
The annual Prime Membership fee + low prices + free shipping = a very sticky business. Amazon was able to use the membership fee to subsidize the growth and chose to scale much faster than Costco (I’ve discussed their similarities in a prior post).
Last Mile Delivery
Amazon found something consumers want (cheap, near instant gratification with little work) and now has over 200 million paid prime members.
So they’ve decided, “hey, this is driving a moat and causing customers to pick us over others – let’s turn it up a notch.” Now big cities are seeing 1-day delivery or even 2-hour delivery in some cases.
Amazon also has been aggressive investing in a last mile delivery service of their own.
This is from a Fedex deck put out in late 2019
Fedex used this graph to explain why Amazon wasn’t that meaningful to them, and why they are ending a contract with Amazon. All it told me was that Amazon is aggressively investing to control delivery, gain scale, and dominate the customer (as an aside, is this an under discussed AWS-like business for Amazon? I.e. something they first use for their benefit, but then farm out for others in third-party fulfillment. Yes.)
Amazon Embraces B&M: The Whole Foods Acquisition
Turning back to the original point of this post: everyone understands the Whole Foods acquisition expanded Amazon’s brick-and-mortar footprint.
Recall this article titled, “Amazon buying Whole Foods puts it right next to one-third of America’s richest households.” I highly recommend you to read it.
Amazon’s expanded touch points and categories allowed the stores to serve as delivery locations (Prime Fresh) and also are stores where customers can conduct returns.
Similarly, Amazon Go is another retail concept Amazon is experimenting with. Just walk in the store with the app open, grab what you want, and walk out. A true CONVENIENCE store. The goal is no line hassles. In fact, a new article just came out applying this tech to a whole grocery store. Hmm.
So, we’ve established that Amazon:
- Wants to create as sticky of a customer relationship as possible
- Wants to get products to customers in a low-cost way
- Knows supply-chain is key and is investing heavily there
- Understands retail footprint will be part of the mix
There is still TONS of white space for Amazon
I assume most people reading this post are in a reasonably populated city. Maybe you’ve experienced Amazon’s 1-day delivery, or even 2-hour delivery. Maybe you get Whole Foods delivered.
Congratulations. But you are only part of America. If there’s anything elections have taught us, what you may think is America, ain’t all of America. Okay, I’m slightly kidding there.
If we go back to that Whole Foods analysis that was done that I linked to above – you need to re-read it. The title is misleading. The article actually says, “one-third of Americans with annual incomes over $100,000 live within 3 miles of a Whole Foods.”
What is the median household income in the US again? It’s $68,000. That’s for household. Median individual incomes are about half that.
That means there is actually much more white space for Amazon by going out beyond the Whole Fooders. Clearly, they’ve been focused on high-density population areas with high incomes. But there is a lot of white space out there.
I wish the Census Bureau chart (left) broke down incomes into more brackets, but I compared it with Whole Foods locations from this website (right). Compare dark green spots on chart of the left with dark green dots on chart on the right.
Pretty clear overlap, and it makes strategic sense for Whole Foods (or Whole Paycheck, as some call it). But if you believed in the Whole Foods acquisition thesis and believe B&M footprint can help Amazon reach the customer, that also means there is tremendous white space for Amazon.
Why? Because that last mile delivery is very expensive. Rural locations do not benefit from the same route density and therefore, shipping to them gets incrementally more expensive. Yes, Amazon has been leaning on the USPS for some of this, but if you want to push the envelope ahead of your competitors, you can’t rely on that forever.
Enter Dollar General as M&A Target
- Who has over 17,000 stores, with ~75% of US population living with 5 miles of a store, and a goal of 25,000 stores?
- Who has stores specifically where Amazon is underpenetrated?
- Who has had a relentless focus on logistics, driving a powerhouse?
- Who already has a private carrier fleet accounting for 20% of their outbound fleet?
- Who has already figured out produce and fresh food logistics to rural areas?
- Who provides low cost products to customers, while also earning a high ROIC?
Let me state these points another way: Dollar General provides low cost products to its customers (in some cases very rural areas), yet also carries ~11.5% EBITDA margins (almost 2x Amazon & Wal-Mart’s margins, despite high margin third-party fulfillment revenue for the behemoths), and has a ROIC in the ~50% range?
That must mean Dollar General benefits from some mix of these things:
- customer acquisition cost is low (only game in town)
- they are getting paid some premium (perhaps for location)
- they have very effective logistics (to keep cost low), and
- they utilize assets / working capital effectively to drive high ROIC.
Dollar General: A Logistics Powerhouse
If you’ve followed Dollar General for a while or read my prior discussions on them, you probably know that they are a logistics tour de force. We’ve talked about a couple things already, but here are a couple more to consider:
Relentless Focus on Reducing Stem Miles: This is the distance between a distribution center (DC) and a store. Reducing the distance reduces cost. Dollar General has 17 DCs for non-refrigerated products, 9 cold storage DCs, and 1 DC that serves both. Goldman recently conducted some analysis that showed DG had reduced stem miles by ~10% since 2016, despite store count increasing by >20%.
DG Fresh Valuable to the Everything Store: I’m just going to let DG explain this one from when they launched DG fresh in early 2019.
DCs Are Valuable: Amazon details it has ~295 million sq ft of properties across fulfillment centers, data centers, and other in North America. Dollar General only has ~20 million sq ft, but its likely in the areas that Amazon is not.
Amazon has $1.7 trillion market cap. Dollar General is $50 billion. Hm. Could increase your North American sq footage by 7% by acquiring something 3% your size.
The Math: Can Amazon to Acquire Dollar General?
Dollar Generals’ market cap is around $50BN with a $53BN enterprise value, ex-operating leases. In contrast, Amazon spent $58BN in capex during 2020.
Amazon also exited Q1’21 with ~$73BN in cash and can issue debt at super cheap rates. They have equity currency too if they really wanted. But any way you slice it, I think Amazon would have no problem acquiring DG.
The synergies would be dramatic and the shear amount of positive headlines would probably be nauseating – that’s how good of a deal it seems to me. Cross-selling, mini-DCs, adding Dollar General’s logistics in the mix, etc. etc.
Imagine combining these two powerhouses together. Imagine taking the learnings from Amazon Go and applying it to 17,000 stores as fast as possible. Imagine Amazon actually having this kind of access to the whole country.
How would you answer this question? Do you think Amazon will eventually provide 1-day or faster delivery everywhere in the country?
Most know it’s inevitable, but this deal would hasten the inevitable.