Saturday, December 10, 2016

More perils lie in wait for the eurozone

Events are testing the eurozone yet again. The latest shock comes from Italy, where Matteo Renzi’s comprehensive defeat in the constitutional referendum has caused his resignation. Italy, which has the eurozone’s third-largest economy, is an important country. Mr Renzi’s departure may not prove a decisive event. But, so long as the eurozone fails to deliver widely shared prosperity, it will be vulnerable to political and economic shocks. Complacency is a grave error.
Things are at least improving. Eurozone real gross domestic product expanded by 5.5 per cent between the first quarter of 2013 and the third quarter of 2016. Unemployment fell from a peak of 12 .1 per cent in June 2013 to 9.8 per cent in October 2016. Thus growth is running above potential. Yet this improvement has not offset the damage done by the financial crisis of 2008 and the eurozone crisis of 2010-12. In the third quarter of 2016, the eurozone’s aggregate real GDP was a mere 1.8 per cent higher than in the first quarter of 2008. Remarkably, real domestic demand in the eurozone was 1.1 per cent lower in the second quarter of 2016 than it had been in the first quarter of 2008. This extreme weakness of demand should not have happened. It represents a huge failure. (See charts.)
A direct way of identifying that failure is in terms of nominal demand. In the second quarter of 2016, eurozone nominal demand was only 6.9 per cent higher than in the first quarter of 2008. So what should it have been? Assume the trend rate of real growth is 1 per cent, while the inflation target is close to 2 per cent. Then nominal demand ought to grow at about 3 per cent a year. If policymakers had achieved that, nominal demand would have risen by about 28 per cent between the first quarter of 2008 and the second quarter of 2016. That must be too much to ask. But US nominal demand rose by 23 per cent over this period. Moreover, the weakness of demand also had a strong downward effect on inflation. Year-on-year core inflation has not exceeded 2 per cent since January 2009 and has averaged just 1.2 per cent since that date.
A severe challenge is the divergence in economic performance among the members of the single currency, with deep recessions in a number of member countries (notably Italy) and stagnation in others (notably France). According to the Conference Board, a research group, between 2007 and 2016 real GDP per head at purchasing power parity rose 11 per cent in Germany, barely changed in France, and fell 8 per cent in Spain and 11 per cent in Italy. It will probably take until the end of the decade before Spanish real incomes per head return to their pre-crisis levels. In Italy, this seems unlikely to happen before the mid-2020s. The painful truth is that the eurozone has not only suffered poor overall performance, but has also proved to be a machine for generating economic divergence among members rather than convergence.
Italy has a problematic banking sector, with some €360bn in non-performing loans. Yet this is mainly the result of the deep and prolonged slump. If this continues, still more bad debt is likely to emerge. The inability to agree on how to resolve the banking crisis in ways that meet the constraints of Italian politics on the one hand, and of European rules calling for bail-ins, rather than bailouts, on the other, is now a canker in Italy’s politics.
One encouraging development, however, is the signs of shifts in competitiveness in the eurozone. One indicator is relative wages. Before the crisis, average wages rose markedly in France, Italy, Spain, Greece and Portugal, relative to German levels. This has been at least partly reversed since then. Other things being equal, this should help restore balance within the eurozone’s economy. Nevertheless, the disappearance of the pre-crisis current account deficits in crisis-hit eurozone countries is largely due to severe collapses in their real demand. In the third quarter of 2016, Italy’s aggregate real domestic demand was 10 per cent lower than in the first quarter of 2008, while Spain’s was still close to 11 per cent lower, as it recovered from its post-crisis fall of nearly 19 per cent. Germany’s real demand has risen by 8 per cent over the same period. But its current account surplus has risen from 7 per cent of GDP in 2007 to a forecast of just under 9 per cent in 2016. This is yet another failure in internal eurozone adjustment and makes it too dependent on a large external surplus.
The combination of weak aggregate demand with huge post-crisis divergences in economic performance has turned the eurozone into an accident waiting to happen. True, it is quite possible that the situation will stabilise. But the interactions between economic and financial events and political stresses are unpredictable and dangerous.
What the eurozone needs most is a shift away from the politics of austerity. In its most recent Economic Outlook, the OECD, a club of mostly rich nations, makes a cogent (albeit belated) plea for a combination of growth-supporting fiscal expansion with relevant structural reforms. This is most relevant to the eurozone because that is where demand has been weakest and the fetish over fiscal deficits most exaggerated. In the big eurozone economies, net public investment is near zero. This is folly.
Alas, little chance of change exists. Those who matter — the German government, above all — view public borrowing as a sin, regardless of its cost. The political and economic impact of breaking up the eurozone is so great that the single currency may well soldier on forever. But it has by now become identified with prolonged stagnation. Those member countries with the power to change this approach should ask themselves whether it really makes sense. It is time for the eurozone to stop living dangerously and start living sensibly, instead.

When Will You Age Out of Your Career?

One way to prepare for retirement is to save. Another way: Don’t retire.
It’s surprisingly common to put very little aside and hope you never need to hang up your cleats for good. Among investors under age 35, more than four-fifths (83 percent) say they plan to work during retirement, according to a survey released this month by Merrill Edge. It’s not just millennials: 79 percent of Generation X and 64 percent of baby boomers who are still working agree.
And how many retirees surveyed actually have some sort of job?
That would be 17 percent.
From a financial perspective, working into your 70s or 80s can be a great idea. It’s also completely unrealistic for many workers, especially if they want to stick to their chosen profession. It’s not just blue-collar workers with physically demanding jobs who can’t work forever. Even office workers need to prepare for the possibility that their careers will have a natural shelf life.
“As white-collar workers, we tend to believe we’re immune to the factors that cause blue-collar workers to retire early,” Boston College economist Geoffrey Sanzenbacher said at a recent conference. 1  His research, done with colleagues at Boston College's Center for Retirement Research, shows how “age-related decline” hits even well-educated professionals.
As we get older, not all our skills decline at the same rate. And in some ways, we get better. Older workers tend to be more knowledgeable than younger workers, research has found. Though it can take longer for older people to learn new skills or process new information, they are often much better at tasks they’ve practiced extensively. Physical ability varies, too. An older worker who can’t balance on a roof or deliver a dishwasher might have no trouble holding on to a broom.
Taking these differences into account, the Center for Retirement Research used U.S. government data to rate each of 954 occupations on the likelihood that its required skills will decline with age. The result was a “susceptibility index,” with compensation and benefits managers ranking lowest and dancers at the top.
The researchers then looked at data on when people actually retire. Controlling for other factors, they found that people in occupations that ranked higher on the susceptibility index were indeed likelier to retire early. A white-collar worker ranking higher than 75 percent of the group was 7.5 percent more likely to call it quits before age 65 than a worker in the 25thpercentile.
Why are some white-collar jobs more susceptible than others? The answer lies largely in the extent to which they require different types of intelligence.“Fluid intelligence,” your ability to process new information and situations, tends to decline with age. Meanwhile, “crystallized intelligence,” your knowledge of facts and how to perform particular tasks, generally increases through your 50s and 60s, researchers have found, with little decline after that. That’s one reason designers and stock traders rank higher, or are more susceptible to decline, than, say, teachers and academics.
“The notion that all white-collar workers can work longer, or that all blue-collar workers cannot, is too simplistic,” the study’s authors concluded. For example, photography, a job that can require lots of fluid intelligence, can be more susceptible to age-related decline than jobs as cooks or cleaners, which depend on physical and cognitive skills that last late into life.
Not all the news about aging is bleak. While the health of one segment of the U.S. population has recently gotten worse, Americans on the whole are living longer, healthier lives than ever. A record number are working past age 65, and the share of seniors with dementia has plunged, from 11.6 percent in 2000 to 8.8 percent in 2012. 
Still, even as some talk about raising the Social Security retirement age, we can’t all work as long as we’d like. Over the course of your career, you might want to move away from jobs requiring physical strength and quick thinking, and toward positions that use the knowledge and wisdom you’ve accumulated.
Exercise and good nutrition can help you stay productive longer. And you might want to try saving more, if at all possible. The IRS allows people 50 and older to save an extra $1,000 in individual retirement accounts and an extra $6,000 in 401(k)-style plans. These “catch-up” contributions may come in handy later on.

The persistent poverty of the Indian State

Tirthankar Roy is arguably the finest contemporary scholar of Indian economic history. He has pointed out in one of his books that the Indian government has had to struggle with low tax revenue for a very long time—an issue that is resonant is our times as well.
Roy has provided data to show that the tax collected for every unit of economic output in India was very low compared to not only a colonial power such as Great Britain or an Asian success story such as Japan but also compared to colonized countries such as Malaysia or Sri Lanka. The government of what was then the Federated Malay States spent on average more than 10 times the money spent in British India per head between 1920 and 1930. Not all of this can be explained by differences in average incomes in these two British colonies. Data from the Maddison Project show that India had an average income of $726 in 1930 while Malaysia had an average income of $1,278, in terms of 1990 dollars.
It was the same story in the case of many other colonized countries. Ceylon spent three times more per head than British India. Once again, the difference cannot be explained by higher incomes alone. The same is the case for Siam and French Indochina. Roy says that a major reason for the poverty of the Indian State was the dependence on land revenue for a large portion of tax collections. These revenue were low as well as inflexible.
Much has changed since then. India is now a $2.2 trillion economy with a diversified base of economic activity. Its tax base is no longer dominated by land. Yet, the problem of low tax collections persists. The Economic Survey published in February said that India’s ratio of tax-to-GDP (gross domestic product) is 5.4 percentage points below that of comparable countries. Vivek Dehejia and Praveen Chakravarty have earlier shown in this newspaper that the tax-to-GDP ratio has barely budged since 1991.
The contemporary numbers tells us an interesting story. Around 48 million people file income tax returns in India; the actual number of people who pay tax is lower because of those who report zero tax liabilities. The number of people who were eligible to vote in the 2014 national election was 815 million. In other words, India has one direct tax payer for every 16 voters.
The imbalance between the number of people who pay income tax on the one hand and the number of people who can vote on the other hand has profound implications for the Indian social contract. It creates political incentives for successive governments to borrow money to buy votes rather than build an effective tax system that will spur economic growth. Citizens are also less likely to put pressure on governments to spend wisely on public goods. Of course, only direct tax payers have been considered here; almost every Indian pays indirect taxes on consumption.
The lack of an adequate tax base has several other implications. The Indian State is incapable of spending for national security, a modern welfare system or public goods from its tax revenue. It has to borrow heavily. The result is a persistent deficit bias in Indian fiscal policy. The very same elite that complains—depending on ideological persuasion—about the lack of national security or support for the poor or terrible roads is hypocritically at the forefront of ducking their tax responsibilities. Successful nation states cannot be built on widespread tax evasion.
Many libertarians make a virtue out of this problem. They argue that it is good that the Indian beast is starved of revenue. Some have overstated economic freedom in India because of the low level of tax collections. A sharp point made by libertarian economist Alex Tabarrok in the popular Marginal Revolution blog is worth reproducing here: “A key point is that only 1% of India’s population pays income tax. India would be a libertarian paradise if it had a libertarian government but it doesn’t. As a result, what low income tax payments mean is that India is forced to raise money in less efficient ways and to govern through regulation.”
Tabarrok goes on to argue that most of the tax burden falls on the precisely the high-productivity sectors that need to grow. He adds: “India’s dilemma is that its high-productivity sectors are taxed while its low-productivity sectors aren’t, so valuable resources are trapped in low productivity sectors. (Prime Minister Narendra) Modi knows this and if he is serious then his surprise demonetization will be followed by more efforts to bring India’s informal sector into the formal sector, levelling the playing field, and increasing total wealth.”
Many commentators have speculated whether an exogenous shock such as the ongoing currency reform can change citizen behaviour in India, be it shifting to digital payments or paying taxes or encouraging enterprises to shift from the informal to the formal economy. It is even doubtful whether a behavioural shift was the original intent of the decision to withdraw bank notes of high denomination from circulation—though the Modi government seems to be rebuilding the narrative in that direction over the past few days.
Could a radical change in Indian fiscal contract be an unintended consequence of the ongoing currency swap? Nobody can say for sure, but it is an interesting possibility

Thursday, December 1, 2016

The Maturation of an Investor

Many of us have had early success in investing. My first microcap investment fifteen years ago was a 15-bagger. Instant success can be a great imposter because you think it’s skill instead of luck. Your head starts to swell. After this first big win I thought to myself, “Warren Buffett who? Investing a marathon? Pfff..This is going to be a race and they better get a spot ready for me on the Forbes 400 list”. Here is a chart I shared in a previous post on my maturation as an investor:

Inline image 2

We all want fame and fortune, but the problem with instant success is you rarely have the power to keep what you haven’t earnedIf you don’t have a firm foundation and understanding on how and why you received something, it’s really hard to keep it let alone duplicate it. Deep down we all know it’s not what we do randomly that will produce long-term returns; it’s what we do consistentlySo the education begins to try to turn random luck into consistent skill

Unfortunately, investing’s greatest lessons can’t be taught in a book or in a classroom. They have to be experienced and often times the teacher is loss. Don’t get me wrong, you can learn a lot from books and from other people’s experiences, but they are no substitute for making your own experiences. 95% of successful investing is controlling your emotions when your money is on the line. This is why paper trading/investing is almost useless. You have to put your own money on the line.

In most cases to step toward your destiny you have to first step away from your security. You have to risk who you are for what you can be.

The market loves to destroy egos because only through humility can it prepare your mind to accept truth. Just like military training, the market needs to tear you down and destroy all your selfish beliefs and tendencies before it can build you back up. It is no accident that the greatest lessons occur when we are the most confident. My biggest losses have all occurred after my biggest wins. During periods of over-confidence is when we decide to get lax with our checklist, analysis, maintenance due diligence, or expand outside our circle of competence into areas we don’t have competence. This is when the market comes in and destroys our ego again. It is not surprising that many successful investors are not arrogant or brash, but self-reserved and humble.

“Wisdom flows into the humble man like water flows into a depression”

An investor must experience the highs of success and lows of failure several times before they can exploit these emotions in others. Through the peaks and valleys of your investing experience you begin to learn and pick up nuggets of truth that begin to shape your investment philosophy. In a recent article, When To SellI shared a bit on how my own personal investment philosophy shifted from short(er) term trading to longer term investing.

I’d like to share with you another story:

In 2008, during the financial crisis, I was well diversified (sarcasm), invested in primarily two companies of equal proportion. The first company was a junior mining company. During the crisis, the stock was down 70% from its highs a year earlier. I held on. I knew the management and company really well. It was a high quality junior mining company, if there ever was such a thing. The stock recovered all its losses before the market bottomed in early 2009, and 18 months later was up 600% more.

The second company was a consumer products company. I had traveled to meet management and did field based research. The company’s products were sold online and in large retailers. Even during the worst economic backdrop since the great depression, consumers bought the product. During Q1-Q4 2008, Revenues were up 200%, 200%, 450%, 320%, compared to Q1-Q4 2007. The company produced record results during the crisis. Since no one else owned the stock it only had one way to go…Up…300% during the crisis while the broader markets were down 50%.

I’m not na├»ve enough to think the success I had navigating the financial crisis of 2008-09 was all skill. You will become a better investor when you accept the role that luck plays (good and bad) in your winners and losers. The mining company literally outperformed all other mining companies in North America for a 5-year period. The consumer company was one of only a handful of companies that doubled or more during the crisis. These two companies were probably in the top 0.1% of all companies during this time period. I just happened to find them (one randomly at a conference, second one through word of mouth), did the work, bought them early, and had the conviction to hold. When the next bear market comes, whenever that may be, it would be hard to duplicate this success.

Nevertheless, I learned a great deal from this experience which ultimately gave me the confidence to become a full time private investor. A few years prior I learned the importance of knowing my positions better than most, and this nugget helped me greatly during the crisis. Owning these two companies during the crisis taught me two more valuable lessons. First, invest in quality because quality always pays you back first. Even before the bottom was put in the bear market, capital started flowing back to quality first. This is something I always remember to this day. Second, invest in the best companies you can find that no one else owns because these companies can do well in any market environment. What does “No one else owns” mean. For me it means zero or very limited institutional ownership.

We as human beings are very impatient, so the hardest part of maturing as an investor is allowing ourselves the time. You can’t force it. Many investors “force it” by being active for activity’s sake. I believe it was Ed Borgato that said, “I find that a lot of what Wall Street perceives as productive activity is needless complexity”. Just like a fine wine, you have to be patient and allow yourself the time to mature. Pastor T.D. Jakes in his book, Destiny, says it best, Many people cannot find success because they lack the patience to go through the process to become who they want to be.”

You cannot force the maturity process but you can shorten it in five ways:
1.      Experience. Don’t be afraid “to do” and learn from experience.
2.      Read. Read a lot of annual reports and industry reports. The key is to develop a circle of competence so you can act quickly and decisively. Read up on business leaders, investing leaders, thought leaders, and even some fiction. Why Fiction? It keeps your creative mind balanced which ultimately makes you more focused.
3.      MentorsPicture in your mind where you want to be in 10-years, and then go find that person today and learn from them.
4.      Self-Awareness. In this context self-awareness is the ability to identify and evaluate your strengths, deficiencies, and outcomes. For example, you need to have the self-awareness to recognize luck versus skill. Sometimes you will make the right decision but you will still lose money. This doesn’t mean you made the wrong decision. Sometimes you will make a wrong decision but you will still make money. Don’t play games with yourself. Have enough self-awareness to recognize that even though you made money your actions were wrong.
5.      Own Your Mistakes. When you blame others for your investing mistakes it proves you didn’t do enough of your own work. Fully own your past mistakes so you learn from them.

Only after you’ve experienced failure can you fully appreciate success. You aren’t defined by your past. You are prepared by it. A big part of the preparation is so you develop a thick skin. True conviction can only be obtained by trusting your own research over that of others. Most multi-baggers will have long periods of stagnation as fundamentals backfill, old shareholders give up or get bored, and new shareholders enter. A multi-baggers journey is filled with the corpses of highly intelligent articulate naysayers. Every investors strategy is different, so don’t waste a lot of time defending your positions to others. Do the work. Trust your work. Let company execution prove you right or wrong.

I’d like to leave you with this. You weren’t put on this Earth to be average so stop thinking like everyone else. The greatest investors ever, they all had different investing strategies. Some of them strikingly different. The commonality amongst all of them is they focused on the downside. Find an area of investing that connects with you and your personality. You will have some painful lessons as you mature as an investor, but it’s all part of the journey. Almost all successful people went through incredible hardship, obstacles, and challenges. The power to endure is the winner’s quality.

Higher Prices, Weaker Currencies Threaten Oil Demand in Asia

Rising oil prices in the wake of OPEC’s production cut could deliver a one-two punch to demand from Asia’s emerging energy consumers, where weakening currencies have already led to higher prices.
China and India, the world’s second- and third-largest oil consumers after the U.S., have each seen declines in their currencies versus the U.S. dollar in recent weeks. The Indonesian rupiah and Malaysian ringgit have also hit the skids.
The currency declines compound the effect of the surge in oil prices following Wednesday’s decision to cut production by 1.2 million barrels a day by the Organization of the Petroleum Exporting Countries, analysts and economists said. Benchmark Brent crude prices are up nearly 7% this week, trading at five-week high above $52 a barrel.
Since oil is priced in dollars, it makes crude more expensive in local currencies that have weakened against the greenback. In terms of Indian rupees, for example, the price of a barrel of oil has actually risen 8% last month.
“You have the negative compound effect of a weaker currency and higher oil prices,” said Virendra Chauhan, oil analyst at the research firm Energy Aspects. “It could dent demand at the margin.”
Emerging-market currencies have fallen sharply in the past month against the dollar, with investors placing bets on higher interest rates in the U.S. and the prospect of reduced global trade under a Donald Trump presidency. The rupee fell 2.7% in November against the dollar, while the Chinese yuan lost 1.6%, the Malaysian ringgit is down 6.1% and the Indonesian rupiah is off 3.9%.
Asia is a crucial market for OPEC as the cartel contends with declining market share and rising competition from domestic production in the U.S. But even in Asia, OPEC is fighting to maintain its hold amid growing competition from Russian crude. OPEC accounted for 59% of China’s oil imports in September, down from an average of 66% four years ago, according to Chinese customs data.
Asia is home to some of the world’s fastest-growing economies and energy consumers, though the pace of the expansion has decelerated alongside economic growth. The International Energy Agency in November highlighted a slowdown in oil demand in China and India in recent months, which it said is contributing to a broader slowing in global oil-demand growth.
Even at $50 a barrel, oil prices are still low compared with a few years ago when $100-a-barrel crude was the norm. Those low prices have been a boon to a region where economic growth has slowed and asset bubbles have rippled across markets.
“There would have been a much sharper economic downturn had oil prices stayed where they were at over $100 a barrel,” said Frederic Neumann, Asia economist at HSBC in Hong Kong.
In China, gasoline demand in October was up 17% to 32.83 million barrels a day from a year earlier, according to consultancy Facts Global Energy. India’s gasoline demand showed the same pattern, rising 13% in October from the previous year.
FGE expects demand in India and China to increase next year, juiced by rising auto sales.
Crude-oil demand by Chinese refiners, however, may slow slightly if prices stay above $50 or higher, as higher crude prices mean narrower margins.
“The ideal crude price range for us is between $42 to $48 a barrel,” said Zhang Liucheng, vice president of Shandong Dongming Petrochemical, one of China’s biggest independent refiners.
But while higher prices usually stunt buying, as long as the increase is between 10% and 15%, Asia demand will be remain largely unaffected, said Jeff Brown, president of FGE.
“If oil level remains in the $50s, it is actually indifferent in terms of economic growth and oil demand. But if you start getting more extreme, like going down past $40 and above $60, then it starts to be more of an issue,” said Scott Darling, head of oil and gas research Asia Pacific at J.P. Morgan.

Customers in the digital economy have the whip hand

If the story of industrial relations has been the tussle between capital and labour, then we might have arrived at the plot twist. The digital economy threatens to unseat shareholders and workers as management aligns itself with a third party that has been sidelined until now. Customers, to whom executives have long paid lip-service, are in the ascendancy. “The customer is always right” is no longer just a hollow corporate slogan.
Nicolas Colin, the co-founder of investment firm TheFamily, sees this shift in power as the inevitable consequence of the way digital companies work. They need enough users to create scale and a network effect. Without them, their business models simply do not work. “The strongest party at the table is not the employees or the shareholders any more; it’s the customers,” he told the annual Drucker Forum management conference in Vienna this month. 
Amazon is a perfect example. Jeff Bezos, the chief executive, warned his shareholders in a letter in 1997 that Amazon would “focus relentlessly on our customers” and market leadership over “short-term profitability”. And it would make its employees sweat in the service of those customers. “It’s not easy to work here … but we are working to build something important.” 
Of course, there are plenty of sectors (utilities, airlines and pharmaceuticals to name a few) where customers are far from empowered. And even in the areas where they are gaining ground, they might not hold on to it for long. Many investors in companies like Amazon believe that eventually, once these companies have reached sufficient scale and dominance, the shareholders will reap the rewards. For now, though, it is the customers in the digital economy who have the whip hand.  
That has not been good news for workers. It is because customers want cheap same-day delivery from retailers that many van drivers are paid a piece-rate per parcel and cannot predict their hours. It is because customers want Uber to take them wherever they want to go that drivers are not told users’ destinations until after they have picked them up. It is because customers want their takeaway food delivered fast and hot that Deliveroo couriers have only 30 seconds to respond to the algorithm that controls them.
Low prices mean low wages. Speed, reliability and convenience mean pressure, monitoring and unpredictable hours. In other words, the same things that make this a wonderful time to be a consumer make it a terrible time to be a worker. 
Mr Colin thinks the smart thing for workers and unions to do would be to build alliances with the most powerful party at the table. That might mean calling fewer strikes, which usually hurt the clientele, and more time appealing to customers’ better natures. After all, most of us are consumers and workers at the same time. The “fight for $15” minimum wage campaign in the US, for example, persuaded some home-care clients to join forces with home-care workers to call for better wages and conditions.
Still, it requires a good deal of optimism to believe that customers will ride en masse to the rescue of workers, particularly if the quid pro quo will be higher prices or slower service. Initiatives such as Fairtrade, which certifies products that treat producers decently, have been a success but remain niche.
I once interviewed a man who worked at Amazon, his feet blistered from the seven to 15 miles he walked each day inside the warehouse. He said the company treated him and his colleagues like disposable automatons. But he was still an Amazon customer. He could see the irony but it was just so cheap and efficient, he said with a shrug. It is that good at what it does.

Amazon’s drive-in grocery store marks new offline push

On a grey industrial block in north-west Seattle, the lights are already turned on in a building that has no name. This is set to be Amazon’s new grocery store, one of two that will open soon in its home town, marking the retailer’s first step into physical stores for grocery and convenience items.
It will be anything but your typical convenience store, however. The store functions around a drive-in concept, and features a large tilted awning that gives it the air of a 1950s drive-in diner. Customers who come here will not browse the aisles — they will order their goods online in advance, then stay in their car while their groceries are brought out to them.
Amazon’s move into bricks-and-mortar outlets marks a dramatic departure from its online-only strategy, whose success has made the company one of the most valuable businesses in the world. It also underscores a key new goal, one that has so far proved elusive: mastering the grocery market.
The company has been expanding its grocery delivery programme, Amazon Fresh. It has more than doubled its footprint this year and expanded to 17 markets, including London, yet Amazon controls just 1 per cent of the $800bn US grocery market, according to estimates from Cowen and Company.
“Grocery is the company’s biggest potential for revenue upside,” says John Blackledge, a Cowen analyst. He estimates that Amazon’s food and beverages sales could grow from $9bn this year, to $23bn in five years, making it one of the top 10 grocers in the US.
This could spell tough competition for Amazon competitors such as Walmart, which controls a fifth of the US food and beverage market, as well as smaller players such as Kroger and Albertson’s. Walmart is struggling to find growth in its grocery sales, which fell 2 per cent in October compared with the previous year, according to a consumer survey by Cowen. Amazon’s grocery sales grew 12 per cent in the same period.
Amazon’s experiments with physical stores come at a time when its soaring overall sales give it room to test out new strategies. In the past 12 months, Amazon’s salesrose to $117bn (excluding Amazon Web Services), up 25 per cent from the same period a year earlier — vastly outpacing the growth of the US online retail market.
Despite this, more than 80 per cent of US retail sales remain offline, and those familiar with the company’s thinking say Amazon is looking for new ways to get a piece of such sales.
“You can only grow faster than the market for so long before the law of large numbers catches up with you,” says Scott Jacobson, a former product manager at Amazon, now a managing director at Madrona Venture Group. “You have to go after a few different markets — and this is a different market.”
[Amazon has] built up such a large physical [logistics] infrastructure, it is a question of how do they maximise the use of that infrastructure?
Mark Mahaney, analyst at RBC
Although groceries are a notoriously low-margin business, shoppers tend to purchase items more frequently than any other category. This makes it highly desirable from Amazon’s point of view, as the company works to get users ever more hooked on its Prime membership service, which could in future include groceries, and to cross-sell other items to grocery shoppers.
Mark Mahaney, analyst at RBC, points out that Amazon’s retail margins are already in the low single digits, and thus not dramatically different from typical operating margins in the grocery business.
“They have a core competency in physical logistics and distribution” that can easily be applied to groceries, he points out. “They have built up such a large physical [logistics] infrastructure, it is a question of how do they maximise the use of that infrastructure?”
Amazon has been investing heavily to bring its logistics infrastructure deeper into urban centres and closer to its customers by building a network of smaller warehouses close to city centres. These serve as bases for Amazon’s one-hour and two-hour delivery programme, Prime Now, which has expanded to more than two dozen US cities, as well as London and Paris.
The new drive-in stores could build off those Prime Now warehouses, which already include a limited selection of groceries. Those familiar with the company’s thinking say the pick-up stores could dramatically reduce the delivery costs of a fresh grocery service, which is particularly expensive because of refrigeration needs.
A one-year subscription to Amazon Fresh, the company’s grocery delivery service, currently costs $15 a month. Amazon declined to answer questions about its new stores for this piece.   
Analysts caution that the drive-in grocery stores are still an experiment at this point. “Do I expect them to set up a chain of physical retail stores? Absolutely not,” says Mr Mahaney.
However, the company has recently starting increasing its brick-and-mortar presence in other areas too. Amazon opened its first physical bookstore a year ago, in Seattle. It has since opened two more, in Portland and in San Diego, with a fourth set to open in Chicago next year.
Analysts expect that it is only a matter of time before Amazon starts testing out bricks-and-mortar strategies in other areas, starting with apparel. Amazon has already upended the traditional retail market with the success of its online model, and now it is looking to take the fight closer to its rivals’ home turf.