Fruit that’s Ripe for Non-traditional Disruption (and how to diligence the prospect of it)

The Amazon Whole Foods tie-up is certainly throwing more than a couple of mature industries for a loop: food production, logistics and distribution, mass-retail and groceries. Since the announcement (and as of today), Costco lost 17% of its value; Kroger is down 30%; Sprouts is down 24%; Wal-Mart took a hit but seems to be holding its own.

There are many fascinating aspects to Amazon’s move – and more than a few material strategic angles.

From a commercial due diligence perspective, this USD $13B deal does highlight a typically neglected acquisition risk (but also an opportunity): the risk of a strong new entrant, that is not only willing to enter, but is interested in competing on very different terms. This is not necessarily a better mouse-trap story (although it has some of those aspects). This is a case of not only deploying tactical changes to the game, but this new entrant has far greater interest in playing an entirely different game with a very different set of outcomes.

As has been noted from the earliest moments of this deal, Amazon is obviously not in this to maximize its debt free cash flow or operating income – measures that all the grocers are in it for (and are held accountable for).

Amazon is not in this business to sell groceries. Amazon is in this game for one reason, and one reason only: Amazon wants greater hooks into the consumers’ daily consumption habits. Groceries are simply one of the very most significant consumer staples. Every family, every week – no breaks.

The water utility company was not for sale, and Starbucks had a market-cap of USD $87B. Whole Foods had some merit.

What does this new business tactic – entering a segment and rewriting the business model rules - mean for PE and M&A strategists? First, take the prospect of this kind of disruption seriously. Second, see this as much of a value generation opportunity as much as other might suggest it is a risk (which it is).

What are the signs to look for (that this could happen)? We are happy to chat through the others, but here are some that you should certainly bake into strategic diligence:

  1. Is this a sector that sells into a broad user base?

  2. Are the users attractive buyers of services or products outside of the current business?

  3. Are the purchase patterns of this user base reliable (e.g., like buying food at the grocer)?

  4. Is this a sector that is mature and without much innovation over the past decade?

  5. Are there competitors (that could serve as some entity’s change agent) that have ..

    • .. a broad loyal customer base, or a smaller, but vocal user base that serve as thought leaders and evangelists (think Apple in the mid-1990’s)?

    • .. specific attributes in its enterprise that are attractive and unique (e.g., technology platform; distribution channel; underleveraged brand that has a unique and powerful story / heritage)

  6. Are there any non-industry participant power-players that ..

    • .. have been playing in the periphery? (Apple’s earliest versions of iTunes music store gave a pretty big hint of what was to come ..the iTunes music store added a viewing tab that put out movie trailers within the first year of the store, and proceeded their entry into movie and television rentals by several years, but still telegraphed its entry into a much broader media play?);
    • .. know how to make money a different way (e.g., Google with advertising hence its willingness to disrupt the desktop office suite or Apple with hardware sales, hence its willingness to disrupt the media industry, etc.);
    • .. have a lot of capital; and
    • .. have a track record of disruption and investor permission to enter new spaces?

Add these factors up, and if you end up with a significant storyline, you have found yourself an interesting factor to think through (and possibly seek to take advantage of).

GRAPH does not believe that this risk is limited to the big mass markets. We believe that that this is a business tactic will quickly grow in prominence (as it has reached a tipping point and is awareness is rapidly growing) and this tactic will show its force in many industries. Capital is abundantly available and the creatives understand the prospect.

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