Amazon, the e-commerce giant that sells everything from toilet paper to Buddhist priests, is reportedly planning to open a series of brick and mortar grocery stores.

The hubs, according to the Wall Street Journal, would be available to subscribers of Amazon Fresh, the company's food delivery service. They would sell produce, milk, meats, and other perishable items for customers to pick up curbside via pre-order, or to browse on the shelves in real time.

This isn't Amazon's first foray into the physical retail space. In 2015, it opened its flagship bookstore in Seattle, Wash., and is said to be planning for several subsequent locations across the U.S. this year.

It might not seem immediately clear why Amazon is entering the brick and mortar space. The so-called "everything store" currently sells items directly online, and by working with third-party retailers through its Amazon Marketplace. It also generates revenue through Amazon Web Services, its fast-growing cloud computing arm. But the vast majority of retail--more than 90 percent, according to Forrester--still happens in physical stores. As analysts suggest, the pain points of e-commerce (i.e., difficulty returning items, or the inability to receive items immediately) still prevent many customers from shopping online.

"Amazon has been very successful in the online world, but probably realizes that the vast majority of retail is still happening in physical spaces," says Brendan Witcher, a principal analyst with Forrester who specializes in retail strategy. "There are two reasons that customers still want to shop in store locations. One is that they want to get that product today. The other thing is that customers need that tactile experience before committing."

The opportunity to gain more from existing members

By entering the grocery store market, Amazon is up against major competition from storefronts like Safeway, Wal-Mart, Sam's Club, and Kroger. And at present, just around 2 percent of grocery sales happen online. Wal-Mart alone accounts for more than 17 percent of the market as of this year, according to Cowen and Company data.

While Witcher characterizes the profit margins on grocery items as "razor thin," Amazon still stands to make a lot of money through the more regular (weekly or bi-monthly) nature of food purchases. It could also benefit from customers making impulse buys, snagging shoes or a novel alongside their produce, say.

"You can think of it [the convenience store] not just as a retail outlet, but as a distribution hub," explains Charlene Li, the founder of business management consultancy Altimeter Group.

Through bookstores, an opportunity to put gadgets in front of new customers

Physical locations are also an opportunity for the company to cross-sell its more expensive offerings, such as the Amazon Echo speaker or the Amazon Fire TV. These items are strategically placed at the center of its existing bookstore locations. As the New York Times' Nick Wingfield recently explained of the fung shui:

"Amazon views its physical stores as an important way to introduce the public to new, unfamiliar devices. Techies might be comfortable buying a device like the Echo online -- a speaker and virtual assistant for the home -- but a lot of people will want to see it in the flesh first."

Challenges of bringing e-commerce to the physical world

Experts suggest that brick-and-mortar stores present new challenges, such as managing in-store employees, or keeping track of store-specific inventory.

Amazon isn't the first e-commerce company to see potential benefits in physical stores. Last year, fashion subscription service Rent the Runway launched four retail locations in Las Vegas, Chicago, New York and Washington, D.C. Meanwhile, beauty retailer Birchbox opened its first location in New York two years ago, cross-selling full-size products alongside the more traditional beauty samples. Its co-founder and CEO, Katia Beauchamp, has cited a need to reach profitability as competition in the beauty industry has led VC investment to cool.

It's unclear to what extent these locations have been successful, however, given that Birchbox recently cut an additional 12 percent of its staff, and Rent the Runway saw its CFO exit in 2015.

"The biggest challenge is people," says Altimeter Group's Li. "In an e-commerce store, you have people who staff warehouses and customer service. In a store, you have to manage people seven days a week. So it's a very different business."

Fortunately, it almost doesn't matter whether the physical stores succeed or fail for Amazon. It's big enough continue operating either way.

"Everything Amazon does is a test," said Witcher, citing the behemoth's recent efforts in drone technology, movie streaming, and even launching rockets into outer space. "They're learning. And that's smart business."

Published on: Oct 17, 2016