How Can Grocery Stores Afford to Dramatically Cut Prices (Like a Certain Huge Chain Just Did)?

Your local grocery store may never be the same again. As you've probably heard, Amazon is shaking up the grocery industry with the recent acquisition of Whole Foods Market for $13.7 billion. And on August 28, shoppers saw changes at all Whole Foods locations nationwide, including the sale of Amazon's popular voice-controlled electronic device Echo and, more importantly, lower prices on many common food items.

Responsibly-farmed Atlantic salmon fillets, for example, now cost $9.99 per pound, down significantly from $14.99, while organic bananas, previously 99 cents per pound, have been reduced by 30 cents per pound. According to Bloomberg, some prices were slashed as much as 43 percent.

But how is Whole Foods—and really, any grocery store—able to slash its prices so drastically? Savvy shoppers might wonder whether this is happening because of the use of loss leaders, where some items are sold below the market value in order to stoke sales elsewhere or threaten competitors. But Phil Lempert, an expert analyst known as The Supermarket Guru, reveals that there are many tactics at play behind Whole Foods' instant discounts.

"Keep in mind that they haven't lowered all their prices yet. This is just a handful of prices, number one," Lempert says. "In the context of their business, this is a very small percentage. Also, it's not totally coming out of their pocket. I'm sure that they've made some deals with their suppliers to give them discounts, whether it's on product that's already in the store or future orders. So, while it's true that the net profit of the supermarket is between one and one and a half percent a year, keep in mind that's not the gross margin. Gross margins, depending on the department, could be 20 percent, could be 50 percent, so this isn't going to put Whole Foods out of business by any stretch of the imagination."

Whole Foods didn't have to take out any advertisements about lowering its prices, either, which likely saved the company a bundle of money.

"It's really looking at it from a merchandising/marketing standpoint," he explains. "The power that they have by doing this and really getting a lot of people in Whole Foods stores that might not have been in Whole Foods stores in years or ever as a result of all the press that they're getting. So it's a small investment. If Amazon had said, OK, we're going to run TV ads all over the place that say we now own Whole Foods and it's a better store and so on, that would have probably cost them a lot more than doing this."

And what other changes are we likely to see at Whole Foods down the road? Lempert looks at the core values of Amazon for cues as to how the company will position Whole Foods in the marketplace; for one, it'll hopefully try to banish the "Whole Paycheck" nickname for the chain.

"[Amazon's] DNA is about value," he notes. "It is about making sure they get as much waste out of the system, and we haven't seen that yet with Whole Foods, but we certainly will see that. I think that they're going to be bringing Whole Foods prices in line with traditional grocers like Kroger or Safeway."

Amazon has also immediately tied in its Prime memberships with the Whole Foods frequent shopping rewards program, started carrying select Whole Foods products on the Amazon site, and is integrating the use of the AmazonFresh delivery fleet.

"Having a rewards program for their Prime members is gonna be huge," Lempert asserts. "That's going to change the way the whole industry looks at frequent shopper programs. Ninety percent of Prime members live within 10 miles of a Whole Foods, so clearly that's going to be their core audience. And also the AmazonFresh delivery trucks, I think, is going to be huge. Folks like Peapod, Instacart, and FreshDirect are going to have a tough time competing because now they've got 460 'warehouses' where they can deliver food."

The Supermarket Guru is optimistic about what's coming next.

"I think it's the most exciting time ever," he says. "Shoppers are going to win, it's going to be a better shopping experience, and in a year or two years we're going to see different formats of stores. We're not going to see aisles with rows of groceries, all the ketchup together. I think it's going to bring a whole new way of thinking to grocery stores, and that's very exciting."