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5 Reasons Why Amazon (AMZN) Can't Kill Brick-and-Mortar Stores

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Today was the second annual Prime Day,’s (AMZN - Free Report) biggest shopping event in the year. Dubbed the “Black Friday in July,” Prime Day is rife with sales on items in every category (see a few interesting ones that our team noted here), and generally results in a massive volume of purchases. On Prime Day last year, Amazon’s sales soared 93% in the United States alone.

While other companies have tried to capitalize on the buzz that comes with Prime Day, none have been able to come out of it the way Amazon does. With such strong brand recognition, an easy to use interface and the convenience of being able to buy things without moving, many believe Amazon has the potential to destroy the current brick-and-mortar store status quo.

The idea of the brick-and-mortar store, that is, a store that has a physical presence in a community, has been a staple of commerce throughout human history. Granted, this image has evolved from small vendors to huge warehouse stores such as those owned by Costco (COST - Free Report) and Wal-Mart (WMT - Free Report) , which is currently the largest retailer on the planet.

The brick-and-mortar store still has its place, but the last two decades have seen significant conversation on the rise of e-commerce, a new threat to current retail behemoths. In particular, Amazon has become a household name and reshaped the retail landscape, accounting for 24% of all retail sales growth in the U.S. just last year, according to Macquarie Research.

Although investors may have reason to grimace at the outlook on the brick-and-mortar store, let’s take a look at five reasons to turn that frown upside-down.

Prime Now Isn’t a Replacement for Buying Things Yourself

Amazon’s most dramatic competitive move against the retail industry is the creation of their Prime Now delivery system. The inventory is smaller than that of the full website, but the idea is consumers can use the service to have items delivered to their doorstep within two hours (or one, for a higher cost).

As audacious as the idea may be, it does not match up to the instant gratification of going to, say your local Wal-Mart and picking out what you want and taking it home. There are times when we need something now, and at this point brick-and-mortar stores are still the way to fulfill those desires. It isn’t feasible enough yet for Prime Now to have a very expansive inventory, because it would put too heavy a strain on their drivers, who at the moment are hired as independent contractors with no benefits (a model similar to Uber).

According to a popular review by a current Prime Now driver, the hourly wage is “decent,” but is eaten into by costs such as gas and vehicle wear and tear that drivers are on the hook for. There is currently a tip system for drivers, which some consumers believe is something that Amazon should remove and compensate for themselves either in wages or in the price of the items delivered through the service.

A Sustainable Business Model Incorporates Both Online and Physical Presence

Large brick-and-mortar stores have an increasing presence online, and are experiencing an increase in sales too. Wal-Mart grew its online sales by 8% year-over-year by Q4 2015, and Target (TGT - Free Report) grew its online sales 34% last quarter, beating Amazon’s growth of 28%.

Wal-Mart already has over 11,000 stores in 28 countries, and that coupled with an increasing online presence does make it a threat. Amazon is just beginning to dabble into expanding into brick-and-mortar, having just recently built its first bookstore in Seattle. Their second location in San Diego is expected to open in a few months.

The move is more so focused on gathering data on retail habits rather than to turn a profit, but essentially this chapter of Amazon’s expansion is farther behind than, say, Wal-Mart and their online expansion.

Another interesting note is the fact that Target hired Amazon’s former VP of operations at the end of February. It announced a few days later that it plans on spending upwards of $2.5 billion annually on improving supply chain infrastructure for online orders.

Amazon’s Newfound Profitability Depends Too Heavily on AWS

As popular as it has become, a crucial point of interest on Amazon is the fact that their e-commerce business had an operating margin of less than 2% in Q1 2016, the quarter in which they beat expectations significantly. The reason why they beat so strongly was actually because of the operating margin of their cloud computing division, Amazon Web Services (AWS).

AWS played an integral role in Amazon’s most recent strong earnings report, accounting for 56% of their total operating income. This is interesting because the $2.57 billion in revenue that it gathered was only about 9 percent of Amazon’s total revenue. The fact that such a small piece of the pie had such a big impact on Amazon’s net income goes to show that their main e-commerce business really isn’t profitable yet.

The boost that AWS has given Amazon is recent, but before that net income was comparatively lackluster, with values of $79 million in Q3 2015 and as low as -$57 million in Q1 2015. With Alphabet Inc. (GOOGL - Free Report) subsidiary Google’s cloud service hot on their tail, AWS may have to cut costs to stay competitive, eating into Amazon’s future income.

By comparison, let’s take a look at Wal-Mart’s net income over the last four quarters. In their Q1 FY2017, Wal-Mart had a net income of about $3.08 billion. This is the lowest income in the last ten quarters, yet it is notably higher than Amazon’s most recent income, one of the best that it has ever reported.

If Amazon is going to kill the brick-and-mortar store, they need a more consistent and sustainable means through which to do so.

Amazon Hasn’t Cracked Into Every Market Yet

As dominant as Amazon has been, it has not become the number one destination for everything. There are numerous industries such as jewelry and cars that Amazon just cannot tackle, at least for the foreseeable future.

According to research by PricewaterhouseCoopers, 58% of people in the United States had not purchased online groceries even once in the last 12 months, a stark difference from many of the other categories which boated percentages above 60. There are things that people just don’t want to buy online yet, and brick-and-mortar stores are satiating those needs instead.

When Shopping, It’s the Experience that Matters Too

We go shopping for all kinds of things, all the time. There’s a difference between going out to buy food and other necessities and going out to buy a luxury item, like jewelry for example. Buying a product is an experience, and interactions with friendly employees while viewing beautifully laid out products leads to more purchases.

Shopping can be a meaningful experience, in which one can try outfits on with friends, give a new video game a test run or see how that new baseball bat feels before purchasing it. Brick-and-mortar stores maintain the experiential element of consumerism, and that’s not something that can be easily replaced.

Items have sentimental value to their owners, and the story behind a bracelet from a day at the mall is far more compelling than a click on the computer and a package on the doorstep.

Bottom Line

I personally love the shift towards e-commerce and the convenience that it brings. With Amazon Prime Day today, it’s clear to see the effect that it is having on our spending habits and on what draws our attention. Although this is the case, the fact of the matter is that the brick-and-mortar store has had and continues to hold its own merit.

It’s very possible that fifty years from now a kid will laugh at how short-sighted the ideas behind this article are. The possibility does exist that in the future there are no physical stores anymore, but for the reasons mentioned, investors shouldn’t rule out companies that operate mainly in a brick-and-mortar environment. For now at least, there’s plenty of fight left to be had.

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