Consumer

Andrea Felsted is a Bloomberg Gadfly columnist covering the consumer and retail industries. She previously worked at the Financial Times.

The next supermarket price war will be a London street fight.

Amazon Fresh has finally made its foray into grocery retailing in the U.K. And the offer looks compelling.

The U.S. giant will offer 130,000 products in 69 London postcodes. Crucially, it will offer delivery with as little as a four-hour window.

Unlike in the U.S., where the service looks to be highly priced, the charge in the U.K. looks competitive.

Amazon's Assault
Its monthly charge for unlimited online grocery delivery looks competitive in Britain
Source: Company websites
Amazon requires £79 a year Prime subscription. Sainsbury's rate is extrapolated from the cost of its three-month deal. Lower cost options may be available if customers sign up for longer periods, and minimum order sizes may apply.

True, to use Amazon Fresh you would already have to have a subscription to Amazon Prime, which costs 79 pounds ($114) a year, but brings other benefits. After that, it is 6.99 pounds a month for unlimited delivery -- including the speediest options -- for baskets costing more than 40 pounds. That's more than what Tesco charges, but is cheaper than the other major players.

So all in all, Amazon doesn't look a bad deal. And that is worrying for Britain's grocers. Margins are already thin on food, and even more so once the cost of delivery is added in. Analysts at Shore Capital estimate that it costs between 10 pounds and 12 pounds to deliver an online grocery order in Britain, but grocers are not charging anywhere near this to their customers.

It is already difficult to make money from selling food online. Tesco said in February 2014 that it did make a profit from its delivery business -- 127 million pounds, taking into account all direct costs. It hasn't given a figure since, but it says the service remains profitable. That's welcome news, given that margins at Britain's largest grocer have otherwise collapsed.

Minuscule Margins
U.K. supermarkets' operating margins have already been hurt by a price war
Source: Bloomberg Intelligence

Morrison is trying to renegotiate its contract with Ocado, which operates its online food business, indicating that its returns from the service aren't up to par. Sainsbury doesn't reveal its online profitability, but it has been trying to improve the economics by cutting back on costly promotions.

But Amazon's entry looks set to stop in their tracks any efforts to introduce more rational pricing.

Meanwhile, Amazon's quick turn-around times for delivery orders will only increase customers' expectations. Grocers will be forced to accept higher standards -- with the associated costs -- when it comes to delivery.

The hurdle Amazon faces to make inroads into the cut-throat U.K. grocery market can't be underestimated. Online food shopping is much more developed in the U.K., with about 6 percent of grocery sales online, compared with about 1 percent in the U.S.

Those who think Amazon will destroy the grocery market overnight should just look at Ocado, which provides delivery through contracts with existing grocers and doesn't have its own stores. It has made a pre-tax profit over the past two years, but that has been helped by running Morrison's online delivery business. The economics would be more challenging were it to be just operating on its own.

Ocado's Savior
Contract with Morrison drove the return to profit, which would have been more difficult otherwise
Source: Bloomberg

But Amazon has two advantages. First, it's got the scale to supersize the Walmart strategy of enticing customers with loss-making grocery items in the hopes they'll also pick up some fatter-margin home furnishing or clothing items.

Second, Amazon is prepared to live with low margins. Britain's big four supermarkets are already battling to preserve their ever-thinning margins, and don't forget that German discounters Aldi and Lidl are snapping at their heels.

While Amazon's assault may not be the death knell of the British supermarket, it opens up a front that U.K. grocers could well do without.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Andrea Felsted in London at afelsted@bloomberg.net

To contact the editor responsible for this story:
Jennifer Ryan at jryan13@bloomberg.net