We knew Amazon (NASDAQ: AMZN.US) had an appetite for setting up a net-based grocery delivery service but cooking up a supply agreement with big four supermarket WM Morrison (LSE: MRW) was a coup. Markets may have been licking their lips but the announcement will have left a nasty taste in the mouths of management at Tesco (LSE: TSCO) and J Sainsbury (LSE: SBRY).

What’s cooking?

Amazon launched its nationwide same-day grocery delivery service Amazon Pantry last autumn, but the hook-up allows it to offer fresh and frozen food for the first time. Subscribers to Prime Now and Amazon Pantry will soon be able to order hundreds of Morrisons products for home delivery. It isn’t hard to see the practical benefits to Amazon, which can now offer perishable items such as soups and orange juice without having to build up a costly supply chain first.

It’s even easier to see the attraction for Morrisons. The mere fact that it has hooked up with a big-hitter like Amazon will raise its standing among investors. It also allows the Bradford-based supermarket to access more customers in the wealthy Greater London area, where its presence is minimal. Maybe it will put a stop to all those sneers about being slow-off-the-blocks in the online grocery race. 

The stock was already on a roll after hitting a low of 139p in December. Today, Morrisons trades at nearly 204p, some 46% higher than its pre-Christmas low. As we’ve seen in the oil sector, contrarians brave enough to buy apparently burned-out stocks can make red-hot returns from time-to-time.

Bitter fruit

Amazon and Morrisons may be enjoying each other’s company, but Tesco boss Dave Lewis has been left feeling like a gooseberry. Despite its recent troubles, Tesco has always remained the big boy on the block, with the punching power to inflict serious damage on rivals if it ever got its act together. 

Tesco has nevertheless struggled against German upstarts Aldi and Lidl. But now the competition has got bigger and badder, especially given Amazon’s willingness to sacrifice short-term profits for long-term market share. Amazon Prime customers get free delivery for just £79 a year, against up to £5 a pop from the big four (who still make a loss on the £20 cost). Expect more complaints about Amazon’s relatively cushy tax arrangements, which give it another edge over Tesco and Sainsbury’s.

Delivering the goods

J Sainsbury’s share price has largely shrugged-off the threat but that may change as we watch Amazon’s progress. Online groceries are big business for Sainsbury’s, with Q3 sales up nearly 10% and orders up 15%, and investors won’t want to see that slow or go into reverse.

Amazon still needs to prove that it can compete by offering customers the same level of choice as Tesco and Sainsbury’s, as I believe most online customers will prefer a one-stop shop. But given its track record, investors now have another reason to fear the supermarket sector.

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Harvey Jones has no position in any shares mentioned. The Motley Fool UK owns shares of and has recommended Amazon.com. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.