Thursday, April 27, 2006


Amazon's Future (Expanded)

When Jeff Bezos originally envisioned Amazon he thought that the Internet would enable a new business model. He knew that no physical store could contain every book catalogued but you could build a virtual store that could list all of these books. His original plan was to leverage the Internet to avoid the expense and hassle of dealing with inventory by linking directly with distributors to fulfill orders. In essence Amazon would simply control the “Information provider” layer by listing books for sale and would link with other companies to handle the rest of the functions. Unfortunately, one of his first discoveries was that if he wanted to provide a good customer experience and to get a good price on product he would have to build and operate warehouses. This lesson was repeated at almost every level in the stack to the point where Amazon has brought almost every competency in the stack in house.

Warehousing: They have built one of the most efficient and advanced warehouses of any retail operation. They turn their inventory 20 times a year whereas the typical turn in retail is about 15 times a year. In the past three years they have lowered the cost of operating their warehouses from 20% of revenues to less than 10%. They are leveraging their warehousing and fulfillment competencies to provide these services to other sellers as evidenced by the Amazon Advantage program in which sellers can ship units to the Amazon warehouse and Amazon takes care of the sale. For this service Amazon takes 55% of the sale price.

Customer Service: Amazon has a customer service center that is the envy of the industry, in fact they provide customer service to most of their partners such as Target and Office Depot. Like warehousing, this was a competency that Bezos never intended to develop but found it necessary to provide the positive customer experience he envisioned.

Payment: Amazon’s 1 click payment system, while subject to some controversy, has been patented, and provides some stickiness for their site. I was not able to find information as to which company they were using to process credit cards but I’m assuming this is not one of the things they do in-house.

eCommerce Platform: Amazon offers its e-commerce platform to large resellers such as Target, Office Depot, Virgin Entertainment Group, and For smaller sellers they offer zShops and an auction site. In this area they have strong competition such as Microsoft, IBM, and Oracle, but what separates Amazon is that they are able to offer their customers cross promotional opportunities with other sellers using the Amazon platform. This is something that none of the other platforms offer.

Delivery: Amazon has very strong relationships with FedEx, UPS, and USPS to deliver product by traditional means. To lock in customers they offer Amazon Prime where you pay $79 to get free two day shipping on select products, discounted upgrade to 1 day shipping, and free standard shipping. Amazon is also entering into the digital content delivery arena with a subsidiary called CustomFlix. CustomFlix allows customers to send or upload digital content and then CustomFlix digitizes the content and either burns it onto CD or puts it in a streaming format to be sold on Amazon. This should scare companies like Netflix or Napster since this is most likely the first small glimpse of Amazon’s strategy for selling digital media content.

If you can’t wait for shipping Amazon has teamed up with Borders to offer same day in-store pickup. Right now they only offer this service through Borders for books, videos or CDs but what if they were to offer this service for other items such as big screen TV’s or other things that are difficult or expensive to warehouse and ship. A retailer like Best Buy might be incentivized to use this to gain an advantage over a competitor like Circuit City. Amazon might even strike a deal whereby the store will deliver to the customers house. Extrapolating this out, could Amazon strike deals with enough partners whereby these partners essentially become the fulfillment arm of Amazon and Amazon no longer has to worry about warehousing, fulfillment or delivery?

Information Provider: Amazon’s ability to use and provide information in the form of their recommendation engine is without peer. Any robust commercial e-commerce site records the users click stream, pages visited, items purchased, etc., and most will do some limited analysis. Amazon goes deeper and wider in this analysis to not only look at what you’ve purchased and where you’ve been but culls information from all of its users to develop a profile of your shopping habits, and then recommends items you might be interested in. We see the network effect in action indirectly here, the more people that use the site and the more information they collect, the better the recommendation they can make. A more direct manifestation of network effects is seen in the user’s recommendations and ratings of product, the wish list, wedding registry, and baby registry features. The one thing that Amazon does not provide, in terms of information, is independent product reviews. This is left to sites like CNet, ZDnet, and

Amazon is clearly capturing value by specializing, and building industry leading competencies, in many of the layers in the stack, but they are also building value by integrating across the layers. Unlike Microsoft, Amazon is not developing a closed system, in fact they are opening up all of the “guts” of Amazon to web developers to see what interesting new applications might come from this. This makes sense since innovation will likely come from startups and small companies. The most common use of the Amazon web services is grabbing the product image and details from the Amazon site and placing it on your site. But their web services go far beyond just providing product information. One of the newest services is their S3, or Simple Storage Service, which provides hosted storage services that they say can be used to store and retrieve any amount of data, at any time, from anywhere on the web. They also offer their e-commerce services which allows developers to essentially built a slightly scaled down version of the Amazon site including customer reviews and detailed product information.

By providing these services they are allowing new entrants the ability to store, sell, and deliver content to end users. This means that content producers won’t have to worry about paying to build those competencies they can concentrate on producing content and Amazon takes care of the rest. So Amazon is lowering the cost of market entry for content providers and at the same time raising the switching costs. Not only will content producers have access to best in class eCommerce platform, warehousing, shipping, and customer service but they can harness the power of the network with the recommendation engine and the user rating system.

Does opening up Amazon’s functionality to web developers ensure that they will be the platform of choice on which new sites are built? Amazon has three critical components already in place in order to make that happen; 1) They are allowing nearly free access to their core asset, the e-commerce platform, 2) they have started to offer hosted storage services, which seems to be for developers but it’s not too far of a stretch to imagine that they will offer this service to individuals for all content. In fact they already have a service called “Digital Locker” that allows individuals to store their eBooks, eDocs, and music and video files. 3) Their CustomFlix service enables a publisher to simply give Amazon a copy of the media they want to sell and they take care of the rest. There is no need to worry about duplication, hosting, warehousing, or delivering product.

Future Strategies:

Amazon creates a storage space for users to store all of their content. They could set up a iTunes killer where users would buy music or video on the Amazon site, or on any other site, but instead of downloading it they would store the music at Amazon. Users would be able to access this content wherever, and on whatever, they wanted and would not be tied to a single device such as the iPod since in the near future wireless access should be ubiquitous enough and fast enough to allow this. Based on what you have stored at your site, Amazon could make recommendations as to what other products you might be interested in and send that directly to the device where you could automatically purchase it.

I could imagine one form of this service taking the form of a Myspace-like account. Users could create their profile, list their favorite movies, books, etc., and use the storage to host some of these files. I’m imagining this as an organic recommendation engine. Where the existing recommendation engine distills the actions of many people into a single recommendation this would essentially be giving recommendations from your friends. The danger of commercializing this site too much is that you lose the viral nature that makes Myspace so successful.

Amazon becomes the premier content aggregator. Amazon already has a huge video library of virtually every CD and video made. With the creation of CustomFlix it seems likely that in the future they won’t take physical product from the content producers but will only take a single digital master and replicate it as needed. This accomplishes a number of goals; first it means that Amazon can serve that content in any form that the users needs, either a mobile streaming, online, or physical format. Amazon would not need to acquire any content companies such as Netflix or Napster, they would already own this content. Next it would mean that they wouldn’t need to support and manage such an extensive system of warehouses. Of course physical products such as a CD player still need to be stored and shipped, but the solution to this is to build relationships with physical retailers, just as they have with, to offer in store delivery.

Amazon separates its core competencies into separate subsidiaries. I think the interesting part of this strategy is that they would be going back to the model that Jeff Bezos originally had in mind. The reason Amazon built warehouses and customer service facilities in the first place was that they weren’t able to get the level of service they wanted with out making these investments. They are already providing many of these other competencies, such as warehousing, as a service and by breaking these out into separate subsidiaries they may be able to grow each company by extending their reach to new customers who would not have previously used Amazon for these functions. Specifically they could break out their customer service and warehousing functions. This would rid the company of a tremendous overhead costs of these service centers and it would allow these subsidiaries to service some of Amazon’s competitors.

Amazon extends its reach into physical retail. We’ve already seen this with Amazon’s in-store pickup partnership with Borders. I mentioned above that they might partner with other retailers to extend this pick up service, but they could take it one step further and provide their product information either in store or via wireless device. Imagine you’re shopping at Best Buy and you log into the Best Buy site, powered by Amazon, and you can find information about each product complete with user reviews and ratings. With the press of a button you make your purchase using Amazon’s 1-click purchase technology and you pick up the item in store, or arrange to have it shipped to you.

Besides enriching the shopping experience the real value of deploying this technology is that it gives you a way to track customer behavior. Other than being able to capture information about customer purchases, it has been impossible to track customers in a physical store in the same way you can follow their click path online. By integrating this online component with the physical store retailers could gain previously unknowable information and allow them to maximize revenues through better product placement or product pairing.

Best case scenario: Amazon is able to leverage its access to media content to build the most extensive library of downloadable or streamable content. Users purchase the content which is then stored remotely, to be accessed anywhere, anytime, and on any device the user chooses. Competitors like iTunes, Napster, and Netflix become irrelevant since they cannot provide the same breadth of content as Amazon. The ability to store your video, audio, eBooks, eDocs, and other digital products all in one place creates switching costs that lock customers in to Amazon.

By providing the hybrid retail/online platform described above to physical stores, Amazon becomes tightly integrated with leading retailers across all retail segments. This partnership enables Amazon to be able to offer in store pickup for almost all of the items they sell. Once they have established enough partnerships they are able to significantly reduce the amount of inventory they need to warehouse and items they need to ship, greatly reducing overhead.

Worst case scenario: The online retail market becomes even more fragmented than it is today with consumers looking more to opinion leaders and social networks for recommendations on what to purchase and where to purchase it. Customers still visit Amazon to check out the consumer reviews but then go elsewhere to purchase products. As fewer and fewer people purchase from Amazon their user recommendations become less relevant and their recommendation engine becomes less accurate. Amazon actually facilitates this increasing fragmentation by opening up it core assets through web services. More and more smaller retailers now have access to the same powerful platform as Amazon and use it to build their own custom branded stores. Every person with a blog or Myspace account becomes a merchant and people find others in their network from which to purchase items. Amazon becomes the fulfillment arm of retail and loses the value of the network.

Large retailers such as OfficeDepot, Target, and Borders follow Toys R Us’ lead and break their contracts with Amazon since they are unhappy with the amount of value that Amazon is extracting fro the relationship. These large retailers build their own sites on proprietary platforms and begin to compete directly with Amazon. Customers continue to go to Amazon to do research but then visit stores to make a purchase.

Most likely scenario: Amazon continues to be the dominant player in online retail, using its ever deepening knowledge of customers to provide ever more personalized product suggestions. Developers user their web services to pull product information to their own websites but instead of creating traditional ecommerce sites which drive sales to Amazon, developers are creating mashups between Amazon and search and mapping engines. These mashups allow users to get product information from Amazon and then find the lowest price through the search engines and find the closest store through the mapping engine. The increased revenues that Amazon had hoped for by opening up their API’s never develop. Amazon begins charging for their web services leading to a stall in developer adoption.

Amazon expands its online storage strategy to consumers and provides at least 1GB of storage. Users can purchase videos and music from Amazon and store it online or they can upload their own content. Due to contractual limitations with the content producers Amazon does not have the rights to distribute their entire catalog which allows competitors like iTunes and Napster to stay in business.

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