May 5, 2004, 12:00 AM

The New Wal-Mart?

(Page 2 of 4)

When Amazon launched in the summer of 1995, Bezos and company started out modestly with a single product category, books and CDs, which were easy to get consumers to buy online since they weren’t high-touch products and because their small size made them easy products to fulfill. Such a beginning afforded Amazon the opportunity to build up its expertise in fulfillment before taking on more complicated product categories like sporting goods and consumer electronics.

Dozens of categories

That start-small approach gets good reviews from analysts who say it gave Amazon the time to build up its expertise and brand. “Amazon did things right and kept building its brand, while it managed to not disappoint customers too often,” says Paula Rosenblum, director of retail research for research and consulting firm Aberdeen Group Inc. “Now they have a huge base of customers and top-of-mind awareness.”

She notes that Amazon has shown consistency in providing a solid online shopping experience through personalized cross-selling, customer service and low prices. In fact, Amazon ranks as No. 1 in the American Customer Satisfaction Index for retailers created by ForeSee Results Inc., with a score of 88 of 100. E-retail in general earns an 84 in the index.

With a strong brand and equally strong reputation for customer service, Amazon has put itself in a position to build out more product categories, analysts say. And that’s exactly what it’s been doing. It now features dozens of category-focused online stores, including Apparel, Toys, Books, Electronics and Jewelry and Watches, along with some still in beta test mode, Sports & Outdoors, Gourmet Food, and Health & Personal Care. Its Sports & Outdoors category alone offers 3,000 brands covering 50 sports.

Amazon keeps its plans for rolling out new categories close to its vest and it reports revenues only for broad category segments. Yet it is moving beyond its initial strategy of selling categories that have been relatively easy to source and fulfill, such as its media category. Although media accounted for 70% of North American net sales last year, it grew at half the rate of other category segments for which Amazon reports sales-14% for media sales vs. 29% for its “electronics and other general merchandise” segment.

The data snowball

Beaulieu of Morningstar notes that Amazon’s strategy for launching new product categories appears to be based on a desire to sell as many products as possible. “There must be a method there, though it’s possible they’re just moving down a laundry list of categories,” he says. “They still want to find more categories to continue driving growth.”

Amazon acknowledges that it wants to find more categories. “Our merchandising plan this year is a combination of giving our customers the widest selection of products possible at the lowest cost,” Goldberger says. But the company also asserts that it is going about this in a methodical way, using its own records of consumer shopping preferences to expand its product categories. “Customer choice and shopping behavior will help drive future category expansion,” says Glenn Cunningham, Amazon’s director of Home & Garden, which includes the new Gourmet Foods store.

In addition, the wider the variety of customer purchases, the more Amazon will make recommendations based on past shopping activity, he says. “Each customer visit and purchase improves the ability of our software to make the next customer experience that much more relevant for our customers,” Cunningham says. “For example, the addition of gourmet foods to our mix has allowed us to recommend food with the appropriate cooking vessel or cookbook.”

But as Amazon moves into new product categories, it will need to reconsider its need for promotional marketing campaigns, Rashtchy says. “They’ve been cutting back on marketing because they figured there was enough buzz about them in the market, and so their idea was to spend their revenue on free shipping for orders of $25 and over,” he says. “But they probably need to ramp up their marketing again, especially as they add categories they’re not known for.”

In its financial statement for last year, Amazon says it has willingly absorbed larger shipping costs as a form of marketing-based customer service. Although shipping revenue grew slightly last year to $372 million from $364.8 million in 2002, it declined as a percentage of sales, to 7% from 9.3%. As a result, its net cost of shipping expanded to $136.5 million from $96.9 million.

Conventional marketing expenditures, meanwhile, traveled in the opposite direction, declining to $123 million, or 2% of net sales, in 2003, from $138 million, or 4% of net sales, in 2001. “These free shipping offers reduce shipping revenue as a percentage of sales and reduce gross margins on retail sales,” Amazon says in its financial reports. But it adds: “We view these shipping offers as an effective marketing tool and intend to continue offering them.”

Adding partners

Rashtchy adds that he’s confident Amazon can hike its marketing costs and remain profitable, thanks to overall efficiencies it has implemented through its operations as well as steadily increasing sales. Despite the free shipping offers, for instance, Amazon has reduced fulfillment costs as a percentage of net sales over the past three years to 9% from 10% in 2002 and 12% in 2003, even as fulfillment net costs rose to $477 million last year, up from $392 million and $374 million, respectively, in the two prior years.

In addition to expanding its own product categories, Amazon’s long-term focus is to add partners, both to its affiliate network and to its roster of retailers who sell through Amazon’s specialized sites, such as apparel or sporting goods. Those partners will generate traffic that in turn will lure other partners, Beaulieu says. “The traffic makes Amazon.com more attractive to new partners, and more partners drive even more traffic to the site,” he says. About 10% of Amazon’s traffic comes through its 900,000 associates, or affiliate web sites, Rashtchy estimates.

A dual strategy

While Amazon creates more distance between itself and other retailers in its efficiencies as well as its scope of retail operations, it’s also working hard to build closer ties with those same merchants-a dual strategy that sets Amazon apart as both a super-sized merchant and a provider of services to other retailers-and puts it in a situation of promoting its own growth while helping its services customers and alliance partners.

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