August 27, 2008, 12:00 AM

Advantage: Amazon

(Page 2 of 3)

Free shipping is increasingly expensive as gas prices rise. But when an analyst asked Bezos recently whether the free shipping programs would hurt Amazon, Amazon’s chief responded that his company is in a better position than other online retailers to handle high gas prices because it has so many distribution centers. (The company has fulfillment centers in 12 states.) That means Amazon can ship quickly to most customers using ground services, rather than more expensive air freight.

“So probably this is a relative advantage for Amazon,” Bezos said. Speaking of the free shipping programs, he added, “We have clearly no intention of changing those. We’ll keep them in place.”

While low prices and free shipping may seem a recipe for losing money, Amazon’s profits are on the rise. The company’s net income more than doubled to $476 million in 2007 from $190 million the year before. And profits were up another 59% in the first six months of this year to $301 million, from $189 million in the first half of 2007.

Among the explanations for the profit growth, despite low prices and free shipping offers, is Amazon’s strong sales abroad-international revenue was up 46% in the first half of this year when sales outside of North America accounted for 47% of net sales. In addition, Amazon is spreading its fixed costs across substantially higher sales volume, reducing its cost per sale, analysts say.

Those strong profits enable Amazon to invest heavily in technology and content-$818 million last year. It also allows Amazon to make acquisitions that bolster its product selection, such as its recent acquisitions of online sewing materials retailer Fabric.com and used book retailer AbeBooks, and to embark on major initiatives, such as the launch of the Kindle electronic book reader last fall.

The Kindle could generate $400 million to $750 million in sales by 2010 and represents “part of a very significant and consistent innovation focus that Amazon has maintained over the last five years,” Citigroup analyst Mark Mahaney wrote recently. Other analysts note that if consumers take to reading books on the Kindle, Amazon’s ownership of the device and the source of electronic books for that device will lock consumers into buying e-books from Amazon much as they download music from iTunes for their Apple iPod music players.

The Kindle is an example of how Amazon seeks to turn a potential weakness-the trend for consumers to buy music and potentially books in electronic format-into a strength. Instead of accepting shrinking sales of the books, music and movies that make up more than half of Amazon’s revenue, the company aims to be a leader in electronic delivery of that content. Another example of innovation is Amazon’s announcement this summer of a deal with digital video recorder supplier Tivo that will enable consumers to buy products they see on their TV screens through Amazon.

Friend or foe

There is little a retailer can do about Amazon initiatives like the Kindle. But retailers have the choice of selling through Amazon.com, and of taking advantage of other services Amazon offers, or of trying to differentiate themselves from the leading e-retailer.

Several big retailers have moved away from selling on Amazon to build their own online brands in recent years, including Nordstrom, Toys ‘R’ Us and Borders. Others, such as Zappos.com Inc., the largest web-only shoe retailer, have declined offers to sell on Amazon. “It is very important to us that we control the entire customer experience,” says Fred Mossler, who oversees marketing and merchandising at Zappos.

But there are more than 1 million sellers on Amazon, the e-retailer says, including many individuals and small merchants that sell used as well as new items. And Amazon is aggressively courting merchants, seeking to broaden its selection beyond the 10 million SKUs it offered by the end of 2007, more SKUs than the next 50 largest Internet retailers combined.

“They came to us and said, ‘We have to have a good lighting company on our lighting store,’” says Michael J. Fox, chief operating officer at online home improvement retailer eImprovement.com LLC, which will soon start selling on Amazon. “They sell it by eyeballs, saying that you’ll get more sales.”

While eImprovement will sell some of its high-margin lighting products on Amazon, it will not sell lower-margin products like faucets because the commission would make such sales unprofitable, Fox says.

Fox is willing to sell those high-margin goods on Amazon, even though Amazon’s contract with other retailers bars them from sending follow-up e-mails to consumers who buy on Amazon. “It’s not our customer,” Fox says. “They don’t want the customer to make the next purchase on our site, they want them to come back to Amazon.”

Information is power

Fox doesn’t worry too much about competition from Amazon because eImprovement sells many products that require custom configuration, something he says Amazon can’t do. However, that doesn’t mean he’s willing to share all his sales data with Amazon. For instance, he has no plans to use the new Checkout by Amazon service introduced in July that allows Amazon customers to pay on other retailers’ sites using the payment card and address data they have on file with Amazon.

“We’d be passing in the payment the item purchased, the price, the customer data,” Fox says. “I’d be concerned about passing that to a competitor.”

Asked about that concern, an Amazon spokesman replies, “We simply plan to use the data to improve the service for our merchant customers.” Amazon declined to make an executive available to comment for this article.

Some others say they are not concerned about possible competition from Amazon, including underwear manufacturer Jockey International, which was among the first to adopt Checkout by Amazon. Jockey.com has had good success with the similar Google Checkout service introduced two years ago, says Chris Smith, vice president of e-commerce and catalog at Jockey.

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