Acing the competition with free shipping, low prices, broad selection and new technology, Amazon is growing faster than e-commerce as a whole. How can other online retailers stay in the game?
By Don Davis
Amazon.com Inc., already the dominant online retailer with more than double the 2007 web sales of its nearest competitor, is widening its lead. Its sales last year grew at nearly double the rate of U.S. e-commerce—38% vs. 22%—and in the first half of this year Amazon’s North American web sales grew by 33% while online retail as a whole grew by only 12%, according to comScore Inc.
Several factors drive this growth. They include Amazon expanding into new categories beyond books and music—more than a dozen in the past year. The e-retailer’s free shipping offers and low prices encourage frequent purchases by 81 million active Amazon shoppers. And thousands of other retailers are helping expand Amazon’s selection by selling on Amazon—even though it means paying a commission and handing over customer data to a competing e-retailer.
“They are a formidable competitor,” says Mark Carson, president and co-founder of Fat Brain Toys, which generates 30% of sales through Amazon. But, he adds, “They realized several years ago that it was impractical for them to sell everything to everyone. So instead of trying to mine all the gold themselves, they decided to sell a few picks and shovels.”
Those picks and shovels include a variety of services Amazon offers partner retailers, such as handling payment and fulfillment. But the biggest lure is the opportunity to reach Amazon’s massive customer base.
The risk to these partner retailers, though, is that Amazon becomes more powerful with each retailer that adds its stock to the Amazon platform, and with each new customer attracted to make a purchase through a retailer selling on Amazon. Those customers become Amazon customers, as retailers selling on Amazon agree that only Amazon can send follow-up marketing e-mails to customers who make purchases at Amazon.com, even if it’s a third-party retailer fulfilling the order.
In short, Amazon has created its own virtuous circle: more customers coming to Amazon make it a more attractive platform for other merchants, while more merchants selling on Amazon lead more consumers to start their shopping at Amazon.com.
Add in Amazon’s low prices, personalized recommendations, free shipping and strong reputation among consumers and it’s easy to see why Deutsche Bank analysts Jeetil Patel and Herman Leung recently concluded that Amazon “has built highly defensible elements into its business model.”
That poses a tough question for other online retailers: Do they recognize Amazon’s growing strength and sell through Amazon, even at the expense of paying a commission—typically 12% to 15%—and missing a chance to add to their customer mailing lists? Or do they try to differentiate themselves from Amazon, and, if so, how?
There are ways to compete with Amazon, observers say, although they may not be cheap or easy. What’s more, one of Amazon founder Jeff Bezos’s central precepts is to have “a bias for action,” and Amazon is moving aggressively to shore up any weaknesses with acquisitions and new technology.
A position of strength
For now, it is Amazon that is on the offensive, moving into new categories rapidly with cut-rate prices. “Our pricing strategy is very simple,” chief financial officer Thomas J. Szkutak told analysts earlier this year. “We are going to make sure we have great low prices for customers.” A spot check by Internet Retailer of three products—a best-selling book, a kitchen appliance and a computer printer—showed Amazon was cheaper than major online competitors in each case, by from 3.7% to 31.9%.
That low price strategy doesn’t always sit well with investment analysts, who often question Amazon executives about why they don’t raise prices to boost profit margins. But Amazon clearly is bent on attracting customers with low prices, even if it means forgoing some profit for now, says Colin Sebastian, a stock analyst who covers Amazon for Lazard Capital Markets.
“They’ve chosen volume growth instead of better financial leverage and operating margins,” Sebastian says. “And long-term that may turn out to be the right strategy.”
With Amazon’s sales growing faster than e-commerce as a whole, Amazon made up more than 10% of U.S. online sales in the first half of the year, compared with 8.9% last year and 7.9% in 2006. Analysts often compare Amazon’s growth to that of eBay, because both are increasingly shopping platforms for other merchants. While Amazon’s sales grew 33% in the first half of this year, the dollar value of merchandise sold on eBay rose only 10%.
Free shipping
Amazon’s free shipping offers are a big part of the company’s success, some analysts believe. The company’s Amazon Prime program, which offers consumers free two-day shipping on every order for $79 per year, has been an “overwhelming success,” say Patel and Leung of Deutsche Bank.
While Amazon, which has a reputation among analysts for revealing as little data as possible, has not said how many consumers have signed up for Amazon Prime since it was launched three years ago, there are clues in the company’s financial reports.
Amazon’s spending on shipping—which includes shipping to Amazon Prime customers, Amazon’s Super Saver offer of free standard shipping on any order of $25 or more, and its Fulfillment by Amazon program of shipping on behalf of merchants that sell on Amazon—went up 38% in the second quarter of 2008 compared with the same period a year ago. And shipping income, which includes Amazon Prime membership fees and merchant payments for Fulfillment by Amazon services, was up 22%.
Patel and Leung say the fact that unit sales growth, 32% in the second quarter, outpaced customer growth, which was 18%, means customers are shopping more often at Amazon. In short, the Deutsche Bank analysts argue, the shipping programs are changing how consumers shop, causing many to go to Amazon more frequently than before.
Loyal customers
There is other evidence that consumers are shopping at Amazon more frequently than at other major e-commerce sites. 54.3% of visitors to Amazon in June had also visited in May, compared with 41.8% for eBay, 40.7% for WalMart.com and 39.5% for Target.com, according to Nielsen Online. And the typical visitor to Amazon.com visited 3.4 times in June, versus an average of 2.6 times for the top 25 online retailing sites, says comScore.
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.
“We found by adding a trusted payment option we can increase conversion on the site,” Smith says. “Amazon has a very large installed base of customers that have stored cards and addresses, and it can make the checkout process very easy.” Jockey also has been selling on Amazon for eight months, and Smith says the sales have been “additive,” although he would not provide details.
Fulfillment by Amazon
Retailers have similarly mixed views about Fulfillment by Amazon, a service launched two years ago. Amazon holds inventory for participating retailers and ships out orders, in some cases putting another retailer’s items in the same box with items the consumer buys from Amazon itself. Amazon has not said how many retailers participate, but has disclosed shipping a half million items on behalf of other merchants during the fourth quarter of 2007.
A big selling point for the service is that Amazon Prime customers get free shipping on all items Amazon fulfills, and the Super Saver offer of free shipping on orders above $25 also applies to merchants using Fulfillment by Amazon. For video game retailer NextGen Games, sales doubled when it signed up for Fulfillment by Amazon, although owner Adam Hunter says part of that increase came from adding items to his Amazon selection. Amazon accounts for 90% of his sales, and Hunter says Amazon’s fulfillment service saves him 25% to 30% over what it would cost him to ship the goods himself.
But other retailers are leery of the fulfillment offer. Carson of Fat Brain Toys says that if Amazon is holding his inventory, selling his goods and shipping his order, “what need do they have for us?” Nor does Jockey International participate. Smith says Jockey distribution center workers take pains to fold and pack items in the most attractive way, and include in each box a Jockey catalog that can help win new customers.
How to compete
While the lure of 81 million consumers may override competitive concerns for smaller retailers, most big brands remain intent on competing with Amazon, which means trying to exploit Amazon’s weaknesses. There are at least three ways to compete with Amazon, observers say: a larger or better edited assortment, better customer service, and, for retailers with stores, offering services that an online-only merchant like Amazon can’t provide.
With Amazon now selling everything from patio furniture to pet supplies, it’s hard to offer great depth in every category. David Goldsholle, founder of HardwareAndTools.com, says his site offers 100,000 SKUs, while he estimates Home Depot offers 12,000 items in this category and Amazon 2,000.
On popular products, like power drills, Amazon’s buying clout enables it to offer a lower price, Goldsholle says. “On power tools, we can’t touch them, but on power tool accessories we can,” he says. Part of his strategy is to move into the business-to-business space, where Amazon doesn’t currently compete, when he launches a new site next year aimed at selling tools to contractors and other companies.
Taking the approach of a specialty store that presents a well-chosen assortment is another way to compete with Amazon, says Lauren Freedman, president of research firm The E-tailing Group. “They’re overwhelming in a lot of instances,” she says of Amazon. “Good retailers are all about the picking of the merchandise. I don’t need 5,000 pairs of shoes for my daughter.”
Freedman also says retailers can compete with Amazon by offering better customer service. Amazon gets below-average marks in customer service in The E-tailing Group’s annual mystery shopper survey because it does not display a toll-free phone number prominently on its site, and did not respond to e-mail questions from the firm’s mystery shoppers. “They’re not going to deliver Nordstrom-type customer service,” Freedman says. “That’s not the business they’re in.” Nonetheless, Amazon remains near the top of the list in customer satisfaction, ranking third last year among the 100 largest e-retailers in a survey by ForeSee Results Inc.
Nor does Amazon provide the depth of information about complex products like computers that some electronics sites offer, says e-commerce analyst Sucharita Mulpuru of Forrester Research. “Amazon has customer reviews, but not a lot else,” she says. “If you can provide more information on high-consideration purchases like electronics you can make people more comfortable with those transactions.”
For retailers with stores, Mulpuru advises, “Focus on the multi-channel piece. Drive customers into your stores where the most lucrative transactions will happen and where you have the strongest ability to convert customers.” For instance, enabling customers to order online for in-store pick-up is a way for a multi-channel retailer to offer a service Amazon can’t.
At least, Amazon can’t offer such services for now. But with sales and profits soaring, a large and loyal customer base, and a management team bent on innovation, there’s no reason to think Amazon is planning to stand pat.
don@verticalwebmedia.com
The Amazon Way
Many retailers claim to be customer-focused. At Amazon, the first of the company’s six “core values” is: “Customer obsession: We start with the customer and work backwards.”
The other five building blocks of Amazon founder Jeff Bezos’s business philosophy are innovation, a bias for action, ownership, setting the hiring bar high and frugality. These guideposts are taken seriously within Amazon, and employees are reviewed every six months on how their performance stacks up against them, says a former employee who asked not to be named.
“This is Jeff’s way of codifying what keeps a company alive and spirited and keeps people innovative, as if they had the high dreams you associate with start-ups,” he says.
Bezos believes strongly in employees taking ownership of their work, which made him reluctant, even as the company grew dramatically, to hire temporary contractors and to create separate teams to maintain software developed by others, the former employee says. “He was concerned that if the people who create the user experience, the web pages, are divorced from the long-term maintenance, they will become separated from the actual costs of customer complaints and bugs,” he says. “And that will lead to lower-quality software.”
As for frugality, Amazon uses Linux as the operating system for its thousands of servers, which means it does not have to pay license fees for operating system software.
