World wide Amazon
By constantly playing the long game, Amazon stands to disrupt any business it enters. The question is what costs and consequences will come with it?
When asked what Amazon is, most people will likely answer that Amazon.com is an e-commerce destination. Some may point out that they also offer cloud services for developers. Others may note that they build consumer hardware such as Kindles and Echos. Fewer may say that Amazon is also a distribution player that builds advanced robotics systems for its own fulfillment centers and buys airplanes for fast overnight deliveries. With the purchase of Whole Foods, Amazon now owns a supermarket chain and is also an advertising player. In fact, it’s more or less impossible to describe it in a simple way, but one thing is for certain; Amazon is set to scale across the planet like no other company before – all in the name of the happy customer.
At its core Amazon is a company that leverages economies of scale and it does it perhaps better than ever done before. Economies of scale are achieved when an investment in operations can be leveraged to decrease the cost per unit of output with increasing scale. A classic example is the printed newspaper. Somewhat simplified – the cost of the very first newspaper printed in a printing plant is equal to the cost of the plant, while the cost of the billionth newspaper printed is equal to one billionth of the cost of the plant.
The bookstore scaled up
With the introduction of software, economies of scale became almost limitless; Microsoft developed Windows and then licensed it to computer manufacturers, Google indexed web sites that were built by the rest of the world to be searched and Facebook built the social infrastructure and let the users create the content to be consumed. What is unique about Amazon is that it excels at scaling in both the physical and the digital world. The origin story of Amazon is well known. It started as an online bookstore. The founder Jeff Bezos’ analysis was clear – retail will shift online, physical bookstores can only offer a limited selection of all books ever published, books are easy to ship and sourcing of single copies of books for delivery is simple. Building the online bookstore represented a significant initial investment, but thanks to economies of scale the cost per book shipped would decrease with every new book shipped.
Five percent of all US retail
Once at scale it was not a big investment to begin selling other categories of goods. As the store grew Amazon invested in fulfillment centers, large warehouses to store and package goods to be distributed. Goods need to be sent to and from these centers and Amazon is investing in its own distribution network of trucks and airplanes to reduce the costs of transportation. The fulfillment centers and the distribution network represent large investments, but by making it all available to third party retailers through Amazon’s online store they achieve scale faster.
Amazon has so far made most of its investments in their home market and now about 50 percent of all e-commerce in the US is happening through Amazon. Still, this only represents five percent of all US retail sales so there is still room for a great deal of growth as more and more retail shifts online. At the same time, Amazon is making significant investments in building fulfillment centers around the world. In fact, more than half of its current 750 distribution facilities are outside of the US, including 194 in Europe.
The online store operates on servers that run software. Both the store and the servers represent significant investments, but by making software available for others to use they again achieve scale benefits. This particular business is called Amazon Web Services (AWS) and has become highly profitable, representing about half of Amazon’s recent profit, with a margin above 25 percent. This is truly an indication of the potential of all of Amazon’s long term investments. In fact, having a long term outlook is a unique characteristic of Amazon. This, and relentless focus on the customer has allowed Amazon to grow its sales exponentially while reinvesting almost all of its net profits into scaling its businesses.
Even with almost no profit, the market has rewarded Amazon with a valuation of almost one trillion US dollars. This is because the market understands what Amazon is doing. Continued investments into scalable operations create a moat that potentially no other single company will be able to match. Alibaba and Flipkart with their respective dominance in China and India are in a position to achieve something similar, but otherwise only massive consolidation of retailers, e-commerce and distribution players can offer serious competition against Amazon. All of the investments aim to build horizontal businesses that benefit from network effects; in e-commerce, more buyers lead to more suppliers lead to more buyers. In cloud services, more tenants lead to great economies of scale, in terms of servers as well as software development.
“Continued investments create a moat that potentially no other single company is able to match.”
At the same time, Amazon is investing in vertical integrations. During the past two years the company has introduced more than 80 private labels to sell their own versions of products including clothing, shoes, jewelry, garden/outdoor, grocery, health/household and home/kitchen. And with Amazon Prime, a subscription bundle, built around the promise of always free two day delivery of most goods, customers loyalty is secured. The bundle now includes Prime video as well as an assortment of other digital services and its own brand for everyday commodity essentials, AmazonBasics, is only available to Prime members. At the beginning of 2018, Amazon had more than 100 million households globally signed up to the 119 USD per year service.
Alexa directs consumers
When a household signs up for Amazon Prime they generally make all future online purchases through Amazon. Once within the ecosystem, they are more likely to purchase an Echo compatible device (about 50 million shipped so far) that allows them to make purchases by directly talking to Amazon’s Alexa who will generally recommend Amazon’s own products or those labeled as Amazon’s Choice. Amazon is clearly moving the customer towards reducing the number of choices they make, especially choices that lead them away from the company. They now also sell door locks that can be remotely opened by their couriers letting them make deliveries directly inside the household. The next logical step in home automation is restocking of the refrigerator. Once deployed households can have their refrigerators replenished automatically by couriers that enter and exit the home while the members are at work and school. A kitchen full of goods without a single decision being made.
If more and more purchasing decisions are made by Alexa instead of the customer the advertising business will change fundamentally. And if the majority of the purchasing decisions are made on Amazon and you get 100 percent confirmation on how well your advertising performs as the purchases are also made on Amazon, why advertise anywhere else? Amazon’s advertising business is booming, in Q2 2018 it generated $2.19 billion, up 132 percent year over year.
Taking the long term perspective on this tremendous growth founded on the ambition of being the world’s most customer centric company, one can wonder where it all ends? A question that gets even more important when considering that Amazon, together with Facebook and Google, excels at not paying taxes. No doubt the company builds its value on top of the collective global infrastructure which to a vast extent is financed and made possible by governments across the planet, yet avoids sharing in any of the costs. Marketing guru and tough critic of the same companies Scott Galloway wrote in late 2017: “The most disturbing stat in business? Since 2008 Walmart has paid $64B in corporate income tax, while Amazon has paid $1.4B. This is despite the fact that, in the last 24 months, Amazon has added the value of Walmart to its market cap. The most uncomfortable question in business, in my view, is how do we pay our soldiers, firefighters, and teachers if a firm can ascend to $460B in value (#5 in the world) without paying any meaningful corporate taxes.”
An exponential scale
By consistently playing the long game, Amazon stands to disrupt any industry it enters while making more and more businesses dependent on its own infrastructure. Currently, less than 1 percent of global retail is happening through Amazon, so the growth potential is almost limitless. But what happens when that one percent becomes ten and beyond as the juggernaut continues to scale exponentially? A great deal of responsibility now lies on the shoulders of regulators in the EU and the US who quickly need to understand if and how to regulate a company whose genuine primary objective is to meet the demands of the customer – at any cost. This will challenge the current interpretations of anticompetitive laws. Some legal scholars, such as Lina Khan, suggest that the US needs to again strengthen its once robust monopoly laws in order to break up Amazon. The one trillion dollar question that now needs to be answered is: what costs and consequences are we as societies willing to accept as Amazon disrupts its way across our planet all in the name of the happy customer?