Archives For Understanding Amazon

The Little App That Caused So Much Trouble

I have this little app on my smartphone called Amazon Price Check. I can take it into Target, scan the bar code of any item I’m thinking of buying, and Amazon will check its catalog to let me know if it offers the same thing at a better price. If so, I make an instant decision whether to walk out of Target with purchase in hand or wait for Amazon to deliver it to my doorstep, exercising some patience in exchange for saving a little cash.

This is a ruthless test of how well stores are maintaining the protection of the convenience barrier; how well “have it now” is holding up against the customer decision to delay gratification and wait for delivery.

The real melee from this little app came last Christmas when Amazon went right for the stores’ jugular. Not only could you conduct the price check, but Amazon would subtract an additional five percent of the purchase price if you bought it from them on the spot. Vicious!

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Amazon has stated over and again that it wants to be THE place where shoppers can find anything being offered on the internet. It wants to go as far down the long tail of selection/demand as it possibly can, offering products even in the deepest niches being purchased by the fewest customers.

The objective is clear: Amazon wants no excuses for shoppers to go to competitive sites to peruse potential purchases. And if Amazon can press its growth levers to the extreme – offering the best convenience, the widest selection, and the lowest prices – why would shoppers even bother looking somewhere else? For that matter, why would they even bother running a Google search when they can just go straight to Amazon and save an extra step?

In short, Amazon wants to be ubiquitous.

Having the widest selection possible is crucial to achieving ubiquity. Amazon can offer a wider selection than Walmart by virtue of escaping the tyranny of physical space. Well, mostly escaping that tyranny anyway. It can pack a wider selection into its 70 or so fulfillment centers than a traditional retailer could ever imagine stocking in its stores. But those warehouses – as big, efficient, and cheap to run as they may be – are still constrained by their four walls.

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The Long Tail

Chris Anderson of popularized this metaphor with a thought-provoking piece in 2004, The Long Tail. He followed it up in 2006 with a well-received business book of the same name. Both are worth reading.

(We introduced the idea in the last article, Walmart’s Selection and Long Tails.)

The key points are these:

1. Store-based retailers fall victim to what Chris calls the “tyranny of physical space.” They are limited by real estate location and a finite amount of shelf space. As he puts it:


An average record store [for the young readers, this breed went extinct about two months after Chris wrote his article] needs to sell at least two copies of a CD [likewise extinct] per year to make it worth carrying; that’s the rent for a half inch of shelf space…retailers will carry only content that can generate sufficient demand to earn its keep. But each can pull only from a limited local population – perhaps a 10-mile radius for a typical movie theater, less than that for a music and bookstore…

Walmart has pressed hard on the selection growth lever, packing upwards of 150,000 individual items in each of its supercenters. Its ideal is getting you in the door for that one thing you want, and loading you up with a shopping cart full of stuff you didn’t know you needed…until you came through the doors.

And that’s priority number one for Walmart: get shoppers through those doors.

Castro-Wright’s Folly or Walmart Hits the Limits of the Pareto Principle

Eduardo Castro-Wright, former CEO of U.S. Stores, perpetrated a great folly by reducing Walmart’s selection in an attempt to improve the aesthetic experience for the shopper and thereby compete with Target for upscale discount customers.

His strategy made sense in theory. I’m sure his analysts poured through the data and saw clear patterns demonstrating some derivative of the Pareto Principle, something that pointed to 20 percent of the inventory generating 80 percent of the sales. You can fiddle with the ratios however you please – perhaps it was 40 percent of the inventory driving 90 percent of sales or 60 percent of the items responsible for 75 percent – the point is that the data highlighted a glut of slow-moving items. If you could just reduce the low-demand inventory you could simultaneously make the stores more spacious and stock shelves with items that sell quickly.

And there’s a strategy an MBA could love!

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With the sales tax story, equating Amazon to Brer Rabbit begging the fox to spare him from the briar patch, we put a fork in our review of the convenience growth lever. We’re now onto Selection, that second of three growth levers in which Amazon – by virtue of its web-based business model – has a clear and distinct advantage over traditional retailers.

But as I’m prone to do, we’ll pick some more on Walmart (the embodiment of traditional retail success) en route to making the larger points about Amazon’s business.

Back to the Broad Middle 

So far we’ve approached discussions of the broad middle exclusively from the left-hand entry point. This is where the right combination of investments in the growth levers (price, selection, convenience) will earn a retailer access to that middle part of the market. This is where the vast majority of customers reside, and it’s where they balance their overarching desire for low prices with their preference for convenience and a wide selection of products from which to choose.

Retailers that press the right combination of those levers win the patronage of the broad middle, increase their sales, and grow their businesses.

But there’s more than one way into the broad middle. There’s also a right-hand entry point. I’m saving the bulk of that topic for explaining the ways Zappos and Quidsi posed a serious threat to Amazon, but we’ll go ahead and take a sneak peak here to setup the Selection discussion.

To close out our discussion of Amazon’s convenience infrastructure, we turn now to current events and consider how collecting sales tax might be the biggest boon to Amazon’s retail business, a body blow to the stores, and the end of the convenience barrier.

Of Inflection Points

Andy Grove’s excellent 1996 memoir, Only the Paranoid Survive, injected the term “strategic inflection point” into popular business parlance. The former leader of chip maker Intel recounts the crossroads in his company’s history where the decisions he made led to momentous, industry-altering outcomes.

For example, since its founding, Intel had made its name by packing more space onto smaller wafers of silicone in the memory chip business. It did very well in this market until Japanese companies killed them on price and quality in the early-1980’s. They were at an inflection point. Market circumstances had changed. The dynamics of the industry had changed, and Intel simply could not compete. The company was hemorrhaging money and needed a different strategy.

Groves led his teams to the difficult conclusion that they must get out of the memory chip business altogether.  They threw themselves into becoming the leader of microchip processing technology. As the history books tell us, these decisions forever changed the trajectory of Intel as a company as well as that of the entire computer industry.

Such inflection points are hard to identify in the real-time fog of battle. When looking backwards, however, the events stick out; the specific decisions define the future of the organizations involved.

But every once in a while the variables line up in such a way that the outcomes seem all but inevitable. We’re now at one of those times with the retail industry…an inflection point that’s sure to force a dramatic shift in market share balance from shopping centers to online stores.

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Amazon’s Fulfillment Center Binge

Amazon is on a construction binge, building fulfillment center after fulfillment center in a seeming reckless abandon of its bottom line. It added 17 warehouses in 2011, a 32 percent increase that brought its global total to 70. And it’s showing no signs of slowing this year.

In the U.S., the new FC’s are going up all over the place. A handful of them follow Amazon’s old model in which the company finds cheap land to build mammoth facilities and staffs them with an abundance of laborers desperate for any wage, no matter how low. That’s a reasonable approach for an internet retailer. Given the growing sophistication of the delivery companies – UPS and FedEx in particular – you can ship your goods from anywhere and know they’ll reach their destination within two business days. So, it would make sense to build the biggest warehouses possible in the places you can take full advantage of cheap labor and cheap wages. The bigger the FC with cheap costs, so the thinking goes, the better the economies of scale. Which is why Amazon has built clusters of warehouses in the rural, post-industrial (i.e., high unemployment) corridors of places like Kentucky and Pennsylvania.

To be sure, Amazon continues to follow that model. Many of the newest facilities are popping up in corporate-friendly South Carolina and Tennessee after the company has extracted favorable tax guarantees and other incentives from state and local governments. It’s easy to make sense of these. They follow Amazon’s long-heeded playbook.

But then we have FC’s going up on pricy real estate on the outskirts of Los Angeles, San Francisco, and New York City. Under the domains of the notoriously business-wary, high-tax collecting states of California and New Jersey. This is a clear departure from the playbook. Surely Amazon doesn’t need to spend the kind of cash required to build and run warehouses near major metropolitan areas. It’s already serving those markets with its popular two-day delivery services plus its overnight options.

Unless Amazon is signaling to the world that two-day delivery isn’t good enough…that it’s investing in this portion of its convenience infrastructure because it wants us to get those boxes, adorned with the Amazon smile, much, much more quickly.

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This is the third post in a series about deconstructing Amazon’s Feedback Loop, an attempt to understand how its components work both as individual units and together as a collective system. See the previous posts, Convenience (and Diaper Stench): Amazon v. Walmart and All Convenience Infrastructures Not Created Equal

The Feedback Loop is about pressing those levers (price, selection, convenience) for the purpose of earning the patronage of millions of shoppers that comprise the broad middle. It’s about driving growth.

Here’s the big difference between being a web retailer as opposed to a traditional one; an Amazon versus a Walmart:

To become more convenient and attract more shoppers, Walmart must build ever more stores. It must go where the customer is. Proximity between seller and buyer is a function of how far a shopper must drive to reach a supercenter.

To become more convenient and attract more shoppers, Amazon benefits from more consumers being connected to the internet with each passing day. Proximity between seller and buyer is a function of how many steps a shopper must take between his seat on the couch and the nearest web-enabled device.

Convenience Infrastructure Factors

The same forces that bring more people onto the internet every day bring those people to Amazon. It must simply be prepared for their business.

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This is the second post in a series about deconstructing Amazon’s Feedback Loop, an attempt to understand how its components work both as individual units and together as a collective system. See also the previous post, Convenience (and Diaper Stench): Amazon v. Walmart.

All retailers must invest in a convenience infrastructure, plowing cash into those components of their businesses that make it easier for consumers to shop with them.

But not all convenience infrastructures are created equal.

For traditional retailers like Walmart, that infrastructure is composed overwhelmingly of stores. And to enhance the convenience it offers customers it must build more and more stores plus staff them, stock them, and maintain them to some reasonable aesthetic and hygienic standard. While this has been a lucrative business for Walmart investors over the years, having an infrastructure rooted in real estate – an inflating asset whose costs increase over time – is pricey. Especially when compared to the alternative.

For web-based retailers like Amazon, convenience is a much different proposition. It’s driven by technology (software, hardware, internet connectivity, etc.) and the speed with which it can deliver packages to shoppers.

To build on our Amazon Feedback Loop schematic, here’s the convenience infrastructure addition:


With such a chunk of its convenience being based on technology, Amazon has a tremendous cost advantage over retailers that are forced to plow so much cash into real estate in order to grow. As we’ll discuss in this article, a convenience infrastructure that depends on technology investment is inherently less expensive and much, much more scalable.

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diaper fillersThis is the first post in a series about deconstructing Amazon’s Feedback Loop in an attempt to understand both how its components work as individual units and together as a collective system. 

We’ll begin deconstructing the Amazon Feedback Loop by focusing on the Convenience Growth Lever.

When retailers invest in the Convenience Growth Lever, we’re talking about the infrastructure that makes the shopping experience as quick, simple, and hassle-free as possible for customers. The better job you do taking away the headaches of shopping, goes the logic, the more consumers will want to spend money with you. And you grow.

The convenience infrastructure for traditional retailers revolves around placing stores as near as possible to the greatest mass of shoppers and then supporting those stores with staff, stock, and maintenance to keep them in good working order. It’s largely steeped in real-estate, an asset that tends to get costlier with time.

For web-based retailers, it’s a different set of variables based largely on technology and the ability to deliver goods to customers as quickly as possible. Technology tends to cost less through its cycles of innovation, allowing users to do more with it at a cheaper price as time marches on.

Let’s start the convenience discussion with a contemplation of diaper stench.

Walmart vs. Amazon: A Case Study in Convenience and Diaper Stench

It’s Monday afternoon and my wife informs me that we’re running low on those special fresh-scented garbage bags that line the sides of the diaper-genie device in the baby’s nursery. Given that we’ve recently introduced our seven-month old daughter to the pleasure of solid foods, that they often don’t agree with her little system and therefore wreak havoc on her little outputs, we’re going through a lot of diapers. And keeping those liners in stock is of some importance to our family’s collective olfactory wellbeing.

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Feedback Loop No Outside CashSo far I’ve put the feedback loop out there (twice!) with no real explanation. What a tease! Okay, we’ll dedicate this post to deconstructing that schematic at a high level in preparation for building it back up in greater detail.  This is the first article in what’s bound to be a longer series than I currently intend. Unfortunately for readers, the Bard’s words are lost on me – brevity is the soul of wit – as I clearly lack both. 

It’s recursive. It feeds itself. It’s a perpetual motion machine.The nature of a feedback loop is that its outputs don’t escape from the system. They get recycled back in, and this creates a compounding effect as they become the fuel to churn the loop and create even more outputs. Which are again recycled back into the system, and the loop churns ad infinitum.

In the Amazon Feedback Loop, the fuel is cash. And in the simplest sense, it runs like this:

Amazon feeds cash into the loop, investing in the growth levers – lower prices, wider selection, and enhanced convenience. This earns it a greater portion of the broad middle, bringing more customers to Amazon, producing more sales growth in the form of higher volume (more overall sales) and faster velocity (selling its inventory at a quicker rate). The combination of volume and velocity generate more gross profit dollars (cash) as well as negative working capital dollars (cash) which Amazon can then use as fuel to feed back into the loop.

And the feedback loop churns and churns. Unless competitors can keep up (unless they can BOTH create cash AND make the decision to invest it in the growth levers), Amazon pulls further away with each repetition of the cycle.

We’ll spend the next several articles reviewing the individual components as we deconstruct Amazon’s Feedback Loop. Next, we’ll focus on convenience, that growth lever which provides the greatest distinction (in a good sense and a bad sense) between web retailers and traditional retailers.

After six entries in this series, and spreading it out over two weeks, we’re finally getting back to Amazon and its feedback loop. I hope you’ve muddled through all this build-up

Here’s the quick version of what we’ve covered so far:

The three variables most important to a retailer’s growth are prices (the lower the better), selection (the wider the better) and convenience (make it easy for the customer to buy your stuff). There are other variables of course, but these three – dubbed the Growth Levers – earn you access to the Broad Middle of the market…that portion with the most customers. By reaching the broad middle, you get high growth.

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sophie_stickerThis is the sixth post in a series about Amazon’s Feedback Loop, the mechanism most responsible for the company’s success. See also the previous posts, The Growth Levers in Retail: Price, Selection, ConvenienceUnlocking the Broad Middle (Hint: Price Is the Key)Sam Walton, Panties and Power LawsThe Productivity Loop (Walmart’s Feedback Loop); and Why Is Price the Ultimate Competitive Advantage? (Playing Games).

To demonstrate Walmart’s productivity loop, let’s use a hypothetical example. Let’s say Walmart begins selling Sophie the Giraffe teething toys, those over-priced French rubbery things so many moms insist on buying for their tykes (my wife included).  Boutique shops sell them for about $24. I’ll assume they buy the toys wholesale for $16 and slap on a 50 percent markup.  (These boutiques are aiming for the less price sensitive customers, those on the right-hand side of our consumer bell curve.)

Even though they sold through the previous order at $21, Walmart sticks with their30 percent markup. They sell the new batch of Sophies at $16.64 and advertise to all the young moms of the world that they have the best price. Moms can’t pass it up, and they sell out within days.Walmart starts off with a small order in which they pay the standard wholesale price and mark it up 30 percent. Their Sophie now costs about $21, a nice discount to the boutiques, and Walmart sells through the first lot pretty quickly. Seeing some customer demand for the toy, the Walmart merchant now goes back to the manufacturer, Vulli, and places an order for 100,000. They require a 20 percent discount – $12.80 per toy instead of $16 –  in return for the bulk purchase. As you wish, says Vulli, and fills the request.

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Price Matrix CThis is the fifth post in a series about Amazon’s Feedback Loop, the mechanism most responsible for the company’s success. See also the previous posts, The Growth Levers in Retail: Price, Selection, ConvenienceUnlocking the Broad Middle (Hint: Price Is the Key)Sam Walton, Panties and Power Laws; and The Productivity Loop (Walmart’s Feedback Loop).

There are two forms of pricing power: the ability to raise prices and the ability to lower prices.

The ability to raise prices for your offerings – demanding a premium over competitors’ products based on something you do better than they do – is an excellent indication that your business offers some form of competitive advantage. Otherwise you probably couldn’t charge a higher price. If you sell clothing, you must be appealing to some fashion sensibility. If you peddle electronic devices, your technology must satisfy some consumer desire for functionality, novelty, or style.

Having the ability to charge high prices can be very nice. Of course you must ask WHY you can charge the high price and whether the cause is defensible and durable for the long-term, or whether it’s fleeting and likely to dissipate with time. And, of course, most advantages do go away with time. New fashion designs get mimicked, and the public’s taste for a particular style is fickle. Innovation in technology may provide a lead over the peloton of competitors for a while, but it has a tendency to figure out your tricks, duplicate your product features, and draw you back into the pack over time.

Most competitive advantages are decidedly NOT enduring.

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I couldn’t find a way to link to this Google+ posting from the resources page, so I decided to cut and paste it here. Steve Yegge is a programmer at Google and a former Amazonian. I’m sure I’m breaching all sorts of etiquette by doing this, but I rationalize it by saying I want to make sure this piece – with all its pearls about Amazon’s transition to service oriented architecture and Jeff Bezos’ mercurial ways – is preserved for posterity.

Steve Yegge originally shared this post:

Stevey’s Google Platforms Rant

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