Case study

7.1 Introduction

Learning Objectives

1. Appreciate the breadth of businesses in which Amazon competes.

2. Understand that Amazon’s financial performance has not been consistent.

3. Begin to recognize the reasons for this performance inconsistency and set the stage for the examination unfolding in subsequent sections.

As CEO of tech industry research firm Forrester Research, George Colony is paid to predict the future. Firms spend big bucks for Forrester reports that cover trends and insight across the world of computing. So when, in the early years of Amazon’s expansion, Colony turned his attention to the Internet retailer founded by Jeff Bezos, there were a lot of people paying attention. Colony proclaimed that the recently public firm would soon be “Amazon.toast” as larger traditional retailers arrived to compete online. Colony wasn’t the only Bezos-basher. Fortune, the Guardian, and Barron’s were among the publications to have labeled the firm “Amazon.bomb.” Bezos’s personal favorite came from a pundit who suggested the firm should be renamed “Amazon.org,” adopting the domain of a nonprofit since it’ll never make any money.

Amazon went seven whole years without turning a profit, losing over $3 billion during that time. The firm’s stock price had fallen from a high of $100 a share to below $6. Conventional wisdom suggested that struggling dot-coms were doomed, as retail giants were poised to bring their strong offline brands and logistics prowess to the Internet, establishing themselves as multichannel dominators standing athwart the bloodied remains of the foolish early movers.

But during those seven years and through to this day, Bezos (pronounced “bay-zose”) steadfastly refused to concentrate on the quarterly results Wall Street frets over. Instead, the Amazon founder has followed his best reckoning on where markets and technology were headed, postponing profit harvesting by plowing cash into expanding warehousing capacity, building e-commerce operations worldwide, growing the Internet’s most widely used cloud computing platform, leading the pack in e-readers, developing the first credible threat to Apple’s dominant iPad in tablets, launching video streaming/gaming devices for television, and defining a successful new product category with Echo, a voice-response speaker platform. The company’s logistics and shipping efforts include a leased fleet of cargo jets (Prime Air), hundreds of tractor trailers, an expanding local delivery infrastructure, a foray into trans-oceanic shipping, and a much-publicized commitment to delivery by unmanned drone. Today, Amazon is clearly more than an online store and has even begun to aggressively invest beyond “clicks” into “bricks.” The firm had begun operating campus bookstores (a once lucrative business for Barnes & Noble). It also has over two-dozen Amazon-branded stores that include “Amazon Books,” concept stores that are physical retailers with no-checkout convenience (Amazon Go). Amazon popup kiosks are now commonplace in malls cross country. And the firm completed a gargantuan $13.7 billion acquisition of Whole Foods—giving the once Internet-only player a 42-state collection of over 430 grocery stores. Not all forays are successful—the firm’s attempt at creating a smartphone competitor to iOS and Android, the Fire Phone, was a multimillion dollar disaster—but the firm’s recent batting average in new product introductions has been impressive.

Amazon-Owned Businesses

CNNMoney offers a look at some of the businesses Amazon owns, including Zappos, IMDb, Whole Foods, Audible, and Good Reads. Some of Bezos’s personal investments are also mentioned. Oh—and there are images of that 10,000-year clock being built.

Tellingly, Amazon’s first profit was posted the week one-time brick-and-mortar Goliath Kmart went bankrupt. Kmart was also the former parent of another giant of the offline world, Borders, a firm that completely shuttered in the wake of Amazon’s dominance. Kmart was eventually purchased by Sears, a reeling retailer that lost $10 billion in six years. As for Amazon, profits continued. In a three-year period following the introduction of the Kindle, Amazon’s net income climbed from $476 million to $1.15 billion. Barnes & Noble’s fell from $150 million to $37 million before dipping into the red. Punditry is a dangerous business, but Barron’s made up for the dot-bomb comment, putting Amazon on its cover under a headline proclaiming the firm the world’s best retailer. Fortune atoned by naming Bezos the “Businessperson of the Year,” and Amazon was recently named as having the “Best Reputation of any US corporation.”

Massive investments had, for years, cratered Amazon profits even as Amazon marched to became the fastest firm in history to reach $100 billion in sales. Yet by July 2019, Amazon had posted its fourth consecutive profitable quarter. The investment in cloud computing has paid off spectacularly, and it now delivers over half of the firm’s operating incomeIncome you generate through your operations. Sales through daily business operations minus related expenses. Net income is overall "profit" but can include things such as income from investments, expenses related to financing costs or taxes, or one-time income or expenses such as a gain from a sales or a corporate fine.. Record breaking profits a year earlier topped $11 billion, trouncing Wall Street expectations. To be clear, those expectations have been sky-high, and Amazon’s highly valued stock with its nosebleed P/E ratio suggests that Wall Street continues to anticipate a huge upside. Let’s dive in and look at how technology and strategy have come together in one of the most innovative firms in history.

Jeff Bezos and the Long Term

“Our first shareholder letter, in 1997, was called ‘It’s all about the long term.’ If everything you do needs to work on a three-year time horizon, then you’re competing against a lot of people. But if you’re willing to invest on a seven-year time horizon, you’re now competing against a fraction of those people, because very few companies are willing to do that. Just by lengthening the time horizon, you can engage in endeavors that you could never otherwise pursue. At Amazon we like things to work in five to seven years. We’re willing to plant seeds, let them grow—and we’re very stubborn. We say we’re stubborn on vision and flexible on details.”

Bezos’s big thinking isn’t limited to Amazon. He has struck an unusual partnership with JPMorgan Chase and Warren Buffet’s Berkshire Hathaway to explore new technologies and solutions to serve their US employees. The deal may have implications for broader society—think telemedicine, early-detection devices, tackling drug pricing and distribution, offering combined care and insurance alternatives, and devices that promote and reward healthy living. Just how far ahead is Bezos’s time horizon? His personal investments (conducted as Bezos Expeditions) include Blue Origin, a commercial rocketry and aviation firm that intends to send humans into space and has already secured payload delivery contracts with NASA. Other investments include Twitter and Uber. In 2013, Bezos (not Amazon) went old school and bought the Washington Post.  Bezos has also built a 10,000-year clock deep inside a mountain on his ranch in West Texas. The timepiece plays an elaborate cuckoo-like sequence, composed by musician Brian Eno, to mark every year, decade, century, millennium, and ten millennia. How’s that for a symbol of long-term thinking?

Why Study Amazon?

Amazon isn’t just the Internet’s biggest superstore, it’s the world’s most valuable retailer and the largest, most profitable provider of cloud computing services, by far. While sales are still a fraction of Walmart’s, Bezos’s firm is worth twice as much as the world’s largest physical retailer, and is growing far faster. Examining Amazon’s various businesses provides a context for introducing several critical management concepts, such as cash efficiency, logistics advantages, and channel conflict. We see ways in which tech-fueled operations can yield above-average profits far greater than offline players. We can illustrate advantages related to scale, the data asset, and the brand-building benefits of personalization and other customer service enhancements. Amazon’s Kindle business and its expanding forays into the tablet, set-top box, and the voice-powered personal assistant markets allow us to look into the importance of mobile, multiscreen, and diverse-interface computing as a vehicle for media consumption, a distribution channel for increased sales and advertising, a creator of switching costs, a gathering point for powerful data, and a competitor for platform dominance. And the firm’s AWS (Amazon Web Services) business allows us to see how the firm is building a powerhouse cloud provider, generating new competitive assets while engaging in competition where it sells services to firms that can also be considered rivals.

Amazon has become so dominant that the doubters have been replaced by those crying monopoly. The firm’s category crushing performance in online commerce, the e-book industry, and cloud computing have created a set of resources (data, scale, network effects, and more) that have a natural end-state of winner-take-all/winner-take-most. This has given the firm enormous bargaining power with suppliers and partners, has made it the first stop for shoppers and the first choice for selling partners, allows the firm to gather an unprecedented amount of data, and has created a distribution footprint that’s difficult to imagine any other firm rivaling. Amazon is now under intense scrutiny from antitrust regulators, workplace advocates, privacy groups, lawmakers, and a public wondering if it’s justifiable that a firm earning $11 billion in profits paid $0 in federal taxes (and in fact, received government rebates) over two years.

Key Takeaways

· Amazon is the largest online retailer and has expanded to dozens of categories beyond books. As much of the firm’s media business (books, music, video) becomes digital, the Kindle business (which has expanded to tablet, set-top box, and smartphone) is a conduit for retaining existing businesses and for growing additional advantages. And the firm’s AWS cloud computing business is the largest player in that category. The firm has even begun investing in physical retail locations, including opening Amazon Books stores, pioneering the no-checkout Amazon Go concept, and buying Whole Foods and gaining over 430 grocery stores.

· Amazon takes a relatively long view with respect to investing in initiatives and its commitment to growing profitable businesses. The roughly seven-year timeline is a difficult one for public companies to maintain amid the pressure for consistent quarterly profits.

· Amazon’s profitability has varied widely, and analysts continue to struggle to interpret the firm’s future. However, after years of investing in new businesses and in building scale advantage, Amazon is now solidly and reliably profitable. Studying Amazon will reveal important concepts and issues related to business and technology.

Questions and Exercises

1. Which firms does Amazon compete with?

2. Investigate Amazon’s performance over the last decade. How has the firm done with respect to revenue, net income, and share price? How does this compare with competitors mentioned?

3. What are some of the advantages in having a longer time horizon? What are some of the challenges? What needs to happen to enable Amazon to continue to “think long term”? What could derail this approach?

4. Consider the success of Amazon. Is it a firm that should be more regulated? Why or why not? What are the potential positive and negative consequences of this? Many cry “break up Amazon,” but if retail and AWS were broken into separate business units, what would likely be the result of these units ranking in the respective markets of e-commerce and cloud computing? What kinds of tensions exist between encouraging entrepreneurship and free enterprise and ensuring that markets remain fair, competitive, serve the consumer, and operate in the public interest or at least in ways that don’t create net social detriment? What should managers do to address public concern and how might a lack of addressing these issues impact a company in the future?

Annotate

7.2 The Emperor of E-Commerce

Learning Objectives

1. Recognize how Amazon’s warehouse technology and systems are designed to quickly and cost-effectively get products from suppliers to customers with a minimum of error.

2. Understand how high inventory turns and longer accounts payable periods help fuel a negative cash conversion cycle at Amazon, and why this is a good thing.

3. Gain insight into various advantages that result from the firm’s scale and cost structure.

4. Appreciate how data can drive advantages not fully available to offline firms, ranging from increased personalization to innovation and service improvements.

5. Identify the two sides in Amazon Marketplace network effects, and why this is important in strengthening the firm’s brand. Understand the financial advantages of goods sold through marketplace versus those that Amazon takes possession of and sells itself.

6. Appreciate how mobile access is influencing opportunities through additional changes in how, where, and when consumers shop.

Everybody starts small, even Bezos. At first the firm focused exclusively on selling books over the Internet. An early office was in a modest space boasting a then-appealing 400-square-foot basement warehouse in a low-rent area of Seattle, where neighboring establishments included the local needle exchange, a pawn shop, and “WigLand.” Today, the firm is decidedly larger. Amazon is now the world’s largest online retailer, by far, and operates over 400 facilities worldwide dedicated to the warehousing, distribution, and delivery of products, sometimes guaranteeing delivery within the hour. The stylized smile in the Amazon logo doubles as an arrow pointing from A to Z (as in “we carry everything from A to Z”). A new downtown Seattle headquarters takes up three full city blocks anchored by three signature office towers. While Amazon’s revenues are still smaller than Walmart, the firm is growing far faster and has a market cap not just bigger than Walmart, but bigger than Walmart, Target, Best Buy, Macy’s, Nordstrom, Kohl’s, JCPenney, and Sears—combined. In Sept 2018, Amazon’s market cap topped $1 trillion for the first time, and by January 2019 the firm was the most valuable firm on the planet. 

How does a firm that sells products that pretty much any other retailer can provide, grow and create competitive advantages that keep rivals at bay? Look to the napkin! The lobby of Amazon’s headquarters sports the framed vision scribbled out by Amazon’s chief, allegedly penned on the nearest writing surface while Bezos was noshing (see Figure 7.1).

At the heart are three pillars of Amazon’s business: large selection, customer experience (sometimes referred to simply as “convenience”), and lower prices. Says Bezos, “I always get the question, what’s going to change in ten years? I almost never get asked, what’s NOT going to change in the next ten years? That’s the more important question, because you can build a business around things that are stable. [Things like] low prices…faster delivery [offering customer convenience]…vast selection.”

Figure 7.1 Amazon’s “Wheel of Growth”

Source: Based on a Jeff Bezos napkin scribble.

The three pillars of selection, customer experience, and low prices reinforce one another and work together to create several additional assets for competitive advantage. Exceptional customer experience fuels a strong brand that makes Amazon the first place most consumers shop online. Having more customers allows the firm to provide more products, creating scale. The larger the business, the easier it is for Amazon to justify vertically integrating to become its own shipper in some circumstances—keeping prices and other costs down while speeding delivery. Amazon also opens its website up to third-party sellers—a dynamic where more customers attract more sellers, which attracts still more customers (and so on). That virtuous cycle of buyer-seller growth is a two-sided network effect, yet another source of competitive advantage. And all this activity allows Bezos and Company to further sharpen the business battle sword by gathering an immensely valuable data asset. Each digital movement is logged, and the firm is constantly analyzing what users respond to in order to further fine-tune the customer experience, make more accurate demand predictions, squeeze out costs, and drive cash flow. Let’s look at each of these items and see how Amazon’s bold tech-based strategy is realizing additional advantages in the domain of marketing, accounting, and operations.

Fulfillment Operations—Driving Selection, Customer Convenience, and Low Price

Amazon has always sold direct to consumers, but it didn’t always do this well. The firm’s early warehousing was a shambles of inefficient, money-burning processes. Amazon hired operations experts from leading retailers, but raiding Walmart’s talent pool wasn’t enough. Amazon’s warehouse and technology infrastructure are radically different than those of any conventional retailer. While Walmart warehouses that support its superstores ship large pallets of identical items in a single shipment (think crates of diapers or toothpaste) to thousands of its retail locations, Amazon warehouses pack boxes of disparate individual items, sending packages to millions of homes. To build a system that worked, Amazon focused on costs, data, and processes so that it could figure out what was wrong and how it could improve, applying technology for the biggest impact.

One effort, “Get the C.R.A.P. out,” focused on products that “can’t realize any profits.” The firm’s senior vice president of North American operations recalls visiting a Kentucky warehouse and watching a staffer spend twenty minutes packaging up a folding chair—a process way too inefficient for a firm with razor-thin margins. To fix the situation, Amazon worked with the vendor to get chairs in prepackaged, ready-to-ship boxes, keeping the product available to customers while cleaving costs.

To automate profit-pushing hyperefficiency, Amazon warehouses are powered by at least as much code as the firm’s website—nearly all of it homegrown. Shipments during the holiday rush topped 2.5 billion packages, all without elves or flying reindeer. The firm’s larger warehouses are upwards of a quarter-mile in length, packed with aisles of shelves. Technology choreographs thousands of workers and robots in what seems part symphony, part sprint.

When suppliers ship new products to Amazon, items are placed and prepped so inventory is ready to fulfill customer orders as soon as possible. Dozens of workers examine the incoming shipments for defects. If a problem is spotted in the receiving area, the staffer flips an adjacent warning light from green to red, signaling a warehouse “problem solver” to swoop in, deal with the issue, and make sure additional items in the rest of the product supply can keep flowing in. Amazon is always looking to cut errors and identify areas for potential process improvement. Other groups of problem solvers scuttle about the warehouse with wheel-mounted laptops, observing operations and offering coaching on how staff can do things better. To foster improvement, warehouse movements are continuously logged and productivity is tracked and plotted. High-performing workers are praised throughout the day, with management calling out the names of workers who hit or exceeded goals. Says one Amazon exec, “If we discover a better way of doing something, we can roll it out across the world.”

While problem solvers can pick up quick-to-implement process improvements, there are also massive tech-fueled changes under way. Amazon previously relied exclusively on human beings rushing around maze-like warehouse shelves to stock products and pick orders. The worker runabout was good for personal cardio, but it required wide lanes between shelving, and technology to coordinate path-crossing, occasionally crash-prone, cart-pushing humans. Today, a robot army turbocharges fulfillment, sparing the worker sprint.

Robots powering redesigned fulfillment centers come from Kiva Systems, a Massachusetts-based firm that Amazon bought for over three-quarters of a billion dollars. Kiva robots don’t look like C-3PO. They’re squat, 320 lb, orange colored, rounded-rectangles on wheels, about the size of a living room ottoman. Now, instead of workers running to shelves, robots bring shelves to workers. Robots don’t yet handle the bulkiest items such as flat-screen TVs or lawnmowers, but Kiva robots carry shelves stacked with upwards of 750 lb of goods, making them capable of handling the majority of what you’re likely ordering from Amazon.

In robot-automated fulfillment centers, those items that are handled by Kivas are sent to one of four floors where the robots roam. A massive robot arm known as the “Robo-Stow” might be used to hoist pallets of products from one floor to another. Shelvers stand on platforms while Kiva robots line up for restocking, bearing shelf towers with open bins stacked nine-or-more slots high along on all four sides. Robots position shelves to expose the correct side for inventory placement. Shelvers scan products that are added to inventory, placing each in a specific location on a specific shelf that is also scanned. Relentless Amazon has even begun doing away with the scanner, using its expertise in computer vision to identify products moving into inventory. This allows workers to use two hands on bulky items and lowers the chance that a dropped scanner or other item would break, trip a human, or delay a robot.

Once shelved, Amazon software knows exactly where a given item is stored. Next, the shelf is whisked away by a robot until one of the items on the shelf is needed for a customer order. The same items might be stored on dozens of different shelves throughout the warehouse. This allows different robots to simultaneously fulfill different orders for the same items. Amazon software enforces an additional rule when stocking shelves, known internally as “random stow”: No two similar products sit next to each other. While this makes Amazon’s shelves look like an unorganized hodgepodge, when a product is the only one of its type on a given shelf, this actually reduces the chances that a picker will confuse a size or color or otherwise grab the wrong thing. Reducing mistakes keeps customers happy in brand-building ways, and it reduces errors that can crush profits.

When an online order is sent to a fulfillment center, pickers wait for shelf-carrying robots to line up with precisely those items that the customer has requested. A monitor near the picker indicates the item that’s needed and where it can be found on the robot-conveyed shelf. Humans are still needed to grab an item off the shelf, do a second quality check, and place items into yellow plastic order fulfillment bins.  Once all items for a given order are picked, the bins containing orders are placed on conveyor belts where they’re whisked away for packing. Software identifies the optimal size of smile-logoed Amazon cardboard box to use for a given order and how many air pillows to protect packed items, and even dispenses the right amount of packing tape. The entire order process involves only about a minute, total, of human contact.

In a set of steps called SLAM (scan, label, apply, manifest), and taking only about a second, packed boxes are weighed, and the software does an additional check to see if the weight is what’s expected. If an order is too light, that’s a sign that a box is missing an item, too heavy and the wrong item may be in the order. Boxes are scanned, and shipping labels are printed and blown on with a puff of air. Systems only stamp names and addresses on boxes after orders are complete and boxes are sealed. No floor workers know who you are or what you’ve ordered. Packed boxes are then loaded onto separate trays that ride into another conveyor belt system, where they are scanned and tipped down the correct chute among dozens of choices so that the box is routed onto the appropriate truck for that order’s shipping provider and destination. Some warehouses ship products so quickly that outbound trucks are dispatched with a less-than-three-minute window between them.

Robots at Amazon Fulfillment

Follow the entire process as items enter an Amazon Fulfillment Center, get stacked on robot-mounted shelves, get called back for order assembly, and get boxed and sorted for shipping.

Amazon is now using over 100,000 robots, and a single warehouse, like the massive Tracy, California facility (which is about as large as fifty-nine football fields) can have over 5,000 Kiva robots, helping the firm ship as many as 21 million distinct products. Motion sensors and floor-mounted guides help robots find their way. Shelf-carrying Kivas travel around 3 to 4 mph and never collide. The wireless, electric robots will run a couple hours on a charge, and they’ll return for a recharge when needed. Robots can’t repair themselves, but repair staff are on site in the event of failure, with no more than ten robots in the fleet expected to be out of commission at any point in time. Kivas keep getting better, too. Amazon claims the current generation is 50 percent more efficient at moving inventory than models that were produced at the time of acquisition.

As for benefits, Kiva robots allow shelves to be slotted closer together and can be queued up for rapid, never-colliding, constant round trips. This helps Amazon store as much as 50 percent more product in Kiva-equipped warehouses (greater selection at lower cost), it has reduced unload time for inbound inventory from “hours” to as little as 30 minutes, and it has cut average order fulfillment time from about an hour and a half to as little as fifteen minutes. While robot workers are cheaper than people, Kiva isn’t a job-killer; in fact, Amazon has actually increased staff since deploying the robots. Says the firm’s VP of worldwide operations, “Kiva’s doing the part that’s not that complicated. It’s just moving inventory around. The person is doing the complicated work, which is reaching in, identifying the right product, making sure it’s the right quality, and making sure it’s good enough to be a holiday gift for somebody.”

Deploying robots isn’t cheap. It’s estimated that Amazon spends over $26 million on equipment and $46 million total getting a large warehouse on board with Kiva robots, but systems also help the firm position itself for even more customer satisfaction. Faster delivery times through speedy fulfillment centers helped Amazon expand same-day delivery to twenty-seven cities in Spring 2016.

Keeping customers happy stems in part from setting expectations, so Amazon’s systems receive weather reports as well. Order a product during a pre-Christmas snowstorm, and expect to see a message on the website indicating that “adverse weather conditions are impacting deliveries.” A nice touch on the few times when a snag might cause problems. Those are quite rare: Amazon boasts on-time package delivery rates of up to 99.9 percent or more.

Amazon’s Cash Conversion Cycle—Realizing Financial Benefits from Speed

Quickly moving products out of warehouses is good for customers, but Amazon’s speed also offers another critical advantage over most brick-and-mortar retailers: The firm is astonishingly efficient at managing cash. Here’s how.

When incoming inventory shows up at most retailers—and this is certainly true for Amazon, Barnes & Noble, and Best Buy—those firms don’t pay their suppliers right away. Instead, they log payment due for these goods as an account payableMoney owed for products and services purchased on credit., a bill that says when payment is due some time in the future. Accounts payable periods vary, but it’s not uncommon for a big retailer to be able to hold products for a month or longer without having to pay for them. However, when customers buy from a retailer, they pay right away. Cash is collected immediately, and funds from credit cards and checks clear in no more than a few days. The firm’s period between shelling out cash and collecting funds associated with a given operation is referred to as the cash conversion cyclePeriod between distributing cash and collecting funds associated with a given operation (e.g., sales). (CCC). There are other factors that influence the CCC, but right now we’ll concentrate on the hugely important time difference between paying for inventory and selling those goods. A retailer wants this number to be as small as possible; otherwise, unsold inventory is sitting on shelves and doesn’t generate any cash until it’s sold. Especially cash-crunched firms may even require short-term loans to pay suppliers, and those firms that can’t generate cash quickly enough are referred to as having liquidity problemsProblems that arise when organizations cannot easily convert assets to cash. Cash is considered the most liquid asset—that is, the most widely accepted with a value understood by all..

While a firm’s CCC varies from quarter to quarter, Barnes & Noble has reported that its inventory has sat on shelves sixty-eight days on average before being purchased. BestBuy has held inventory for as many as seventy days before a sale. Costco and Walmart sell goods more quickly, but they also pay for inventory before it is sold. When compared with these peers, however, Amazon alone consistently reports a negative CCC—it actually sells goods and collects money from customers weeks before it has to pay its suppliers. This gives the firm a special advantage since it has an additional pool of cash that it can put to work on things like expanding operations, making interest-bearing investments, and more.

Figure 7.2 Cash Conversion Cycle (in Days) among Select Major Retailers

Source: Data from firm-published financial reports.

The efficiency of a firm’s cash cycle will vary over time. And numbers reported are an average for all products—some products are slow movers while others are sold very quickly. But the negative cash conversion cycle is another powerful benefit that Amazon’s fast-fulfillment model offers over rivals. The goal for Amazon? Keep inventory turnsThe number of times inventory is sold or used during a specific period (such as a year or quarter). A higher figure means a firm is selling products quickly. high (e.g., sell quickly) and pay suppliers later.

Internet Economics, Scale, and Pricing Power

Selling more goods often gives Amazon bargaining power with suppliers. And the size (scale) of Amazon’s business provides the firm with negotiating leverage to secure lower prices and longer payment terms. Walmart’s sales dwarf Amazon’s. Walmart’s 2018 revenues were $514 billion. Amazon’s 2018 revenue was about $233 billion, but a direct comparison would need a bit more math. The dollar-value of products moved through Amazon is quite a bit larger, but the firm only books the money it keeps selling third-party products, not overall sales figures. Also, a retail compassion of Amazon’s numbers would subtract out $25.6 billion earned from the cloud computing business and about $10 billion earned from “other” activities, mostly advertising. But Walmart has over 11,500 stores worldwide and Target (with only $75.4 billion over the same period) has 1,855 stores. Amazon has about 400 logistics facilities worldwide, including fulfillment centers, sortation centers, delivery stations, and Prime Now hubs. Putting aside the Whole Foods acquisition (which Amazon says it will, in the short term, run as a separate business, retaining its current CEO), and its opening a modest number of Amazon Books, Amazon Go, and other retail outlets, Amazon still has a massive economic advantage over traditional retail. While Amazon spends significantly on software, automation, and expansion of its warehouses, its overall costs in non-grocery consumer sales for things like real estate, energy, inventory, and security are far lower than costs experienced by brick-and-mortar rivals. And employee efficiency should be greater as well, since Amazon shift workers are working at fairly constant rates throughout the day while retailer activity fluctuates with the ebb and flow of customer visitation hours.

The Advantage of Being Big: Realizing Scale Advantages as the Retail E-Commerce Leader

Retail can be a cutthroat business. Competition often boils down to whoever has the lowest price. Amazon’s sales volume scale enables it to operate with thin margins and low prices. As former Amazon employee Eugene Wei puts it, this allows Amazon “to thin the oxygen” of competitors. Amazon’s breadth of operations brings in cash from other businesses, giving the firm the stamina to endure the challenge of an unprofitable price war. After vanquishing a category rival following a price war, Wei put it this way: “Our leading opponent had challenged us to a game of who can hold your breath longer,” and Amazon had “bigger lungs.” The lesson is clear: A smaller firm looking to pick a price fight with Amazon might not survive.

Figure 7.3 Key Retailer Average Price Difference above Amazon.com

Source: Adapted from J. Jannarone, “Retailers Struggle in Amazon’s Jungle,” Wall Street Journal, February 22, 2011; and S. Distinguin, “Amazon.com: The Hidden Empire (2013 Update),” faberNovel, February 2013.

Amazon’s retail prices aren’t just cheaper than other e-commerce firms; they’re usually cheaper than larger rival Walmart, too. Wells Fargo compared a diverse basket of products available at both firms and found that Walmart prices were actually 19 percent more expensive than Amazon prices. Target was 28 percent more expensive, while products purchased at specialty retailers cost 30 percent more. Even more impressive, Amazon seems to be monitoring the availability of products at competitor websites and using stockouts as an opportunity to earn more. The Wall Street Journal reports that “where rivals sold out of items, Amazon responded by raising its prices an average of 10 percent.” Firms should be careful—consumers have been known to react angrily to so-called dynamic pricingPricing that shifts over time, usually based on conditions that change demand (e.g., charging more for scarce items). if they feel they are being taken advantage of. But the insight does show how data can drive a nimble response to shifts in the competitive landscape.

While Walmart, through Jet.com, has made some strides in narrowing price differences, analysts point with concern that Amazon may go after Walmart’s category-leading grocery business by continuing to lower prices at Whole Foods, all while offering discounts to those who sign up for Amazon Prime. Amazon generates a lot of cash, and for years had been plowing nearly every penny back into the firm, mostly via investments in fulfillment center infrastructure and (as we’ll see later in this chapter) capacity for the firm’s dominant, higher-margin cloud computing business (visible in accounting statements by analyzing the sizable gap between the firm’s operating cash flow, which eliminates capital expenditures, and free cash flow, which includes them). Now the firm is harvesting profits from that infrastructure investment. Larger warehouses, more warehouses closer to big cities, and more efficient warehouses all build a moat around the firm’s existing businesses, making it less likely that any firm will be able to attack Amazon’s three-pronged value trident of selection, service, and price.

Scale delivers bargaining power with suppliers, and Amazon has used its massive influence to demand price-saving concessions from partners, as well. Amazon has set standards that require vendors to send it products using less bulky, easier-to-open, and more environmentally friendly packaging. Glossy boxes and see-through packaging aren’t needed for Amazon customers, who have already made a purchase decision and have paid for goods by the time they first touch a package. Products that pack as rectangles are also easier to stock and ship than those with odd shapes. Good for consumers, better for the environment, and a clear benefit for Amazon, but suppliers have had to spend to retrofit packaging lines and in many cases now package otherwise identical products in a completely different way to meet Amazon standards. Amazon has also stopped offering products in quantities that are less profitable to ship, and has shifted other, less profitable products and sizes to the firm’s Amazon Pantry section, which only ships via ground and may require additional subscription fees.

While not well known for its own brands beyond Kindle, Amazon’s scale has allowed it to create several of its own branded product lines. Amazon’s private-label brands include AmazonBasics (cables, batteries, and other consumer electronics accessories), Mama Bear (diapers and other baby products), Happy Belly (foodstuffs, including nuts and trail mixes), Presto! (home cleaning products), Pinzon (bedding and bath), Strathwood (outdoor furniture), Pike Street (bath and home products), Denali (tools), and at least seven private-label clothing brands. 

Putting its own brand on high-volume products allows Amazon to cut out some of the costs that would otherwise go to a branded supplier, lowering prices and improving margins over conventional brands. The willingness to sell its own brands can also give Amazon even more negotiating leverage with suppliers. Firms unwilling to provide Amazon with the price breaks, payment terms, conform to shipping requests, or complete product-line access it demands may see Amazon compete directly with them via a private-label product. And a scale-reinforced brand that screams “best price” in a space crowded with me-too retailers selling the exact same thing is a powerful asset and enormous barrier for competitors to try to overcome. Amazon can keep advertising spending down, as customers see the firm as the first and often only stop needed when moving from product research to purchase. Consider that Target (with billions less in sales than Amazon) spends over $400 million more on advertising than Amazon (with most of Amazon’s spending on non-retail offerings like Kindle and Amazon Video). And once customers show up on its website, Amazon can use customer data to surface its brands to those it thinks will be most likely to buy. 

Amazon also sees growth beyond consumers. Amazon Business is going after the corporate procurement market, which Forbes generously estimates as being valued at $7.2 trillion. Amazon’s selection, selling everything from paper to IT products to break room snacks to lab equipment, may make the firm a first-choice destination for buying in many categories, especially given that the average business products wholesaler offers only about 50,000 products online. Special features are targeted at business customers, including the ability to create multiple user accounts, integrate with corporate procurement systems, set up a purchase approval workflow, work with purchase orders, and even negotiate bulk discounts. A pass-through link will allow a visitor to Amazon to chat with experts from firms selling technical products. In 2017, Amazon announced it had over 1 million business customers, double the amount a year earlier. Amazon’s entry into the market is thought to have contributed to the sale of office supplier retailer Staples at a bargain basement price, and the category of Amazon Business competitors that includes big firms you may not have heard of (Grainger, Fastenal, and MSC Industrial) lost some $8 billion in market value in just one year. Getting most products in and out of a warehouse is the same regardless of category, so Amazon can quickly expand in any area where it thinks the model will work.

Amazon Business

Amazon is building a gargantuan business selling supplies to business customers, challenging everyone from Staples to parts supplier Grainger.

Transcript

Customer Obsession

Figure 7.4 Amazon Breaking Records

Letter posted to Amazon’s home page following the firm’s second record-breaking ACSI score.

Source: Amazon Press Room; http://media.corporate-ir.net/media_files/irol/17/176060/images/letters/letter_acsi.jpg.

For a firm that does so much, Amazon’s moves are largely motivated by one thing: relentless customer focus. Sure, every firm says they care about their customers. But consider this: In meetings, Bezos is known to insist that one seat be left open at the conference table as a symbol representing “the most important person in the room,” the Amazon customer. To keep even the most senior executives empathetic to the customer experience, every two years every employee, from Bezos on down, must spend two days on the service desk answering customer calls.

It’s an eye on improving the customer experience that has motivated so many of Amazon’s pioneering efforts, among which include one-click ordering (which the firm patented), customer reviews, recommendations, bundles, look and search inside the book, where’s my stuff, and free supersaver shipping. While pioneered by Amazon, many of these efforts are now accepted as must-have features across e-commerce categories.

Amazon is also using the Amazon Prime subscription service to make customers happy, and along the way, to create habit-changing behaviors that fuel sales growth. Subscribers to Amazon Prime now get next-day delivery on roughly 10 million products, so users don’t have to bundle products in a shopping cart before they can qualify for free shipping. It also loads up Prime members with additional perks like a selection of thousands of videos and hundreds of thousands of songs that subscribers can stream for free. Show your loyalty with an Amazon Prime Visa card? You’ll get 5 percent cash back, not only from Amazon, but also at Whole Foods. Prime members will get another 10 percent off Whole Foods sales items—a welcome discount for customers that used to refer to the high-priced grocery chain as “Whole Paycheck.” And when Amazon expanded same-day delivery to fourteen US cities, it waived fees for Prime subscribers (cementing a same-day Amazon habit may be important as firms that include Google, Macy’s, and Nordstrom all experiment with same-day service for a fee). In 2018 Amazon, for the first time, announced how many Prime customers it had—100 million—that’s about half of all US households. Many estimates have Prime customers spending twice as much as non-Prime. Many on Wall Street have been critical of free shipping, but it’s yet another way that Amazon improves the customer experience. Free shipping can cost Amazon upwards of $600 million in a single quarter, and shipping costs have been rising as much as 25 percent a year since 2004. The firm’s recent increase in Prime’s subscription price (from $99 to $119 in the United States) coupled with increased volume and loyalty seem to be making the program worthwhile.

As we’ve mentioned earlier, strong brands are built largely through customer experience. As evidence of the strength of customer experience, Amazon has repeatedly scored the highest rating on the University of Michigan’s American Customer Service Index (ACSI). Not only was it a rating that bested all other Internet retailers; it was the highest score of any firm in any service industry.

Leveraging the Data Asset—A/B Testing, Personalization, and Even an Ad Business

Moving early and having scale allow Amazon to amass that profoundly valuable tech-derived competitive resource—data. The more customers a firm has, the more accurately the firm can understand various patterns related to recommendations, preferences, customer segments, price tolerance, and more.

At Amazon, data wins arguments, and the corporate culture gives employees the freedom to challenge even the most senior managers, all the way up to Bezos himself. When Amazon coder Greg Linden proposed that Amazon present “impulse buy” recommendations that match patterns associated with the consumer’s shopping carts (e.g., customers who bought that also bought this), he was originally shot down by a senior vice president. Linden was undeterred; he ran an A/B testA randomized group of experiments used to collect data and compare performance among two options studied (A and B). A/B testing is often used in refining the design of technology products, and A/B tests are particularly easy to run over the Internet on a firm’s website. Amazon, Google, and Facebook are among the firms that aggressively leverage hundreds of A/B tests a year in order to improve their product offerings.—capturing customer response for those who saw option “A” (recommendations) versus option “B” (no recommendations). The result overwhelmingly demonstrated that recommendations would drive revenue.

Two-Pizza Teams: Keeping an Entrepreneurial Culture in a Big Firm

One challenge growing firms often face is that they become slow and less innovative as they expand. In order to keep Amazon nimble and innovative, Bezos has mandated a rule known as “two-pizza teams,” stating that any individual project team should be small enough that it can be fed by no more than two pizzas. This helps ideas flourish, discourages the kind of “groupthink” that diminishes the consideration of alternative approaches, and even provides a mechanism where several efforts can compete to identify the best solution.

While the “abandoned shopping cart” problem plagues many Web retailers, Amazon is considered one of the best “converting” e-commerce sites, moving customers from product evaluation through completing checkout. A/B tests drive this; the firm has relentlessly experimented with tests that modify and compare all sorts of variables, including the wording associated with images and buttons, screen placement, size, color, and more. Constantly measuring customer activity also helps the firm direct its investment in infrastructure. One test, for example, revealed that a tenth of a second’s delay in page loading equaled a 1 percent drop in customer activity, pointing to a clear ROI (return on investment) for keeping server capacity scalable.

While you’re shopping on Amazon, you’re likely part of some sort of experiment—perhaps several. While Amazon doesn’t say how many A/B tests it runs, Google runs over seven thousand annually. Amazon has gotten so good at A/B testing that it launched a service offering scalable options for running simultaneous tests and gathering measured results for developers that use the Amazon app store. A/B testing is yet another advantage e-commerce firms have over conventional retailers. Constant experimentation, refinement, and retesting are far easier in the digital world when every user’s click, delay, and backtrack can be measured and compared.

Amazon’s data trove on you individually, and users collectively, fuels the firm’s personalization effort (efficiently referred to internally as p13n, since there are thirteen letters between the p and the n in the word personalization). When visiting the Amazon home page, it’s more accurate to say that you’re visiting your Amazon home page at a given point in time. Your page may vary not only based on any ongoing A/B tests but also based on Amazon’s best guess of what you’ll want to see as well as any myriad of other sales and promotion goals. Behind the scenes, your Web browser receives a unique tracking string called a cookieA line of identifying text, assigned and retrieved by a given Web server and stored by your browser., and Amazon tracks your surfing behavior as well as your buying history. Rate products? Even better! Amazon knows what you liked and what you didn’t. The firm’s proprietary collaborative filteringA classification of software that monitors trends among customers and uses this data to personalize an individual customer’s experience. software compares a user’s data with others’ data, mapping a best guess of what you’ll like to see each time you visit. A parent who has searched for and bought items for young children will likely see recommendations for other age-appropriate kid products—maybe even guessing at your kid’s gender and likes. Athletes, gamers, and romance novel fans should also expect interest revealed by surfing and purchasing to create a custom experience. Amazon has claimed that as much as 35 percent of product sales have come from the firm’s recommendations. Scale means the firm has more users doing more things, allowing the firm to collect more observations that fuel greater accuracy in tailoring the user experience. And this fuels that oh-so-important, brand-building positive customer experience.

All of this customer insight data also positions Amazon to grow a massive, Google-competing ad business. Amazon initially sold ads as a way to generate more sales through its website, but Amazon now offers advertisers the ability to advertise on Kindles, on other Amazon-owned sites like Twitch and IMDb, within mobile apps, and via Amazon-targeted ads on third-party websites. Even the firm’s cardboard boxes and packing tape provide ad real estate. Analysts estimate $15 billion in ad revenue in 2020, which would be just under 10% of the digital ad market share in the US. Only Google and Facebook have bigger ad businesses, and advertising is yet another business Walmart is unlikely to be able to match. Amazon ad offerings are feature rich, including things like the ability to play a movie trailer in an ad or embedding a discount coupon in a click-to-purchase offering. Amazon reportedly charges up to $1 million for ads placed on the welcome screen of the new Kindle Fire. Alexa is also an outlet for promotions (one option, “Alexa, tell Budwiser ‘Whassup’” would prompt a ‘conversation’ with the guys from an old Bud ad). Don’t like ads? You can pay $20 more for a Kindle without the “special offers.” Have you also ever looked at a product on Amazon, didn’t buy it, but then started seeing the product pop up in ads as you surfed the Web? That’s called retargeting, and Amazon is building this business as well. Retargeting is especially attractive to suppliers since a click through brings you right to Amazon’s cash register, a place where you’ve likely already got all of your account information online and where buying is just “1-Click” away.

Figure 7.5 How Retargeting Works

In this retargeting example, a user visiting the Amazon page for a moisturizer (background) was tracked using a cookie, and the user’s interest in this product was recorded. Advertisements for this product were shown when this same user visited other websites (foreground).

Sources: Amazon, https://www.amazon.com/bareMinerals-Bare-Haven-Essential-Moisturizing/dp/B01A3HO1W2/ref=sr_1_2?keywords=bare+minerals+cream&qid=1568321319&sr=8-2; Politico, https://www.politico.com/story/2018/03/29/facebook-data-privacy-448737.

Selection and Network Effects

Amazon’s radical focus on customer experience also caused it to take what many would consider a contrarian move—offering products provided by others alongside its own listings. Third-party products are referred to as being part of the Amazon Marketplace. Amazon doesn’t own inventory of marketplace items. Sellers can warehouse and ship products themselves, or they can opt to use Amazon’s warehouses as part of the Fulfilled by Amazon program. The latter lets Amazon handle logistics, storage, packaging, shipping, and customer service, while customers get Amazon shipping prices—including supersaver discounts and free shipping for customers enrolled in the Amazon Prime program. Customers also benefit if they already have credit card and other information on file with Amazon (a switching cost potentially deterring users from going to a new site).

Nearly half of all units sold by Amazon are from the firm’s 2 million participating Amazon Marketplace sellers worldwide. Marketplace allows Amazon to build a long tail of product offerings without the costly risk of having to take ownership of unproven or slow-moving inventory, while the firm gets fat and happy in the middle of a two-sided network effectProducts or services that get more valuable as two distinct categories of participants expand (e.g., buyers and sellers). (i.e., more buyers attract more sellers, and more sellers attract more buyers). Some Marketplace products compete directly with Amazon’s own offerings, but the firm doesn’t shy away from allowing competitive listings, new or used, even if they’re cheaper. Competition among sellers reinforces low price and lowers the chance that customers will look first to sites like PriceGrabber, Shopping.com, Google, or eBay. Even if a rival wins a sale, all products sold through Amazon allow Bezos’s firm to collect a fee. Third-party sellers may send a signal to Amazon that a certain product category may be worth entering itself, all while sellers pick up the initial risk of inventory ownership. And when Amazon sells third-party goods through its site, it continues to “own” much of the customer relationship for that sale, gathering data that would have otherwise been lost if customers went elsewhere. Amazon also won’t hesitate to kick out sellers with bad ratings to ensure quality and protect the Amazon brand.

Scale from Selection: The Long Tail

More than half of shoppers start their product search on Amazon—making the firm the leader in product-oriented search (sorry, Google). Much of Amazon’s appeal as a first-choice shopping destination comes from the firm’s selection. Internet businesses are free of what former Wired editor Chris Anderson calls the limitations of shelf space and geography, which trouble traditional retailers. Traditional retailers stock their limited shelves with the most popular items, and consumers are limited to the selection available in the stores that they are willing to travel to. Amazon’s warehouses and third-party seller selection offer the equivalent of virtually limitless shelf stock, something you’d never find in a store. This selection is delivered by US mail or package shippers, so geography is no longer a concern. This allows the firm to leverage what is often called the long tail (as introduced in Chapter 4 “Netflix in Two Acts: Sustaining Leadership in an Epic Shift from Atoms to Bits”,  the tail refers to the large number of products unavailable through conventional retail stores, see Figure 7.6). The cost to house and ship a popular book, or a more obscure one, should be the same. While popular items make up traditional retailer inventory (the area on the left-hand side of the curve in Figure 7.6), it turns out there’s actually more money to be made selling obscure stuff (the stretched-out but larger area on the right-hand side of the curve) if you can reach a greater customer base over the Internet. As evidence, consider that at Amazon, roughly 60 percent of books sold are titles that aren’t available in even the biggest Barnes & Noble Superstores. Amazon is also moving from distribution of the “atoms” of books and video to digital distribution of media products via the Kindle. This eliminates the cost to warehouse and ship the atoms of physical goods.

Figure 7.6 The Long Tail

Not only does Amazon allow others to sell products through its site, it allows others to market for the firm. The Amazon Associates program is the world’s largest affiliate marketing programMarketing practice where a firm rewards partners (affiliates) who bring in new business, often with a percentage of any resulting sales., offering a sort of “finder’s fee” for generating sales. Website operators can recommend Amazon products on their site, and Amazon gives the affiliate a percentage of sales generated from these promotions. For Amazon, fees paid are pay for performance—associates get a commission only if their promotions generate sales.

Acquisitions and Category Expansion: Fewer Rivals, More Markets, and More Customer Choice

Acquisitions of other firms and the growth of new internal businesses has allowed Amazon to accomplish several things, including broadening the firm’s product offerings to underscore Amazon as the “first choice” shopping destination; absorbing potentially threatening competitors before they get too big; experimenting with new product offerings and services; and integrating value-added businesses and technologies into the Amazon empire. BusinessWeek once ran a cover story titled “What Amazon Fears Most,” featuring a diaper-clad toddler. The implication was that New Jersey-based Quidsi, operator of Diapers.com, could grow brand and scale in staple products, drawing customers away from Amazon. Amazon bought the firm for over half a billion dollars, and even though Quidsi never turned a profit and Diapers.com, Wag.com, and other Quidsi brands were eventually shuttered, Amazon took out what was once regarded as one of the biggest threats to grabbing high-growth markets that Amazon didn’t dominate, and prevented Walmart (a rival bidder for Quidsi) from gaining that expertise (Quidsi’s founders went on to start Jet.com, selling that firm to Walmart for $3 billion a short time later). Amazon’s $1 billion purchase of Zappos (which continues to operate as a separate firm) also took out a fast-growing Amazon rival before it became a threat. Other acquired firms include Alexa, a Web analytics and tools provider; Audible, the leading provider of digital audio books; Goodreads and Shelfari, social networking sites for book readers; Woot, a flash salesOffering deep discounts of a limited quantity of inventory. Flash sales often run for a fixed period or until inventory is completely depleted. Players include Gilt Groupe and Amazon’s MyHabit in fashion, and One Kings Lane in home décor. site; Lovefilm, often described as the “Netflix of Europe”; and Souq, often described as the “Amazon of the Middle East.” Some experiments fail, such as the now shuttered flash-sale site MyHabit, but Amazon’s deep pockets and relentless experimentation make it one of the most threatening competitors in retail and services.

Amazon is also growing its own brands in new categories. Amazon Instant Video offers streaming television and movie titles for rental or purchase, and some are included free with an Amazon Prime subscription. Amazon Fresh is a FreshDirect-like competitor, offering same-day or next-day delivery of groceries and more. 

Key Takeaways

· Amazon’s sophisticated fulfillment operations speed products into and out of inventory, reinforcing brand strength through speed, selection, and low prices.

· Rapid inventory turnover and long payment terms enable Amazon to consistently post a negative cash conversion cycle. The firm sells products and collects money from customers in most cases before it has paid suppliers for these products.

· The cost structure for online retailers can be far less than that of offline counterparts that service similarly sized markets. Savings can come from employee costs, inventory, energy usage, land, and other facilities-related expenses.

· Amazon’s scale is a significant asset. Scale gives Amazon additional bargaining leverage with suppliers, and it allows the firm to offer cheaper prices in many categories than nearly every other firm, online or off. Scale through multiple warehouses allows Amazon to offer more products, a greater product selection, and same-day delivery for urban areas near warehouses. Amazon financials suggest that the firm is deferring profitability due to its increased investment in capital expenditures such as its warehouse and data center buildout.

· Around 40 percent of products sold on Amazon are offerings sold through Amazon Marketplace by third parties. Amazon gets a cut of each sale, maintains its control of the customer interface, and retains the opportunity to collect customer data that would be lost if users went elsewhere for a purchase.

· Amazon takes advantage of the long tail, a concept where firms can profitably offer a selection of less popular products. Amazon’s enormous product selection—with offerings from the firm and from third parties—reinforces its position as the first-choice shopping destination.

· Amazon’s ability to acquire and leverage data further allows the firm to enhance customer experience and drive sales. Internet retailers have a greater ability to gather personal data on consumers than do offline counterparts. Data is used in personalization and in innovation fueled by the result of A/B experiments.

Questions and Exercises

1. When you walk into a conventional retailer, similar items are stacked next to each other. But Amazon tries not to do this in its warehouses. Why?

2. How do Amazon warehouse staff know where to find items? How does technology help make the process most efficient?

3. How have robots changed the way Amazon warehouses operate?  What are the benefits these robots bring to Amazon? Which firm supplies Amazon’s shelving robots and why might this be important for Amazon?

4. Does Amazon buy most of its warehouse automation software from others, or is most of the software written in house? Why do you suppose this is the case?

5. In what other ways do Amazon’s information systems reduce errors? Why is error reduction so critical to firm performance?

6. Which requires more code—the firm’s customer-facing website or warehouse automation?

7. Although Amazon is investing in robotics, human beings still do most of the product picking. How does Amazon ensure that customer privacy is protected despite heavy human involvement? Do you think it needs to go to such great lengths? Why or why not?

8. What is the cash conversion cycle (CCC)? What factors enable Amazon to have a CCC that is negative? Why are offline rivals unable to match these efficiencies? What advantage does this give Amazon over rivals?

9. How do Amazon’s prices compare with rivals’ prices? What gives Amazon such advantages? What other pricing advantages does Amazon have that a conventional retailer might not be able to take advantage of?

10. What is dynamic pricing, and why might this be risky?

11. What are private-label products, and what advantages do they offer Amazon?

12. How is Amazon trying to create a special experience to encourage the growth of its fashion business? Would you find this an attractive option? Why or why not? What could Amazon do to lure you into more e-commerce fashion purchases?

13. Log into Amazon (or pull up a page if you “remain” logged in). Compare it to a classmate’s page. What similarities do you notice? What differences? Why do you think Amazon made the choice to show you the things that it did? Do you think it guessed accurately regarding your interests? Why or why not?

14. Amazon’s unique customer data have allowed the firm to enter the advertising business. Which firms does this bring Amazon into competition with? Research Amazon’s role in matching advertisers to consumers. How big a player is Amazon? How do you feel about a firm using your personal data on purchases, product browsing, and recommendations for advertising? Under what circumstances (if any) are you comfortable with such targeting, and under what circumstances are you concerned?

15. How does Amazon keep management focused on customer issues and “putting the customer first”?

16. Describe how Amazon Marketplace offers two-sided network effects.

17. Besides network effects, what additional benefits does Amazon gain by allowing other retailers to sell potentially competing products on Amazon?

18. What is the long tail? How does the long tail change retail economics? How does it influence shoppers’ choice of where to look for products? What firms, other than Amazon, are taking advantage of the long tail in their industries?

19. How is scale important to Amazon? What advantages does scale offer Amazon over its smaller rivals?

20. Amazon’s operations are a marvel of automation and procedural efficiency, but the firm has also been subject to criticism regarding its warehouse work environment. Investigate these criticisms on your own. Do you feel they are valid? Are any of the critics also worthy of criticism? If so, how? Do you feel Amazon has responded appropriately to this criticism? How would you have responded if you were CEO of the firm? What takeaways from your own investigation will inform your own actions as a manager?

Annotate

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7.3 The Lord of Logistics

Learning Objectives

1. Understand how and why Amazon is increasingly taking over aspects of its own logistics business.

2. Understand Amazon’s various delivery options and why it would choose one vs. the other.

3. Explore how scale is enabling the firm to vertically integrate several aspects of delivery, from air freight and ocean freight to long and mid-haul trucking, to last mile delivery.

4. Learn how Amazon is using technology to provide more delivery convenience to consumers, and potentially set itself up as a better alternative for consumer delivery than UPS, FedEx, or the USPS.

Building a Delivery and Logistics Business Inside the Business

Amazon has also been rapidly building out its own shipping and delivery infrastructure, which now includes a fleet of Prime Air cargo jets, long-haul trailers, local trucks, trans-oceanic shipping operations, and plans for automated delivery-by-drone. Amazon has even snapped up abandoned shopping malls, gutting them, and converting them to fulfillment centers (their location to highways and major urban centers make closed malls excellent candidates). One analyst estimates that by mid 2019, Amazon was already carrying about half of its own shipments, compared with just 15 percent only two years earlier. Cost and control drive Amazon’s interest in logistics.

Amazon spent $27.8 billion on shipping costs in 2018; that’s up from just $1 billion spent in 2007. Add in fulfillment costsInclude receiving and packaging costs, in addition to shipping costs., and that total value ($61 billion in 2018) accounts for about a quarter of the firm’s revenue. That’s about 4.8 million packages a day in the US alone. By taking control of its own shipping needs, Amazon is expected to save about a third in costs that would normally go to third parties.

A delivery network also gives Amazon more control over the customer experience. Interest in taking control of logistics increased after December 2013, when UPS couldn’t handle the massive volume of Amazon’s holiday package delivery, costing Amazon millions in refunds, and damaging the firm’s reputation for delivery reliability among those who were left with empty spaces under the tree.

Controlling parts of its distribution channel means Amazon partners will be increasingly disintermediated from a larger percentage of Amazon orders. The worldwide delivery market brings in about $400 billion in annual revenue. Amazon has already launched its own Amazon Fulfillment business, and at least one analyst says this has the potential to be the firm’s “next AWS.” This could lead to the firm selling a wide assortment of delivery and logistics services to others, not unlike how the firm turned its computing infrastructure expertise into a multibillion-dollar cloud computing business. Longtime partner FedEx was so unhappy with its Amazon relationship that it dropped the firm for both air and ground deliveries in 2019.

Cost savings, happier customers, plus a new revenue stream are all sweet incentives for Bezos to go after shipping, and Amazon has been aggressively poaching executives and other experienced workers from Uber, FedEx, and UPS to bring in the brains needed for a best-in-class operation.

Figure 7.7 Choosing the Right Shipping Partner

Crunching data and creating infrastructure lets Amazon choose the right shipping partner (including itself) to optimize on factors such as speed and cost. Prime Now customers ordering in areas served by a Prime Now hub can get goods fulfilled within an hour or two (and packages may arrive via van, bike, or on foot). Products outside of Prime Now are sourced at fulfillment centers and may be handed off to UPS (but as of 2019, no longer FedEx), or moved to a sortation center where sorted products are passed to the US Postal Service, or go out for delivery in Amazon trucks or by private citizen drivers contracting with Amazon. 

Amazon already cherry-picks the optimal way to get packages to consumers, crunching data that considers cost, fuel prices, routing, delivery time commitment, weather, traffic, fleet availability, and other factors, to dispatch packages to either UPS, the US Postal Service (USPS), or for home delivery arranged by Amazon itself. Efficiencies through vertical integration has prompted Amazon to cut in half its reliance on the US Postal Service in just two years.

Long and Mid-Haul Trucking: Amazon owns thousands of its own branded truck trailers that get loaded with customer packages at fulfillment centers. While Amazon owns the trailers, they can be driven by any firm or independent contractor. Amazon is rolling out a service which is a sort of Uber for truckers, matching trucks with shippers, which could include Amazon or any other firms that need a load hauled. An app as part of the system offers driving directions, truck stop recommendations, and suggested pick-up and drop-off routes to maximize capacity, shorten delivery time, and cut costs. Even more important, this kind of software could cut out middleman trucking brokers that typically charge a 15 percent commission.

Prime Air: For items that need to travel farther and faster than trucks, UPS jets might be involved in forwarding Amazon packages, but Amazon has realized that in some cases it can fly cargo jets more cheaply and efficiently than shipping partners. Amazon plans to grow its fleet of aircraft to 7o by 2021, each of the leased aircraft painted with the “Prime Air” logo. These planes often fly in and out of low-traffic airports, like Pennsylvania’s Lehigh Valley, which is near Amazon facilities and is only 90 minutes from downtown Manhattan. Reports suggest that Amazon cargo jets are flying full, but with lighter loads (cutting fuel costs). By running the numbers, Amazon software can decide when it makes sense to move products onto its own planes for delivery, and when products (likely fuel-burning heavier goods) are better sent through third-party shippers. Flying its own route-optimized planes point-to-point also offers speed advantages. While FedEx was a partner, that firm’s planes leaving from the West Coast departed no later than 9:00 p.m. to ensure they arrive at the firm’s massive Memphis, Tennessee sorting hub. However, if Amazon software says it can fill a plane with cargo that can a third-party hub and go straight to its destination, Amazon planes can leave as late as 2:00 a.m.—allowing the firm to take more orders even later, but still guaranteeing fast delivery. And if a stop is necessary to channel orders to disparate locations, Amazon is building its own $1.49 billion 900-acre hub in northern Kentucky so it can handle these options without an air freight partner.

The Last Mile: In the three-year period after UPS botched holiday deliveries, Amazon has built out its network of sortation facilities, which now number at 70 throughout the US.  The network is so extensive that 75 percent of the US can now be serviced with next-day or same-day delivery. These facilities are designed to take customer orders boxed up at the fulfillment centers and get them to customers as quickly as possible. Packages sorted by zip code might be dropped off at US Postal Service facilities, or Amazon could forward packages to its own facilities, where it controls the final delivery leg.

With just three months from FedEx dropping Amazon to the start of the Holiday season, constructing its own, reliable delivery network became an even more urgent priority. It has offered $10,000 and up to three months salary to existing employees for them to quit and become “delivery entrepreneurs.” Anyone joining the program will also have access to Amazon delivery technology, hands-on training, and discounts on products including insurance and vehicle leasing.

Amazon is also using technology in ways that could eventually make it an even more attractive choice than FedEx, UPS, or the US Postal Service. The Amazon Key delivery option uses smart home technology to allow delivery people to drop off packages inside the home. This effort should be boosted even further with Amazon’s $1 billion purchase of one-time Shark Tank reject, Ring, a maker of smart home security technologies. Amazon also has an early lead in allowing you to accept delivery to the trunk of your car—partnering with GM and Volvo in a 37-city rollout linking an Amazon App to OnStar car systems. As mentioned in our Moore’s Law and More chapter, fast/cheap computing embedded in all sorts of devices is opening up new opportunities.

Amazon Key In-Car Service

Why would you need delivery to your car instead of your home? Hear from the first customers of Amazon Key In-Car service.

By Sea and Global Reach: Amazon is on land, air, and also at sea. Amazon’s China subsidiary has become an ocean freight shipping operator moving goods from Chinese manufacturers to the US Ocean shipping isn’t for rapid delivery, but for forecast demand, say to bulk up fulfillment centers with goods Amazon knows it will need, managing ocean freight is another way for Amazon to control another leg of its value chain, cleave costs, and potentially even enter the $350 billion ocean freight market.

Amazon’s global logistics march continues beyond China and the US. In Europe, the firm has taken a stake in two European logistics companies, giving it partial control of 6,700 delivery trucks handling 170 million shipments in the UK and France, and it has built out its last-mile delivery network in the highly competitive German logistics market (home to DHL and well serviced by FedEx).

On Deck—Delivery by Drone and Robot: Bezos used a 60 Minutes profile to announce and demonstrate Amazon Prime Air, an effort from the firm’s next-generation R&D lab. The goal is to eventually use copter-style drones to deliver small packages to consumers in thirty minutes or less. While some initially thought this was a publicity stunt, the firm made its first test delivery outside of Amazon property in Cambridge, England, delivering a package of books in thirteen minutes from click to delivery, and it made its first US public demonstration commercial drone delivery, a four-pound package of sunscreen for attendees at an Amazon conference in Palm Springs. Regulation may be more difficult than building the technology—the FAA currently does not allow commercial drones to travel beyond operator line-of-sight, or through heavily populated areas.

Amazon’s First Commercial Drone Delivery

Watch a demo as Amazon details its pilot drone delivery program in Cambridge, England.

Prime Air Drone

Video of this Prime Air delivery drone that takes off like a helicopter, then flies like an airplane, was shown during the 2019 Amazon MARS conference.

Source: (

Amazon via YouTube

)

While drone delivery awaits commercial take-off in the US, some customers in Washington State and Irvine, California may get products delivered by the six-wheeled, cooler-sized “Scout” robot. A product of years of Amazon’s own in-house development, Scout has been designed to avoid pets and pedestrians and scuttles along the sidewalk about as fast as a person walks. Although autonomous, Amazon’s initial Scout deliveries are accompanied by a “Scout Ambassador” who ensures nothing happens en-route and is on-hand to explain the technology to customers and curious onlookers.

Amazon’s Autonomous Scout Delivery Vehicle

Scout tests have now expanded from Washington State to Irvine California.

Source: (

USA Today via YouTube

)

Key Takeaways

· Shipping represents a large portion of Amazon’s expense for each order, and the firm leverages several approaches to bring down this cost.

· In the United States, Amazon can choose to deliver products to consumer homes via the US Postal Service, UPS, FedEx, or itself. Algorithms decide which path is most effective from both a cost and customer service perspective.

· Local delivery is coordinated in several ways, including Amazon’s Uber-style recruitment of contract drivers.

· Amazon owns its own trucking fleet to handle long- and medium-haul product transit, when appropriate.

· The firm has also leased 40 cargo planes, allowing it to funnel the most cost-effective shipping to its own fleet, and giving it more time to accept orders for next-day shipment. Planes utilize underserved airports that are still near metro centers or other Amazon facilities. The company is also building its own air hub in the center of the US, to further improve cost and speed efficiency.

· Amazon also operates its own ocean freight for products from overseas (primarily East Asia), which it knows it will need in its warehouses, but which lack the immediacy of plane delivery. 

· While Amazon is a customer of large shipping firms, it has also begun offering its own shipping option to third parties, making it both client and competitor to package delivery firms. Amazon’s experience in shipping provides an opportunity to create a shipping and logistics business in the way that its expertise in computing allowed it to create a cloud computing business.

· Amazon has leveraged technology in ways that may make it a more attractive shipping partner, and which better serve consumers. Amazon Key is the firm’s service for providing the option of in-home delivery, even when customers are not present. The acquisition of Ring smart home products gives Amazon a supplier of this tech, vertically integrating components of the solution offering. The firm has also partnered with GM and Volvo to offer app- and OnStar-powered delivery to customer automobiles.

Questions and Exercises

1. In what ways is Amazon increasingly taking over its own shipping and logistics needs? When can a firm attempt such a move? Why does this move make economic sense for Amazon?

2. What advantages does Amazon enjoy by being able to consider various shipping options at the time a package is to be shipped?

3. Why is Amazon leasing planes that are painted with the “Prime Air” logo? Why is it involved in ocean freight shipping? What advantages does this give the firm? Should Amazon fear other e-commerce rivals might do the same? Why or why not? 

4. What sort of customer would use Amazon Key or Amazon Key In-Car (auto-delivery) options? Would you? Do you think this will be successful? Why or why not?

5. Describe the ways that Amazon has expanded its “last mile” delivery network. Act as an investor or stock analyst and research online to get a sense of the size of the delivery market, the savings Amazon may gain, and the potential for additional revenue that Amazon might earn by expanding these efforts. Would this prompt you to invest in the firm? To advise the firm to continue or slow these efforts? Come to class prepared to defend your answer.

Annotate

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7.4 Beyond Clicks: More Bricks

Learning Objectives

1. Understand how Amazon is expanding into campus bookstores, physical stores, kiosks, and groceries.

2. Examine various models for the grocery business, understand why this is an attractive option, and explore how Amazon can apply technology and logistics to improve real-world shopping.

Amazon as Your Campus Bookstore

Technology and the economics of being the world’s largest e-commerce retailer are at the core of Amazon’s success, but the firm is beginning to think more broadly about how the “bricks” of a physical retail presence can goose growth, expand into new markets, and better serve customers. For an example of this, look to your campus bookstore! Barnes & Noble was once a leader in operating campus bookstores, and the firm spun off the university business as a separate stock in 2015. But the college textbook market is changing. Many students are renting textbooks or going entirely digital, and Amazon sees an opportunity for disruption. Amazon opened its first Amazon Campus store at Purdue University in 2015, with similar facilities following at several others schools, including UMass Amherst and Stony Brook University. Over thirty universities now have dedicated on-campus Amazon package pickup facilities. The Amazon-staffed Amazon@Purdue facility functions as a pick-up and drop-off location for Amazon products. Students who buy an item and specify the store as their shipping address will receive an e-mail or text alert once their shipment arrives. A link in the e-mail or text generates a bar code to gain access to an in-store self-service locker or pick-up desk. A modified Amazon website shows class information and required texts for Purdue classes. Students receive free one-day shipping on Purdue textbooks shipped to Amazon@Purdue. The partnership is assumed to have lowered textbook costs by 40 percent, and a Purdue administrator claims the school brought in $1 million from the Amazon deal in the first two years of the partnership. Amazon has also been aggressively courting students without a Bezos bookstore, by offering Prime Student (http://amazon.com/primestudent), a six-month free membership to Amazon Prime.

Amazon@Purdue

Amazon@Purdue was Amazon’s first consumer-facing brick-and-mortar facility.

Bezos’s “Brick-Based” Bookstores

Amazon has gotten physical in many locations without a full-fledged investment in storefronts, but after experimenting with nearly 90 popup stores, temporary kiosk-style spots in malls or other heavy-traffic retail spaces, Amazon has moved to pull these efforts in favor of a network of more permanent oferings. These include the real-world Amazon Books stores, with roughly 20 locations coast to coast, and many more planed. The stores aren’t especially efficient when compared to the economics of its e-commerce business, Amazon financials show the stores don’t really make any money, and by offering only 6,000 titles in a small retail footprint, this isn’t the place to go for selection. However, Amazon contends the main reason is to serve customers and help them discover great books—shelves are organized sort of like the website, with signs like “Customers who bought this title also bought these.” Other than new releases, the firm only carries books that have earned a four star or greater rating. Other highlights include “page turners”—books that Kindle users finish in three days or less, on average. 

Bookstore as a print-product discovery engine can’t be the only reason this makes sense, and a visit shows that “Amazon Books” carry much more—including the firm’s own Kindle, Echo, and Fire devices, Ring doorbells, and Cloud Cam security cameras. Amazon Books are an on-ramp to recruit more Prime members and a perk that keeps them loyal. The store doesn’t accept cash, and books don’t carry prices—customers use the Amazon smartphone app to show how much an item will cost. Prime members pay the website price; those who don’t subscribe to Amazon Prime may pay full list. In-store purchases also add Amazon Books orders to your online purchase history.

Amazon Books Retail Store

Want to hear from the VP of Amazon Books while getting a look at an Amazon Books retail store and what makes the experience special? See the video in Yahoo!’s report “Amazon Books Chief: Why We Opened Brick-and-Mortar Bookstores”: https://www.yahoo.com/news/amazon-books-chief-why-opened-052518520.html.

Beyond books, the Amazon 4 Star concept highlights products that have received top customer reviews—either best-sellers or worthy finds. Products may be grouped as “trending” or “most wished for.” Another concept, “Presented by Amazon” is being tested in several malls, launching after the announcement that the firm would discontinue its kiosk program.

More “Green” from Groceries?

Amazon has also rolled out its Amazon Fresh, a FreshDirect-style grocery competitor, in several metro markets in the US, offering same-day or next-day delivery of groceries and more. Groceries are a potentially attractive business for Amazon. While Amazon has 43 percent of the online retail market, over 90 percent of purchases happen in physical stores, and the US grocery business alone is worth three-quarters of a trillion dollars. Amazon is still experimenting with getting the model for groceries right. New Amazon Fresh “click and collect” centers in Seattle allow customers to order online and then drive through to have their groceries loaded directly into their cars at a predetermined time. Set a pick-up time in as little as 15 minutes after placing your order. Stop by after you’ve picked up kids from the soccer game, or shortly after you leave work, and shopping remains low cost and is even more convenient. No minimum order, no delivery fee, and employees bring orders out to your car.

But as we learned with FreshDirect, groceries are a lot different from books and consumer electronics, and Amazon still has a lot to learn. One estimate has Amazon Fresh losing more than twice as much due to spoilage than typical supermarkets, making early blunders like fixing banana orders as a “bundle of 5” where employees discarded the few extra bananas in a larger bundle. And despite the heavy investment by Amazon and others, the number of online grocery shoppers is still a measly 4.5 percent in the US, increasing only 0.3 percent in the prior four years. The anemic results of early attempts seems to have pushed Amazon to go old school—buying Whole Foods markets and its 450 stores for $13.7 billion. Whole Foods had been struggling, and had been in search of a buyer. In fact, about 70 percent of the cost was categorized in Amazon financials as “goodwillAn accounting term for an intangible asset above and beyond the operations value of the firm. Goodwill can include the perceived value of the company’s brand name, customer base, and loyalty, positive employee relations, as well as proprietary technology and patents.,” meaning most of the gain wasn’t for operations, but rather less tangible value. And although the firm has initially committed to operating the firm with its old CEO under the Whole Foods name, Amazon gains the average twice-a-week visits from the grocery chain’s tech-savvy, high-income, well-educated customers—a solid overlap with a large portion of Amazon’s customer base. Whole Foods comes with a trained workforce where many see their jobs as offering a long-term career path—unusual in an industry known for high employee turnover. An educated sales staff can boost sales as much as 60 percent, with 90 percent of consumers reporting an increased likelihood of making purchases from someone knowledgeable. The firm has begun selling its line of customer products, accelerating the trend in in-store popup shops during holiday season that feature Kindles, Fire, FireTV, Echo, and more; some stores have Amazon delivery lockers; and of course, Whole Foods will happily set you up with a Prime membership and Prime Visa rewards card. Integrating Amazon’s logistics prowess in Whole Foods is a natural, and might keep Amazon’s growing truck, van, and jet fleets efficiently filled with even more fast selling. With Whole Foods’ emphasis on higher margin semi-prepared and prepared meals, Amazon could also lay the ground for an increased business catering push, or explore serving institutional customers like schools and hospitals (a business you may have seen in your community, served by Sysco trucks, not to be confused with Cisco, which is networking equipment). And tying in-store purchases (pay with your app, Prime members) with online shopping could also offer up a wealth of new data for additional consumer insights. Amazon has been pushing the perks for Prime members to spend their own green at the green grocer. The firm has begun rolling out free Whole Foods delivery for Prime members in select markets, customers will get 10 percent off existing sale prices, and if you buy with an Amazon Prime Visa card you’ll get an additional 5 percent off.

In addition to Amazon Go (below), The New York Times reported that Amazon was also planning to roll out a new grocery concept, separate from Whole Foods, which blends the best of online and offline shopping. Said one executive who had previously worked for Amazon’s grocery business: “People really need to understand—Whole Foods is the beginning, it’s not the end.”

Hello Machine Learning, Goodbye Checkout Line

Finally, the new Amazon Go store shows how a tech giant is radically changing the face of physical retail. These stores have no cashiers or cash registers. Instead, customers scan an app (tied to a credit card, of course) when entering. Image recognition, motion detection, weight sensors, and other advanced artificial intelligence can tell what a customer picks up, and charges them when they leave the store. The commercial viability of this technology underscores points on the impact of machine learning fueled by cloud-based server farms (and increasingly powered by special graphics processors, ASICs and FPGAs), that were introduced in the Moore’s Law and More chapter. That growingly powerful Amazon cloud, described later in this chapter as well as in the chapter titled “Software in Flux,” may be an important force redefining your real-world shopping experience, too! One important key to all of this: a store without registers can have a smaller footprint, or can carry more items, and could operate with fewer, but more highly skilled workers.  Amazon now has roughly 20 Amazon Go stores from cost to coast and one unconfirmed report suggests the firm may be planning to roll out “thousands” in the next few years. That’d be an early-mover land-grab to get ahead of rivals who are already gearing up with concepts of their own. In Dallas, Walmart has introduced its first Sam’s Club Now concept with cashierless checkout, while UK and French retail giants Tesco and Carrefour also have no-cashier systems. When it comes to revolutionizing the way we shop, Bezos clearly thinks it’s still only “Day One.”

Amazon Is Using AI in Almost Everything It Does

The Amazon Go store uses sensors, image recognition, special package markings, and continually refined artificial intelligence to allow customers to scan a phone app and enter, then pick whatever they want and be billed automatically when they leave the store. No lines, no checkout. This is one of many examples of AI and machine learning permeating all aspects of Bezos’ business. Other examples shown in the video include robotics on fulfillment center floors, and a demo of Amazon’s Alexa-powered home by the firm’s VP of Alexa AI.

Source: (

CNN Business via YouTube

)

Transcript

Key Takeaways

· Amazon is expanding into the university bookstore business: providing a hub for free textbook delivery and rental, and a link to customer acquisition and retention among college students.

· Amazon Books is a real-world bookstore chain that offers website prices to Prime members, and that also sells the firm’s growing line of consumer electronics.

· The grocery market is massive and could fuel significant Amazon growth. The firm’s tech-fueled logistics model, and other advantages in leveraging tech for customer service and enhanced shopping convenience, are influencing several models, including Amazon Fresh delivery, Fresh “click and collect” pick-up centers, and even the firm’s purchase of Whole Foods Markets.

· The Amazon Go concept store shows how machine learning influences computer vision, AI, and other techniques to eliminate cash registers. A shopping experience without lines is potentially far more attractive for consumers, and would offer any retailer benefits such as more shelf space, stores in a smaller real estate footprint, and perhaps even a smaller staff size.

Questions and Exercises

1. Have you seen an Amazon physical bookstore or kiosk? If so, what was your experience like? If not, browse online to find videos or write-ups about these. Do you think these make sense? Why, why not, or under what conditions?

2. Why are grocery stores attractive for Amazon? In what ways is Amazon entering the grocery business, and how do these models differ?

3. How is Amazon using Whole Foods? How is the firm creating synergies between the grocery chain and its existing businesses? What benefits, other than more sales through groceries, does Amazon get through Whole Foods?

4. What does the accounting term “goodwill” mean? What was included in the goodwill category when Amazon acquired Whole Foods?

5. Are any aspects of Amazon’s various grocery models appealing to you? Are there demographic trends in the US that might influence the rise of alternative models to conventional store shopping for others? List them, and also list any factors that might prompt you not to use an Amazon-powered grocery option. Have you or family members ever shopped for groceries online? If so, share your/their experience: if not, why not?

6. List the ways in which Amazon Go’s in-store technology could improve the customer experience. How might it improve the cost economics of retail? What kinds of additional costs do you think are associated with the rollout of this tech?

Annotate

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7.5 Amazon's Disruptive Consumer Hardware Businesses: Kindle, Fire, Alexa, and More

Learning Objectives

1. Understand the motivation behind Amazon’s consumer Kindle, Fire, and Echo businesses.

2. Recognize the various ways that Amazon earns money and strengthens its competitiveness via the Kindle platform.

3. Examine the changes Amazon’s digital media offerings have brought to the traditional publishing industry value chain.

4. Understand key concepts such as channel conflict, wholesale pricing, and agency pricing.

While Amazon has built solid advantages by selling a broad array of products, media (books, music, and video) still represents about 20 percent of the firm’s revenue, and nearly all of that business is going to shift from atoms to bits, shipped not in physical packaging but through the Internet. Losing this market would be a blow that any publicly traded company, especially one with razor-thin margins, would find difficult to sustain. This is what prompted the creation of the Kindle. While many refer to the Kindle as an e-reader, the Kindle isn’t as much about reading digital books as it is about putting a store in the hands of the firm’s over 300 million customers, not only allowing them to lap up goods from an increasingly massive digital trough, but also instantly linking those customers with the firm’s entire inventory of physical products. What started as an e-book reader has now expanded to Kindle and Fire product lines that span categories that include tablet and television set-top boxes, and helped prime the pump for new product categories like the voice-responding Amazon Echo line. Beyond media consumption and sales, Amazon consumer electronics devices are also data-gathering conduits, arming Amazon to collect more customer insight to power existing and new initiatives.

The Kindle Line: Igniting Possibilities on E-Book and Tablet

The first Kindle was optimized for book reading and featured a black-and-white display that used e-ink. That display can’t refresh fast enough for animation or video, but it is legible in sunlight and only draws power when flipping a dot from black to white or vice versa, offering exceptionally long battery life. Thanks to Moore’s Law, Kindles, originally offered at $399, grew in power while plummeting in price, with a low-end model selling for just $69 five years after introduction. The success of the Kindle is staggering. By the holiday season of the product’s second year, the Kindle was Amazon’s top-selling product in both dollar volume and unit sales. That means Amazon was selling more Kindles than any single book, CD, movie title, or toy—or any other product among the millions that it offers. Consumer Intelligence Research Partners estimates that some 20 percent of Amazon’s US customers own some form of Kindle device, an astounding rate.

Up next is the high-resolution, color, and touch-screen Kindle Fire tablet. In its introduction, the Kindle Fire came to market for half the price of the competing iPad and quickly became the second best-selling tablet on the market. The Kindle is also a cloud machine. The first Fire came with half the RAM of the iPad, the thought being that your media would be snugly stored on Amazon’s servers, downloaded when you need it, creating a big sticky switching cost in the process.

Even more noteworthy for competitors in the e-book and tablet space, Amazon doesn’t look to make money directly from Kindle hardware sales; various Kindle versions are regularly sold at or below costs. But any Kindle device ordered from Amazon arrives linked to your Amazon account. That means the device comes, out of the box, as a preconfigured cash register with a vacuum attached firmly to the credit card in your wallet. Over 6 million titles are offered in the Kindle “always-open” bookstore, with “search inside the book” features and the first chapter downloadable for free. Voracious readers can gorge at the buffet of Kindle Unlimited, a subscription service providing unlimited access to over 1.5 million titles. Estimates of the firm’s Kindle-generated revenue bump vary, but all point to positive Kindle-fueled sales gains. RBC Capital estimates that despite being sold at a loss, each Kindle Fire generates over $136 in operating income, with operating margins above 20 percent over the lifetime of the device. Kindle owners buy three to four times more books than they did prior to owning the device. And Amazon today sells more electronic books overall than their print counterparts. In terms of fueling overall sales, SmartMoney reported that Amazon customers who don’t own a Kindle spend an average of $87 each month while those with a Kindle spend $136 and Kindle Fire owners spend over $150.

Amazon for Your TV

The e-book and tablet Kindles were followed by Fire TV. The firm offers a range of devices, from the often-discounted USB-sized $39 Fire TV stick that plugs directly into your TV’s HDMI port, to a $69 version that supports 4k Ultra HD video. Fire TV also runs apps for a host of other services, including Netflix and Hulu. Voice search is enabled through a mic in the remote. An optional game controller opens up another world of entertainment. While Fire OS is based on Android, it’s what is referred to as a modified Android “forkIn software development (sometimes also called project fork).  When developers start with a copy of a project’s program source code, but modify it, creating a distinct and separate product from the original base.,” with differences significant enough that fire runs only a subset of Android apps. During its launch, Fire TV only had 180 apps in total, while the competing Roku device, which had been on the market for years, was offering over 1,200 apps. The savvy manager should consider what forking means when trying to create network effects from complementary apps.

The market for television streaming media players is crowded. Apple TV, Android TV, Google Chromecast, and Roku all have a head start, yet none of these has achieved any real scale. Fast/cheap computing means these devices are usually much less expensive than a phone or tablet, and nearly 70 million US households now have some sort of connected TV streaming media device. That number will only climb. In a surprise partnership with its retail nemesis, Best Buy has partnered with Amazon to create and sell a Fire TV-branded version of its own Insignia house-brand televisions, and Fire TV will also be a platform that powers Toshiba products.

Echo, Alexa, and the Breakout Success of Amazon’s Voice Interface and AI-Powered Assistant

While Fire TV lets you talk to your remote to search for video entertainment, Amazon Echo is the wireless speaker that you can talk to. The branding here is a little clunky—Echo is the brand name for voice-powered devices, while Alexa is the name of Amazon’s voice assistant software platform. The original Echo was a high-quality speaker equipped with seven far-field-listening microphones that taps into Amazon’s cloud. Call it by the name “Amazon” or “Alexa” and you can ask it questions (“How many teaspoons in a tablespoon?”); set a timer; inquire about the weather, traffic, or sports; ask it to tell you jokes; summon up a news briefing; dispatch it to play songs on Amazon Prime Music, TuneIn, or other services (“Play 80s music”); control smart home devices like the Belkin Wemo and Philips Hue lighting (“Turn off the living room lamp”); read back your Google calendar appointments; create reminders; and of course, create shopping lists and place shopping orders. Voice recognition can be tricky (early versions would mistakenly think they were summoned with the name “Amazon” when you asked the kids to get their “pajamas on”), but with most of its brains in the cloud, Echo will only gets smarter over time and consumers will instantly see improvements the next time they talk to their devices.

Amazon has continued to expand the Echo line and had tens of thousands of “skills”’ (the firm’s term for apps) available, positioning the firm with a category-defining lead ahead of Google and Apple. Alexa-enabled products from Amazon include the low-end Echo Dot and Echo Dot Kids Edition; the camera-equipped, fashion-advice-dispensing Echo Look closet companion; the voice-call-capable Echo Dot, and the Echo Show with a touch-screen and video conferencing capabilities (for a look at the entire family of Echo devices, visit http://amazon.com/echo). Alexa has wheels, too, with Alexa skills extending to Toyota, Mercedes, BMW, Ford, Hyundai, and many others (“Alexa, start my car and turn on the air conditioner”). Visitors to my office will find an Alexa-powered robot that can answer student questions (e.g., “when are Professor Gallaugher’s office hours?”), can perform certain tasks when it recognizes a particular face, and provides a form of telepresence, broadcasting my voice when I connect removely via an app and showing video and audio of anyone in its field of view. And Alexa for Business extends the Alexa platform for enterprise use, including running private, custom skills; acting as a corporate help desk; handling room scheduling; offering support for multiple users and device administration, and powering otherwise challenging tasks such as “set up a conference call.” And remember, since these devices are powered by machine learning, the firm with more customers should have more data for accelerated improvement and skill refinement—potentially beefing up the appeal of the firm’s AWS cloud offerings, as well.

The Echo Look

This “Alexa with a camera” will let customers snap photos, offer 360° views, and send images on for a second opinion “style check.” With a growing stable of firm-owned brands, as well as offerings from some of the world’s leading clothing lines, Amazon hopes the Echo Look will develop into a conduit to make home clothes shopping via Amazon even more attractive.

Source: (

Amazon via YouTube

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Transcript

Did Dash Make Sense?

For several years, Amazon had offered the Dash button, a single button device that could place an Amazon order each time it was pressed. But in 2019, Amazon discontinued the product and stopped taking Dash orders. With Alexa increasingly embedded into more products, specialty ordering devices may be less useful. Amazon cited significant declines in usage as the reason for sunsetting Dash. That may be the case, but many of the items that could be ordered from Dash were low-cost, low margin items where profits would be eaten up by shipping costs, so it might also be likely that getting another box of grocery bags with a single press was no longer an Amazon priority. Another reason Dash may have been discontinued—a customer who visits Amazon.com will see a personalized page of AI-curated items the firm hopes you’ll buy. Each customer pulling up the Amazon app or browser is a chance to order more than the one-click Dash purchaser.

The Failure of Fire Phone: Lessons for Late Movers

Amazon followed Fire TV with Fire Phone, a high-end smartphone that came with several innovative features: one-handed operation, 3D perspectives that shifted when the phone was tilted, and most notably, a signature feature called Firefly. Firefly software used the phone’s camera to recognize all sorts of objects: bar codes, QR codes, books, artwork, and grocery items. It could also recognize songs and movies, Shazam style, and dial scanned phone numbers. A dedicated Firefly button on the phone brought up the feature even if you were outside the lock screen, trigger-ready for the quickest of draws to make an impulse buy or visual search. Why create a shopping list? Out of a household item? Just scan, hit 1-Click order, and you’re done. 

Neat features, but no one bought it. The initial price of $199 with contract for the base phone placed it in line with Apple and Samsung’s smartphone pricing, not the value-pricing Amazon customers have enjoyed on profitless Kindle hardware. The phone came bundled with a year of Prime, which equates to another $100 in value, but many of the customers Amazon hoped to appeal to were already wedded to iOS or Android, and getting them to break up means overcoming switching costs. In less than one year the price was cut to $99, or $189 out of contract. A little over a year after launch, the Fire Phone was canceled, with Amazon declaring a $170 million write-off. Like Fire TV, the Fire Phone’s OS was an Android fork that didn’t run the vast majority of Android apps—that means Fire Phone was fighting against switching costs with a malnourished network effect—it’s snazzy new features alone weren’t enough to gain any sort of market traction. A New York Times piece reminds us that “phones are a graveyard of tech dreams.” Google struggled with the Nexus and sold off Motorola. Microsoft has been at it for years and has never gotten phones right. BlackBerry is withering. Apple and Samsung are the only players making money in hardware.

Amazon Gets into Content Publishing

As device and storefront, Amazon has begun to vertically integrate, capturing several segments in the traditional book value chain. Today, Amazon accounts for nearly three quarters of all adult book sales online, and nearly 50 percent of new book sales by unit. The printed book, or “dead-tree,” publication value chain involved a publisher, bookstore, agent, and author. Publishers typically get half of a physical book’s retail price, the bookstore takes about 30 percent, and the author keeps about 15 percent as a royalty but shares 15 to 20 percent of this with his or her agent. At the time of the Kindle’s rise, six (then consolidated to five) large publishers controlled about 60 percent of the US book business commonly referred to as “trade publishing” (that means most of the books you’d find in a typical bookstore but not books such as educational, scientific, and medical texts). While most Kindle titles are from publishers that sell both print and digital versions, Amazon has gotten into the book publishing business as well, creating fifteen of its own “imprints” (publishing divisions that specialize in a genre, like foreign translations, romance, or sci-fi). For authors wanting to bring books to market through Amazon instead of through traditional publishers, Amazon offers royalty options ranging from 35 to 70 percent. There’s even a “Kindle Singles” program that allows authors to sell work too short for a stand-alone book (fiction, essays, magazine articles). And since digitally published work doesn’t require printing, shipping, and shelf-stocking, these titles can often come to market far faster than physical offerings. Using Amazon as a publisher doesn’t mean your titles will only be available through Kindle. The firm will also produce print books and even offer them to bookstores willing to carry the titles. But Amazon has incentivized many authors to sell exclusively through the world’s biggest e-commerce outlet and largest e-book platform. To get a sense of Amazon’s influence as a publisher, consider that recently 16 of the top 20 romance novels were either titles where an Amazon imprint was the publisher, or that were self-published on Amazon’s platform  Jeff Bezos claims that over 1,000 authors surpassed over $100,000 royalties in 2017 through Kindle Direct Publishing.

Amazon’s vertical integration—from publisher to storefront to reader—has the potential to offer an author tremendous exposure. The Amazon First Reads newsletter goes out to 7 million avid book fans, promoting Amazon titles, exclusively. One recent e-mail featured six Amazon titles—by evening these six titles had occupied the top six slots on the Kindle Bestsellers List.  There are also over 100 million Amazon Prime members in the country, and each can select a single Amazon First Reads title for free, each month. And the firm’s Kindle Unlimited service, offering 10 books a month via a Netflix-style subscription, is reported to have nearly 5 million subscribers, offering the potential to a new author in front of even more potential readers. A recent Wall Street Journal article cited one literary agent who stated that Amazon isn’t “gaming the system, they own the system.”

How Big Is Too Big?

The breadth of Amazon’s business, coupled with its tremendous advantages that include scale, network effects, data, distribution, have many wondering if Amazon is just too big and too powerful. While it is legal to dominate a market in the United States, antitrust regulators are most concerned with whether a firm has used its size to unfairly influence an existing market, or to give it an advantage when pursuing new markets.

The US Justice Department has included Amazon in a problem of big tech firms, stating it will investigate: “the pricing structure of Amazon’s logistics service, whether Amazon competes against its own sellers, and how Amazon Prime bundles services.” Amazon also has many skeptics in both parties. Sen. Elizabeth Warren has proposed a breakup of Amazon, including splitting off its Whole Foods acquisition, while President Trump has repeatedly criticized Amazon, calling the firm’s CEO “Jeff Bozo” and mocking his high-profile divorce. It's noted that Bezos owns the Washington Post—an outlet regularly disparaged by the President as "Fake News."

And Amazon’s publishing ambitions aren’t limited to the printed word. The firm’s Amazon Game Studios has released titles for Kindle Fire as well as Android, iOS, and Facebook. Amazon has also recruited top-tier talent to beef up its game platform for Fire devices. Many of the firm’s staff have pedigrees from Microsoft’s Xbox group and Nintendo USA, both located a short drive from Amazon HQ. The firm has also recruited industry stars Kim Swift (designer of the game Portal), Clint Hocking (designer of Far Cry 2), and Ian Vogel (senior designer on Age of Empires Online and BioShock).

Amazon has also spent lavishly to build up digital media offerings, especially for Prime customers. Amazon spent $300 million for exclusive streaming access for a subset of HBO back titles, and has locked up content from Nickelodeon and others. The firm offers a Spotify-like music streaming services for Prime subscribers, as well. None of this comes cheap. Reed Hastings of Netflix claims Amazon may be losing as much as $1 billion a year in video licensing. Amazon is also pulling a Netflix, moving aggressively into original programming. Amazon Studios is touted by Bezos as a “completely new way of making movies” and television shows. The firm has floated several feature film ideas and television pilots ranging from children’s programming to adult comedies. Amazon Studios uses crowd feedback to drive what makes it to market. Amazon has lagged Netflix, with its buzzy titles like Stranger Things and Orange is the New Black. But the firm did back Oscar-winning films Moonlight and Manchester by the Sea, and Oscar nominee The Big Sick. It’s more notable series include the alternate-history sci-fi Man in the High Castle, the Tom Clancy-inspired Jack Ryan, and the anti-hero superhero-as-villains series The Boys. Amazon has also shelled out over a quarter of a billion dollars just for right to make a Lord of the Rings prequel series, with another $1 billion expected to be spent on production, making it the most expensive series of all time. Amazon has also extended an estimated $65 million a year deal with the NFL for streaming rights for Thursday Night Football (bundled with Prime, free on Twitch). Amazon has also attracted well-known directors Woody Allen and Spike Lee for projects.

Amazon is also spending big for non-conventional broadcast entertainment, buying the Twitch video game streaming site for roughly $1 billion. Twitch allows gamers to stream their gameplay live, and offer real-time commentary to viewers. Is watching other people play video games really a big business? You bet! The service boasted 55 million unique viewers before its third birthday, with 1.1 million broadcasters bringing in 16 billion minutes of total videos watched in a single month. In terms of Internet traffic, only Netflix, Google, and Apple are bigger bandwidth hogs than Twitch. The service has nearly as many viewers as the established cable networks MTV, Comedy Central, and MSNBC. Twitch shares ad revenue with broadcasting gamers, and while few are big earners, some Twitch stars have been known to pull in six figures a year. The 32 million people who tuned in to watch the “League of Legends” championships comprised an audience bigger than the finales of Breaking Bad, 24, and The Sopranos combined!

Figure 7.8 Viewership Comparison

At the time of its acquisition by Amazon, Twitch boasted a viewership comparable to several established cable networks.

Source: Data from N. Wingfield, "What’s Twitch? Gamers Know, and Amazon Is Spending $1 Billion on It," The New York Times, August 25, 2014, https://www.nytimes.com/2014/08/26/technology/amazon-nears-a-deal-for-twitch.html?partner=rss&emc=rss&smid=tw-nytimes.

Channel Conflict and Consolidated Power

Amazon’s ambitions to be a publisher that also sell e-readers, content, and just about everything else puts it at odds with partners who also increasingly see Amazon as a rival. Channel conflictExists when a firm’s potential partners see that firm as a threat. This threat could come because it offers competing products or services via alternative channels or because the firm works closely with especially threatening competitors. exists when a firm’s potential partners see that firm as a threat. This threat could come because it offers competing products or services via alternative channels or because the firm works closely with especially threatening competitors. Amazon has become a victim of channel conflict when other retailers have dropped its offerings. For example, Barnes & Noble and other book retailers have refused to carry titles from Amazon’s publishing arm. And Walmart and Target once carried the Kindle but have since stopped, fearing Amazon’s e-reader would also be a conduit for stealing physical sales. Authors and firms partnering with Amazon can also suffer channel conflict. When Amazon announced a partnership with DC Comics involving exclusive digital rights to Superman and Batman comics, Barnes & Noble and other book retailers pulled DC titles from their shelves. The winner in channel conflict is the firm or group that offers greater value to conflicted partners. As Amazon’s scale grows to a seemingly insurmountable size and offers additional deal sweeteners like better author royalty rates, authors and providers of other goods may not care that working with Amazon will cut off other distribution channels. Those fearing that Amazon is achieving this kind of scale worry that the firm may gain near-monopoly market power.

Amazon’s power in the publishing industry again became an issue when the firm faced off with one of the big five book publishers, Hachette, over e-book terms. As a pressure tactic against Hachette, Amazon refused to allow customers to preorder Hachette books, it delayed sales (stating books that should ship in two days would usually ship in “one to two months”), and refused to offer some Hachette e-books. Several big-name authors were impacted, including Harry Potter scribe J.K. Rowling. Comedian Stephen Colbert, whose books are also published by Hachette, skewered Amazon on his TV show, encouraging book patrons to shop at other websites. Amazon had enjoyed advocacy among some authors for helping spur sales and deliver greater author royalties, but the dispute eroded goodwill. Even worse, it called into question the firm’s commitment to the customer. The dispute was eventually settled with Hachette continuing to set its own prices for e-books, but gaining additional incentives (presumably in terms of the percentage of revenue it can keep) if it sets lower prices. While Amazon’s stated intentions were to lobby for lower e-book prices and hence, benefit the consumer, the short-term negative impact on customers (and authors) continues to raise concerns about power concentration. With Amazon controlling 41 percent of US new book sales and 61 percent of online sales, the firm will need to tread carefully to avoid government inquiry and possible sanctions.

A lawsuit involving Apple and Amazon shows the uncertain terrain when a firm with feared dominance (Amazon) comes up against an oligopoly of suppliers seeking to balance the market by favoring a rival (Apple). Amazon’s initial pricing agreement with many e-book publishers was what is often referred to as wholesale pricing, where Amazon paid publishers for titles and then sold those books at whatever price it wished. Jeff Bezos has stated that traditional trade books should not be priced at more than ten dollars, and Amazon offered many digital titles near or even below the wholesale price in order to fuel the market for Kindle and cement its own dominant standard. When Apple introduced the iPad, five of the top publishers switched from wholesale pricing to agency pricing, where the publisher sets the price and the reseller gets a cut (usually around 30 percent). Agency pricing isn’t illegal, but rivals colluding to set prices is. A lawsuit contends that publishers collectively introduced agency pricing to the iOS bookstore and shut out Amazon unless Bezos’s firm agreed to switch to agency pricing, too. Apple and the publishers have since settled the case, and Amazon has regained the ability to offer wholesale pricing, but the case shows challenging issues that arise as network effects, switching costs, scale, and standards in the digital world create radical power shifts. And even as publishers allow Amazon to resume wholesale pricing, Apple still has weapons to wield on its own devices. Apple legally charges app developers 30 percent for all revenue earned through in-app purchases, a fee that would further crater Amazon’s thin-to-nonexistent margins on many e-books. As a result, Amazon dropped the “purchase” button from iOS Kindle apps. (You can still buy e-books to read in your iOS Kindle app, but you’ve got to exit the app and do so from the Web, a Kindle, or some other standard that Apple doesn’t control).

Key Takeaways

· About one-quarter of Amazon revenues come from the sale of media businesses that are rapidly shifting from atoms to bits.

· Moore’s Law has allowed Amazon to radically drop the price of Kindle offerings while increasing device functionality.

· Amazon does not make money by selling Kindle hardware; instead, it seeks to fuel media and e-commerce sales as well as side businesses such as on-Kindle and in-app advertising.

· It is estimated that 20 percent of Amazon’s US customers own at least one Kindle device. The dominance of the platform potentially creates several advantages, including network effects (more Kindle users attract more Kindle-compatible titles and products), switching costs, and user data.

· The firm’s Kindle Fire, Fire TV, and Echo are additional platforms for delivering digital content, sales, and data gathering. These platforms face significant challenges in growing market share, and none has seen the success of the firm’s e-book readers.

· Fire tablets and Fire TV have prompted Amazon to accelerate gaming efforts.

· Fire Phone provides a cautionary tale to late-movers. A high price, entrenched rivals, consumer switching costs, and a lack of compatible apps all contributed to the device’s failure.

· Amazon has upended the publishing value chain and significantly changed the cost structure of the industry.

· Amazon has also become a force in sponsoring original film and video series and creating video games, and has spent over $1 billion in the acquisition of the extremely popular Twitch video game broadcasting service.

· Amazon and partners have also been victims of channel conflict, stopping the sale of Kindles and blocking the sale of books published through Amazon imprints. But when channel conflict occurs, the winner will likely be the channel that offers the greatest aggregate value to its partners.

· Amazon’s dominance of publishing, 41 percent of new US book sales and 61 percent of online sales, suggests inordinate market influence. The firm will need to be careful how aggressively it uses its bargaining power, as this could prompt domestic and international regulation and sanctions.

Questions and Exercises

1. Roughly how big is Amazon’s existing “media” business? What is happening to much of the physical media business?

2. Both Amazon and Apple would like you to store books, music, and other media in their “cloud.” What critical key strategic advantage comes to a firm when consumers adopt one firm’s cloud versus the other?

3. Amazon prices Kindle hardware at or below cost. Conduct research to find out Apple’s margins on iPad hardware. How does Amazon make money from the Kindle? Which firm do you think will win the battle for tablet computing? Is it the same firm you think will win the battle for e-readers? Do you think there should be one winner? Why or why not?

4. Why is e-ink useful in an e-reader?

5. What operating system do Fire devices use? How does this impact the firm’s network effects from complementary products?

6. Investigate the Amazon Echo online. Would you buy the product? Why or why not? Why will the Echo get “smarter” and offer more features over time?

7. Why do you suppose Amazon’s Fire Phone struggled in its first iteration?  Do you think Amazon could ever be successful in phones? Why not, or what will it take to be successful?  What, beyond phone hardware, could Amazon do to leverage smartphone platforms?

8. How successful have Kindle e-book readers been? How about Fire tablet, Fire TV, and Echo? What barriers does the firm face in competing? What advantages does Amazon have?

9. How has Kindle pricing changed over time? Would you expect similar changes with Amazon’s other consumer electronics products? Why or why not?

10. How does the traditional publishing value chain differ from the Kindle value chain when Amazon is an author’s publisher? List the rough percentages of revenue taken by each element in the value chain.

11. What advantages does the Echo platform offer for Amazon? Would you (or do you) use an Echo? Why or why not?

12. If you were an author, would you use Amazon as a publisher or not? What factors would influence this decision? What do you think will happen regarding trends and these factors over time?

13. How is Amazon acting as a hothouse for content creation beyond books? What other categories of media products is Amazon involved in developing? Investigate these—has Amazon done well, or have these products been flops? Does your research suggest why the firm has had success or struggled in various categories?

14. What is channel conflict, and how has Amazon been subject to channel conflict?

15. Is Amazon good or bad for the book business? Explain your answer.

16. What is Twitch? Why did Amazon buy it? Why is it a compelling service for the firm?

17. Why do you suppose Amazon has begun publishing video games? Producing more original video content?

18. Consider the e-book publishing case between Amazon and Apple, as well as the spat between Amazon and Hachette. Research the current state of these disputes and any court rulings. Is Amazon a monopoly? Does Amazon have too much power, and do you think it should be regulated? Is Amazon’s pricing “predatory” in a way that unfairly disadvantages would-be competitors? Should Amazon be allowed to continue agency pricing without limitations? Do you think publishers were wrong to work with Apple? What is the current status of this case? (Note: similar cases in the United States and Europe may be at differing stages or have differing outcomes.) Are Amazon’s actions with respect to Hachette fair? Do you believe they help or hurt consumers? How might this impact Amazon’s brand? The firm’s relationship with authors? Come to class prepared to discuss your opinions and findings.

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7.6 Amazon and the Cloud: From Personal Storage to AWS

Learning Objectives

1. Identify several of Amazon’s personal cloud offerings, how they are used, and the value they provide both users and Amazon.

2. Understand Amazon’s cloud-computing offerings, the services provided, the firms that use AWS, the size of this business, and the firm’s vision for its future growth.

3. Recognize why firms use cloud-computing platforms and some of the risks associated with giving up control of certain infrastructure.

Amazon’s shift from selling media atoms to selling media bits has led to its expansion into consumer cloud-based offerings that store and serve up digital content over the Internet. It’s already been pointed out that the Kindle can load a customer’s “virtual bookshelf” and other content on demand, even if you delete purchases from your device. The same is true with Kindle Fire apps. Fire TV and Alexa services are also thin devicesThin or thin client computing devices have very little computing power in the device itself, and instead perform the bulk of computing and storage over the network, “in the cloud.” Smart speakers and television streaming sticks are all examples of thin clients. The term is also used to describe applications that run in a browser, but where most of the computing happens remotely (e.g., SaaS tools like Salesforce)., with very little computing in the devices themselves, and the bulk of computing (apps, recommendation software, media storage) happening at a remote location, over the Internet. Amazon Cloud Drive offers file storage similar to Dropbox and Google Drive. Amazon Prime users get free, unlimited photo storage in the Amazon cloud. And Amazon Music is a Spotify-style DJ in the cloud. But Amazon’s biggest cloud push comes in offering access to corporate-quality computing as a service.

AWS, or Amazon Web Services, allows firms, and really anyone with a credit card, to rent industrial-strength computing capacity on an as-needed basis. The best-known offerings are Amazon’s EC2 (Elastic Computing Cloud), which provides the virtual equivalent of physical computing hardware; and S3 (Simple Storage Service), providing Web-based storage. But AWS provides dozens of service offerings, including various operating systems, database products, enterprise software, programming environments, networking services, security, artificial intelligence and machine learning tools, and more. Amazon WorkSpaces provides access to fully functional, remotely served, virtual Windows PCs through the cloud—offered up in a desktop browser window, or even on an iPad or Kindle Fire—for prices starting at just $25 a month. These kinds of products are great choices for clients that want securely locked down PCs—think call centers and law enforcement. They’re also an alternative to a student who may have a Chromebook, but needs access to a Windows PC for a particular class or project. Amazon AppStream is a cloud offering for game developers wanting to use Amazon’s massive processing power for rendering complex images and gaming environments, squirting the results down to devices that would not otherwise be able to quickly create complex graphics on their own (think smartphones and tablets). When it comes to AWS cloud offerings, it seems the sky’s the limit.

For years, big server firms like IBM, HP, and Sun worked at creating a market for so-called utility computing—a rent-not-buy model where consumers paid for technology as needed, similar to how one pays for water or electricity. But in true disruptive form, it wasn’t enterprise-class hardware firms but rather a company originally launched as an online bookstore that managed to get real traction in this market. Today AWS powers thousands of businesses, including Etsy, Airbnb, Pinterest, Yelp, and Zynga. It’s Amazon’s services that allowed thirteen guys to scale Instagram to tens of millions of users and a billion-dollar acquisition price in just fifteen months. And firms that might consider Amazon as a rival, including Netflix and Dropbox, rely on AWS as well. What’s notable is that many of these firms aren’t just big firms; they’re the largest firms in their categories. NASA, Eli Lilly, the New York Times Corporation, and ESPN have all used AWS for key tasks, too. Advantages of using the cloud are outlined in  Chapter 14 “Software in Flux: Open Source, Cloud, Virtualized, and App-Driven Shifts” ; they include allowing organizations to rent server capacity as needed—scaling up during high demand periods or intensive but short-term projects without having to over-invest in hardware, software, and personnel. And Amazon’s deep experience in scalability, security, machine learning, and fault-tolerance are usually far better than a smaller firm could develop on its own. AWS isn’t fool proof. Well-known outages have temporarily taken down or dramatically slowed several sites that have used the service, but most don’t feel they could do a better job at a better price, even if this means relying on another firm to provide vital resources. Target provides a cautionary tale: The discount retailer had been relying on Amazon to power its website but left in an effort to create its own infrastructure. Three weeks later, an unexpectedly popular Target promotion crashed the firm’s website.

AWS was introduced in 2006, although some offerings were available as early as 2002. Google’s competing AppEngine wasn’t offered until 2008, and Microsoft’s Windows Azure cloud platform came out in 2010, although Bezos is found of referring to AWS as really having a “seven-year lead head start” before facing serious, “like minded” competition. There are advantages to moving early as a platform provider. An early lead with a market-serving product creates a big share, customer lock-in, internal learning, and a network effect derived from complementary offerings ranging from the employment base provided by a growing number of AWS-skilled developers to a rich assortment of software capable of using the platform. Even server providers like Rackspace and HP are playing catch-up with Amazon. They’ve got a long way to go. Research firm Gartner estimates that “AWS offers five times the utilized compute capacity of the next fourteen cloud providers combined!”

“I have never seen any person develop two really important industries at the same time and really be the operational guy in both... You do not want to give Jeff Bezos a 7-year head start.”

—Investment legend Warren Buffet, praising Amazon’s founder and CEO, referring to Amazon’s dominance in providing industrial-grade cloud computing services over the Internet. By all measures, AWS dwarfs rivals, and the division is responsible for the majority of Amazon’s profits.

While e-commerce brings in the most in terms of sales revenue, AWS is now responsible for the majority of the firm’s profits. AWS brought in $25.7 billion in 2018, that’s more money than McDonald’s, Starbucks, or drug company Eli Lilly. Noting the growth, Amazon has appointed two additional division CEOs under Bezos—one to run the cloud business, the other to handle retail and consumer businesses.  

As for the competition, research firm Gartner has estimated that, for two years in a row, AWS “ran more than ten times the computing capacity as the next 14 cloud providers combined.”  Another report has estimated that Amazon’s cloud business earns over four times the revenue of Google’s corporate cloud. Why did Amazon decide to get into this business in the first place? Some have suggested that AWS came out of Amazon’s desire to make money from the firm’s excess computing capacity, but the firm’s CTO has debunked that as a myth and a misconception. The real goal of AWS was to monetize the firm’s expertise in scalability and reliability and turn this into a revenue-generating business. The benefits of having an entire skilled division of technicians creating reliable, standard platforms that Amazon can then use itself (instead of buying these services from others) is also seen as a key benefit. Building this capacity doesn’t come cheap. From 2005 through 2013, Amazon spent $12 billion building out the AWS infrastructure. But long term, Bezos sees the future unfolding, and he wants to rake in billions more, not only by selling you just about everything you need, but also by powering any organization that is willing to farm out computing to the cloud. Rivals aren’t willing to let Bezos dominate another industry—Microsoft has been heavily discounting services in an effort to grab more market share, and IBM purchased open source leader Red Hat in part to beef up cloud offerings, but displacing a dominant firm with significant switching costs and network effects will prove very difficult, indeed.

Figure 7.9 Amazon’s AWS Web Page

A visit to Amazon’s AWS site will show the growing breadth of the firm’s cloud offerings. The “Machine Learning” section has been expanded, and lists products for understanding natural language, translation, image recognition for photos and video, machine learning training tools, and more. 

Source: Amazon’s AWS Web page; https://aws.amazon.com/.

Key Takeaways

· Amazon offers personal cloud storage options for all forms of media, including books, games, music, and video. It even offers file storage akin to Dropbox and Google Drive. These personal cloud offerings allow users to access files from any app, browser, or device with appropriate access.

· Amazon Web Services (AWS) allows anyone with a credit card to access industrial-strength, scalable computing resources. Services include computing capability, storage, and many operating systems, software development platforms, and enterprise-class applications.

· Firms using cloud providers lose control of certain aspects of their infrastructure, and an error or crash caused by the cloud provider could shut off or scale back vital service availability. Amazon and other vendors have experienced outages that have negatively impacted clients. Despite these challenges, most firms believe they lack resources and scale to do a higher-quality or more cost-effective job than specialized cloud providers.

· AWS and competing cloud services offer several advantages, including increased scalability, reliability, security, lower labor costs, lower hardware costs, and the ability to shift computing from large, fixed-cost investments to those with variable costs. Since Amazon also uses products developed by AWS, the firm’s e-commerce and Kindle operations also benefit from the effort.

· AWS provides the majority of Amazon’s corporate profit and is significantly ahead of rivals in terms of market share and available infrastructure.

Questions and Exercises

1. What other personal cloud products exist for vendors beyond Amazon?

2. Do you use personal cloud services? Do you use Amazon products, or products provided by rivals? Why have you made these choices regarding cloud platforms?

3. What is AWS, and what services are provided? Investigate online and report back on the costs associated with key services such as EC2 and S3.

4. Consider Amazon WorkSpaces: Why would a firm want a virtual version of Windows served in a browser? How might AWS AppStream help the firm’s Fire efforts?

5. Which firms use AWS? What do they gain by using a cloud provider, and what do they give up? How might Amazon or other cloud firms reduce concerns potential and existing clients might have?

6. If there are alternatives available, why would firms that compete with Amazon in some businesses use Amazon anyway?

7. Are network effects at work in cloud platforms? How so? What kinds of complementary products might make AWS seem more attractive than a new cloud computing effort?

8. How big is this business relative to Amazon’s other divisions? How big does Amazon think it can get?

9. Why did Amazon decide to get into cloud computing? This business is radically different from shipping books and other physical products. Do you think Amazon should continue to keep AWS as part of Amazon, or should it spin the firm out as a separate company? What would be the advantages to either approach? Search online to see if you can find opinions that analysts or journalists may have regarding AWS’s growth prospects in Amazon or as a separate firm, and be prepared to report your findings back to class.

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