amazon case analysis - … … · web vieweven though it is a low margin business we are uniquely...

September 08

Executive Summary

The following are my recommendations to the board of directors of Amazon in my capacity as

the SVP of Strategy

1) Free shipping – Continue with supersaver shipping program and Amazon Prime. This

does not have a simulative effect on revenue but is a competitive necessity. The program

should be used to understand consumer behavior in terms of order quantity and frequency

of orders so that the shipping package can be fine-tuned based on the customer rather

than on dollar value of order

2) Online Grocery Business – Modify strategy to establish partnerships with traditional

grocery stores that do not have an online presence to expand reach and utilize existing

technology platform. Even though it is a low margin business we are uniquely positioned

to leverage our current customer base who value convenience through our order

fulfillment process. This would help us secure larger “share of the wallet” of a customer’s

online purchases.

3) Support to third party sellers – Continue supporting third-party sellers but charge them

a fixed fee per month for providing them the technology platform and commission based

on sales transactions completed through our platform. We can aggregate small business

owners and generate revenue by providing a cost-effective way for advertisers to target

them. These third-party sellers are also consumer customers in one way and helping them

grow their business would help us increase customer life time value through increased

customer loyalty.

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Free shipping policy

Amazon is a pioneer in e-commerce retailing and introduced the free shipping policy for orders

above a minimum threshold purchased on its website. This program has enabled it to attract

customers. But it has also placed an enormous burden on Amazon’s financials because of the

huge costs involved in shipping the products. The purpose of this memo is to determine whether

the program has had a (a) simulative effect on revenue and (b) is a competitive necessity. The

conclusions drawn would help determine the future course of action.

(a) Simulative effect on revenue

The effect of free shipping on simulating revenue has to be analyzed on 2 factors

(1) Inducing existing customers to purchase more & (2) enticing new customers to buy

through Amazon because of its free shipping policy.

We have been adjusting our free shipping thresholds over the past few years. Research

indicates that this strategy has not resulted in a simulative effect on revenue. Initially,

Amazon offered consumers free shipping if they spent $99, and then lowered the bar twice

during 2002-first to $49, then to $25. Data from comScore, a firm that tracks Internet

browsing and purchasing behavior for academic research, documented the impact of the

changes. When a $49 purchase triggered free shipping, the average purchase quantity of

products per order was 3.31. When the threshold fell to $25, the average purchase quantity

dropped to 2.53. The comScore data included 45 purchasers who bought from Amazon.com

when both thresholds were in place. Those consumers spent $17 less per "free shipping"

order under the lower threshold, and purchased 1.82 fewer items (1)

This data proves that lowering the free shipping threshold has not had a simulative effect on

revenue.

(b) Competitive Necessity

To determine if free shipping is a competitive necessity 2 points needs to be considered

(1) what are our competitors doing? & (2) How much do we lose on free shipping?

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(1) Competitor actions

Wal-Mart offers free shipping to its stores. This drives foot traffic to its stores and helps

increase same-store sales.

“Gap Inc., for instance, has for roughly two years charged customers who shopped at the

Web site of its Old Navy subsidiary $5 for shipping, regardless of the order size. Based

on the success of that approach, in August the company put into effect a similar strategy

for its BananaRepublic.com and Gap.com sites, with customers paying $6 for each

shipment”2

Analysis of the competitive landscape reveals that the market has accepted free shipping

as a ‘necessary evil’. All the above retailers offer free shipping or subsidize the shipping

charges for orders in one way or the other.

(2) Cost of Free shipping

The net cost to us of shipping activities was $128 million and $75 million for Q2 2008

and Q2 2007 (Exhibit 1 (a)), and $256 million and $162 million for the six months ended

June 30, 2008 and 2007 (Exhibit 1(b)). The net cost to us of shipping activities was $434

million, $317 million, and $239 million for 2007, 2006 and 2005. (Exhibit 1(c)). The

crucial element that needs to be noted is that our shipping costs as % of net sales have

remained relatively constant around 2.8% – 3%.

The above analysis seems to point out that competitive pressure to continue with the current free

shipping policy is huge. Since we pioneered this concept it would be very difficult for us to

rescind the free shipping policy and start charging the customers. This factor assumes added

importance at this point of time when we are going through a slowdown in consumer spending

because of the economic downturn. People are prone to becoming more cost-conscious during a

recession and adding a shipping cost would deter them from purchasing products through

Amazon.

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However, charging for order fulfillment can be an uncertain proposition. A January 2004 survey

by NetIQ Corp concurs: “shipping and handling costs trigger 52% of the abandonment of online

shopping carts.” (DMA 2004). Clearly, anecdotal evidence suggests that: (a) consumers are

highly responsive to shipping policies, (b) there is room for improvement in how policies are

crafted, and (c) little is known about consumer trade-offs that lead to the observed behaviors3.

We need to keep this in mind when adopting a shipping policy.

So my recommendation would be to extend the free shipping policy but modify the way in which

it is administered. We need to determine which customer segments (new customers or existing

customers) are more responsive to the policy and decide the free shipping threshold accordingly.

To illustrate my point let us consider what happens when we lower our free shipping thresholds

(1) more people hit the threshold through their orders which results in increased shipping costs

and (2) new customers are encouraged to buy because of the low shipping fee threshold on

orders. We need to determine whether it is more economical for us to ship in smaller or larger

quantities when determining the threshold. If we lower the threshold it results in more frequent

purchases by customers. But if the threshold is large then customers tend to order in bulk to save

on the shipping costs. Since offering low prices is fundamental to our future success we need to

re-evaluate our price each time we alter the threshold. In our case, we would be better served by

lowering our prices when we lower our threshold. This would induce customers to order multiple

quantities in a single order to meet the free shipping threshold. Comp store sales gain is up 13%

year-over-year in 2Q 2008. This can be attributed to the success of Amazon Prime ($79 per year

for free shipping) and its ability to shift consumer purchasing behavior from other e-commerce

retailers5.

A detailed analysis of the consumer behavior in terms of ‘Average number of products in an

order’ would help us offer the best shipping option for that particular customer to minimize our

costs and also provide value to the customer. Continuation of the Amazon Prime free shipping

program is crucial to collect the data needed to narrow down on consumer preferences and drive

the continued growth of our business.

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Online Grocery Business

Amazon entered the online grocery business in August 2007. It wanted to leverage its capability

in order fulfillment to keep expanding its revenue base. Although online grocers have existed for

a long time, shopping for groceries has not picked up as fast as expected among consumers. The

market for groceries in the US is estimated to be $500 Billion according to the Food Marketing

Institute. “Online grocery shopping still accounts for only 5% of all online retail sales, according

to Patti Freeman, a senior analyst at Jupiter Research. As a percentage, it’s even a smaller piece

of the total U.S. grocery bill. Last year, consumers spent $5.5 billion shopping for their groceries

online or less than 1% of U.S. grocery sales, Freeman said” 6 The penetration of e-grocers in

terms of the locations served is also less, which points out that there is a huge market potential

waiting to be tapped (Exhibit 2 (a)).

Sizing up the competition would help determine whether Amazon has a sustainable competitive

advantage and should continue with this business. The competition in the internet grocery market

falls into 5 segments 7

The pure-play full-line Internet grocers. (Grocery Gateway)

The limited-line category specialists. (Ethnicgrocer)

The system-providers. (Peachtree Network Inc)

The infrastructure builders. (E-Box, Homeport)

The traditional grocers. (Safeway, Tesco, Giant)

Amazon fits into the limited-line category specialist segment since we sell non-perishable items

and our focus is on highly populated areas like Bellevue and Kirkland in Washington State. But

we compete with the all the segments of the market for a pie of the internet grocery market. Our

top competitors and their offerings are as follows

(1) Peapod - Groceries for home delivery, plus office and cleaning supplies. Delivery limited to

metropolitan areas in USA's Midwest and Northeast regions. Includes coupons, shopping tips

and recipes. Its supermarket partners are Stop & Shop and Giant. (Exhibit 2 (b)).

(2) Netgrocer - USA nationwide delivery of non-perishable groceries, health and beauty

supplies, and home and gift items.

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Peapod is successful because of its tie-up with the traditional grocers like Stop & Shop and

Giant. It is able to deliver goods by the next day in most cases and provides features like Sort

by nutrition, new items, Express shop, Shopping lists, Aisle Browsing and Item Search. The

delivery charges are as low as $6.95 and peapod combines the value of diverse product

selection with the convenience of delivery. Because of its tie-up with supermarkets which

have higher purchasing power from grocery suppliers it is able to operate successfully.

Netgrocer on the other hand concentrates on non-perishable goods which do not impose a

burden of temperature controlled storage. Amazon has adopted the right strategy by

concentrating on Non-Perishable & high-margin items like health and beauty products.

E-grocers' scheduling requirements and the desire to consolidate purchasing activities to

a single trip are two factors affecting the consumers' desire to purchase groceries online.

Other factors negatively influencing consumers' decisions to purchase groceries or other

goods online include shipping costs, credit card security, the need or want for immediate

delivery of products, and the social aspects of the shopping experience 8. Amazon is well

positioned to overcome these factors because it has established credibility in the marketplace

through its secure payment gateway, supersaver shipping and the ability to set a delivery

schedule. Amazon has also kept the business model simple by shipping centrally, not selling

perishable goods and not providing overnight delivery. This in large part has removed the

challenges faced by traditional online grocers who have trouble with delivery and storage of

perishable products.

There is a strong reason to believe in the growth of the online grocery industry because of 2

factors (1) Increase in the number of dual-career couples who do not have the time needed to

purchase groceries from traditional stores and (2) Increase in the price of gasoline. These 2

factors fit well with our strategy of providing convenience and low prices to our consumers.

Our existing customer base is also very busy which is indicated by their preference for online

shopping rather than going to a traditional store for buying Books, Music or Movies.

The strategy to enter the online grocery business is a good one since it allows us to leverage

our existing strengths in order fulfillment. Customers can maintain their shopping lists online

which would give us more insights into the consumer behavior in terms of grocery shopping.

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This can be leveraged to cross-sell other products of Amazon. For example, if a customer

purchases a cooking book we can suggest that the recipe for the dishes in the book can be

ordered through Amazon. This would be a convenient way for a customer to get the required

items delivered to his doorstep.

Market selection is another important determinant of success of online grocery business. The

key driver for online purchase of groceries would be time/convenience rather than price.

Population density also needs to be taken into account to figure out whether the market can

be served profitably. The more the number of people who order from a particular location the

less the cost would be for the retailer to service the order. We have the taken the right steps in

terms of deciding to test the market in the Washington area. A plan to identify the target

markets based on the above mentioned characteristics needs to be developed. Based on the

plan a phased roll-out strategy needs to be worked out.

According to the Forrester Research report, multi-channel shoppers spend two to three times

as much as their single-channel counterparts. Further, 51% of online consumers in North

America researched a product online and then purchased it offline, while 22% of store

shoppers who had visited a retailer's website specifically looked for or purchased something

in store that they had previously seen on that retailer's website. By the same token, 25% of

online shoppers who had previously visited a retailer's stores purchased something that they

had seen in those stores at that retailer's website10. Currently we have 3 distribution centers

through which we serve the customers. Scaling up quickly depends on our ability to build

more distribution centers which would obviously put a strain on our cash flow. In such a

scenario, assuming the role of a system provider to the established grocery stores would be a

good option. This would be advantageous in the following ways

(1) Utilizing the multi-channel play which is favored among customers

(2) Expanding our product offerings

(3) Learning the nuances of grocery business distribution

(4) Ability to reach a wider audience without the need to put in huge amounts of money

upfront to establish distribution centers

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The online grocery business is of strategic importance to us especially in the current economic

climate because

(1) Of its ability to compensate for the reduction in the impulsive purchasing behavior of

customers

(2) Due to the downturn, customers would be cutting down on eating out and might prefer to

order pre-packaged food. Amazon by serving this population can generate significant profits.

The customer relationship established during this time can be leveraged to sell other

products.

So I strongly recommend that we continue the on-line grocery business.

Support of Third party sellers

An analysis of the advantages and disadvantages of providing support to third party sellers is

necessary to determine future course of action.

Advantages

Amazon makes a tidy sum as revenue from the commissions for the products sold

through its technology platform. We can earn additional revenue by leveraging the

existing infrastructure

By making competitors dependent on us, we are aware of their growth potential and can

take steps as necessary to sustain our competitive advantage

Our pricing algorithm can be fine-tuned by collecting data about the pricing of third party

sellers. This would enable us to gain knowledge about the market prices for products and

consumer behavior when they are presented with an option to purchase from Amazon or

from a third party seller

Aggregation of small business owners is highly lucrative. They could be the potential

target market for cross-selling our services. Amazon can monetize that market by

providing a way for advertisers to target the small business market through it.

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Disadvantages

If seller fails to deliver high-quality merchandise then Amazon’s reputation might be

damaged

We provide a path for our competitors to grow by using our technology platform

We cannibalize our sales by providing customers the option to buy either our product or

the product from the third party seller

Huge amount of money needs to be invested to maintain the technology platform to serve

the seller customers

On weighing the pros and the cons of providing support to third party sellers it seems to be

profitable to continue with the support because of following reasons

1) Customers always like choice when purchasing goods. That has been the driving factor

for our success since we have provided the customer the option of comparing different

products and choosing the one that best suits their needs. Value conscious customers

would anyway find a product at some other site at a lower price. By supporting third

party sellers on our site we are getting an opportunity to share the gains from the

transaction done by such a consumer

2) Allowing third party sellers would help us keep in touch with the market trends. Since

data is collected about every transaction, it can be used to determine the highest selling

items on the platform. Amazon is continually looking out for new opportunities to expand

our revenue base. This would be an ideal opportunity to learn about the market and the

“sweet spot” in terms of price before entering it. For example, if we allow a third party

seller selling jewels and find that there is a huge demand for that we can start selling

jewels to our customers directly.

The way to minimize our risks would be to charge a monthly fee for technology support and

commission for every sales transaction done through the platform. In addition, providing “fraud

protection” for the customers who purchase products from third party sellers through Amazon by

charging a small fee would be a good option. This would make sure that consumers would be

more confident in making purchases from third party sellers and we can also make sure that our

brand image is not affected by the actions of third party sellers.

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Exhibit 1 (a)

1 2

-9.0%

-7.0%

-5.0%

-3.0%

-1.0%

1.0%

3.0%

5.0%

7.0%

4.6%5.3%

-7.8% -7.9%

-3.2%-2.6%

3 Months Ended June 30, 2008 vs 2007

Shipping revenue Outbound shipping costsNet shipping cost

Year

% o

f Net

Sal

es

Exhibit 1 (b)

1 2

-9.0%

-7.0%

-5.0%

-3.0%

-1.0%

1.0%

3.0%

5.0%4.6% 5.1%

-7.7% -7.8%

-3.1% -2.7%

6 months ended June 30, 2008 vs 2007


Year

% o

f Net

Sal

es

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Exhibit 1 (c)

1 2 3

-10.0%-8.0%-6.0%-4.0%-2.0%0.0%2.0%4.0%6.0%8.0%

5.0% 5.3% 6.0%

-7.9% -8.3% -8.8%

-3% -3% -3%

Year End - December 31st 2007 , 2006 & 2005


Year

% o

f Net

sale

s

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Exhibit 2 (a) – Locations served by e-grocers across U.S.A. (2005)9

Exhibit 2 (b)

Peapod products

Peapod features over 8,000 products in a range of categories: produce; meat and seafood; deli items;

prepared foods; natural and organic foods; Kosher foods; office and school supplies; seasonal items; and

video products; pet items; health and beauty aids; wine, beer and spirits (in specific markets) and

private labels from Peapod by Stop & Shop and Peapod by Giant

Amazon Products

Amazon.com features Grocery, Natural & Organic products, Gourmet Food, Health & Personal

care and Beauty.

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Bibliography

(1) http://news.cnet.com/The-psychology-of-free-online-shipping/2030-1069_3-6063440.html

(2) Nothing Says 'Buy' Like 'Free Shipping'

Bob Tedeschi. New York Times. (Late Edition (East Coast)). New York, N.Y.: Oct 8, 2007.

pg. C.8

(3) “Free shipping and repeat buying on the internet” – Theory and Evidence by Yinghui Yang,

Skander Essegaier and David R. Bell

(4) “The effect of shipping fees on customer acquisition, customer retention and purchase

quantities” – Michael Lewis Journal of Retailing 82 (1,2006) 13-23

(5) Behavioral Shift in Prime powers 2Q growth – Deutsche bank securities Inc July 24, 2008

(6) Amazon Gets Fresh Challenges With New Grocery Business –

http://www.cnbc.com/id/20463088/

(7) The Green Mile Digest 2001: Analyzing The Online Grocery Business - National Bank

Financial Jan 26, 2001

(8) Strategies and Challenges of Internet Grocery Retailing Logistics – Tom Hays, Pinar

Keskinocak and Virginia Malcome de Lopez

(9) Are E-Grocers Serving the Right Markets? by Casie Berning, Stan Ernst, and Neal H.

Hooker

(10) Channel surfing - Sally Praskey. Canadian Grocer. Toronto: Mar 2003 Vol. 117, Iss. 2; pg. 57

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http://news.cnet.com/The-psychology-of-free-online-shipping/2030-1069_3-6063440.html

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