The Great Wall of Amazon

by Ben Bajarin   |   August 9th, 2013

I love shopping from Amazon. I always have and as long as they are around–which will be a long time–I always will. There are aspects of this statement I just made that need to be analyzed from a market standpoint as well as from a consumer centric viewpoint. I want to do several things in this column. First, I want to highlight some things about the shopping experience with Amazon that is unique to their differentiated offering. Second, I want to relate that to Amazon’s business model and growth strategy going forward.

Convenience and Delight

Amazon is a retail company plain and simple. Retail is by a nature a services business. When you survey the competitive landscape of retailers you conclude that Amazon’s greatest service is convenience. Without question buying things from Amazon is the most convenient retail experience out there today. I don’t think many would argue this point so I’m not going to spend much time on it. Rather, I’d like to focus on an under analyzed aspect of the Amazon buying experience–delight.

When I first started shopping with Amazon it started because of the convenience factor. This simple value proposition was certainly a critical part of the reason I continued to shop with Amazon. However, something deeper was happening psychologically that I picked up on.

Most of us in the developed world have traditions where on special occasions our culture engages in the act of receiving presents. These dates, like a birthday or a holiday, are marked on the calendar and we wait in anticipation for the special day when we receive gifts.

I would propose that shopping on Amazon, followed by the anticipation of the delivery of the package, and then receiving the “little brown box with a smiley face on it” surfaces the same feelings as receiving presents on special occasions. Thus, delivery day becomes a special occasion. It is the climax of the entire experience. This little psychological effect is the cherry on top of the convenient service Amazon provides.

There is another psychological element to the Amazon shopping experience at play as well. When we buy something from Amazon we are engaging in a principal behavioral scientists call delayed gratification. We are resisting the urge to satisfy our immediate impulses with a purchase and are choosing, for various reasons, to buy online and wait for our package to arrive. Interestingly in many studies, researchers found that those who intentionally delayed gratification of something genuinely enjoyed it more and had fewer instances of buyers remorse than those who satisfied their immediate impulse of the same item.

Trust

Another important foundation to understand is the element of trust which Amazon has built and is continuing to build with its customer base.

I’m actually yet to have a bad buying experience on Amazon. I buy at least a dozen things a month from them, so this is perhaps surprising or perhaps not. I do quite a bit of research before I buy things. For the most part when I order something from Amazon, I know its the product I want. I have heard stories from consumers who have had a few bad experiences with Amazon but all of them confirm that they are rare cases and overwhelmingly they have positive experiences shopping with Amazon. Because of this, Amazon has built a level of consumer trust that few companies have.

This is demonstrated by the number of credit cards and extremely high levels of repeat customers Amazon has. In fact, our own research, as well as data I have seen from other firms, suggests that once people start shopping with Amazon, they continually increase their spending with the retailer. Offering the theory that the lifetime value of an Amazon customer potentially has no ceiling. The limiter, if this is true, is Amazon not the customers willingness to spend with them.

“The Profit Switch”

Much has been said about Amazon’s business model this week. It is the topic of the week and a worthy one at that. There are several well written articles I want to highlight that provide a base for this discussion.

The first is by M.G Seigler, who was once a blogger and is now a venture capitalist at Google Ventures. He still writes for TechCrunch from time to time and recently provided his own analysis of Amazon’s model. The theory which he proposes that I want to highlight is that Amazon has a magic “profit switch” that as soon as they are ready they will flip on and start making massive(my emphasis) profits.

The next article was one by Horace Diedu at his site Asymco. Horace makes many significant points and this one in particular.

“The premise that Amazon can, on a whim, change its business model from selling other people’s products at a razor thin margin while investing in capital-intensive distribution to selling other people’s products at a large margin while not investing in capital-intesive distribution is not credible.”

This is exactly right. If we believe that Amazon does indeed have a profit switch then we need to analyze at what they would do, namely in what way would they change or tweak their business model, in order to suddenly realize such profits. There are really only two fundamental ways. They either raise their prices or all of a sudden change their capital expenditures model. Neither of these proposals seem credible given Amazon’s business model.

If Amazon raises their prices two things happen. First they ruin the trust they have built with their consumers. Knowing I am likely going get the best price on Amazon is the single driving factor for repeat transactions. It is, in fact, the only reason that when I am in the physical presence of a retailer that I scan an item of interest using the Amazon app to see if there is a better price on Amazon. Often there is and I choose to buy it through Amazon even though I could have spent $10 more and walked out the store with it. Clearly this matters more with items that are not time sensitive. The key point is, as Ben Thompson pointed out on his site Stratechery yesterday, that Amazon has chosen to focus on breadth and depth of selection and the best price at the same time. This means keeping prices competitive and maintaining the needed CapEx to maintain and expand selection and guarantee timely delivery.

Another element to this profit switch theory is that Amazon will raise prices at the point in which they have a monopoly. Meaning that they have bankrupted most if not all of their competition. This is a sound theory but not plausible. If Amazon was to all of a sudden raise prices, even if they had a monopoly, it would not just hurt trust as I raised before but it would open the door for their own disruption. Even if we believe that Amazon would bankrupt its retailer competitors, raising prices would open the door for its partners to start competing by offering lower prices on their own website for their own goods. The retailer themselves would favor this model because an Amazon monopoly would have conditioned the market to online spending even more than it is today, and allow them to cut out the middle man and not have to profit share with Amazon.

Amazon has no profit switch in my opinion but there is still the possibility of growth. As Ben Evans pointed out yesterday, and to which I wholeheartedly agree, the key to Amazon’s growth is more of the same. Offering the best price, on the widest selection of items. This means Amazon must invest in new areas, which they do, as loss-leaders at first, but as revenue machines over time. This is the model they have used and its the model I believe they will continue to use. It is also one that is requires more CapEx spending not less. Amazon has this model down and they are exceptionally good at it. The question may not be what will Amazon offer but what won’t Amazon offer. 1

[For Tech.Pinions Insiders: A Further Analysis of Amazon]

  1. This column has gotten long enough so I’m adding additional analysis on topics I didn’t cover related to Amazon for our Tech.pinions Insiders []

Ben Bajarin

Ben Bajarin is a Principal Analyst at Creative Strategies, Inc - An industry analysis, market intelligence and research firm located in Silicon Valley. His primary focus is consumer technology and market trend research. He is a husband, father, gadget enthusiast, trend spotter, early adopter and hobby farmer. Full Bio
  • http://www.BarnesFamily.com/ davebarnes

    Selection is one HUGE reason that I shop at Amazon.
    I go to Amazon first looking for an item. If they have and the price seems reasonable, then I buy.
    For example, batteries for my Canon camera. Or Rubbermaid containers.

  • dr.no

    Since you like psychology so much. How about this.

    Jeff Bezos is son of cuban american. hate communism.
    He is super libertarian who set up his company in
    Washington State which has no state tax. He funded
    campaign to defeat the ballot measure to tax millionaires in that
    same state which Mr. Gates was in favor of.

    He keeps low profit because he doesn’t like paying taxes.
    With his purchase of Washington Post. He will extend that
    even more.

    So much for genius playing chess which rest are watch checkers.

    • dr.no

      ps.

      “Most of us in the developed world have traditions”

      This is such a White Man’s burden statement I would
      think that you have no idea that Humans evolved in Africa
      for 4 million years. You psychological notions are quite quaint.
      What I am saying is that All social, psychological, cultural are product of evolution not some white man superiority complex.

      • benbajarin

        I think you may have missed the point of my making that correlation.

        I’m on board with many cultures given I studied anthropology. I used that particularly point to make a point, that was all. Also Amazon has no business in Africa yet.

  • jfutral

    Great piece.I was a bit baffled by the profit switch concept. Now I see why.

    Sort of OT, I have actually been using Amazon for the opposite reason most people do. I research there first and then find the product locally, if I can. After all, the local businesses are my neighbours and family and the taxes support my schools. I have no idea who Amazon supports.

    I do use Amazon for convenience, just not solely for convenience. Bought a book on their recently that is written by a friend. Could not find it locally. Also some computer stuff I couldn’t find locally or all at one online shop, and did not want to carry it with me on the plane so had them ship it to where I am going.

    Joe

  • rationalchrist

    Key point: “there is still the possibility of growth.” and key questions: where?

  • thecity2

    If Amazon were ever to be truly profitable, it will be with AWS and AWS alone. Otherwise, it’s just a big supermarket.

  • Neil

    I’m an Amazon contrarian for many reasons, including the following:

    1. The site might have some white space but you have to squint to see it. I exaggerate but it’s extremely cluttered with both internal and external advertising competing for your attention when you’re trying to learn about a product.

    2. When you search for a product, you can buy it from several different vendors. This is not customer friendly. I have to spend time figuring out if Amazon sells it or not since I don’t like buying from the many mom and pop sellers on Amazon.

    3. There’s no telephone number emblazoned on every page. I’m not the type who calls but I find online stores that tout their call center more trustworthy.

    4. I know a filmmaker. In other words, I have witnessed how most Amazon reviews get created. The real names feature has not stopped the astroturfing. Suffice it to say that most of the reviews are not trustworthy.

    Funnily enough, I like shopping at Soap.com and Zappos, both of which Amazon owns but which Amazon hasn’t messed up. In fact, Amazon could learn a lesson from the Zappos product videos.

    Other online stores I like — Apple, Donald Pliner, Original Penguin, Banana Republic, and Cole Haan. What these stores all have in common is a focus on the product, good photography, and a clear checkout process. They also send email messages that contain good offers.

  • Nevermark

    Given the uniqueness (in quality and scale) of the value that Amazon provides, and their relentless pursuit of efficiency and customer service, it is going to be able to increase margins at some point enough to make a reasonable profit without enabling competitors.

    The only questions are: How big will their revenue be when growth slows? Will the profit margin end up as 10%, 5% or 3%? I suspect 3-4%. How much is that worth in today’s dollars?

    As for Bezos, I don’t think he cares, he is having the time of his life and no doubt sees many opportunities beyond the core Amazon business. He seems to be someone who sees every existing business as a strategic stepping stone to other business opportunities, not as something that ever stops or settles into a stable “mature” form. He will eventually run into a wall or leave the playing field, but for now he just keeps running (i.e. scaling up and leveraging into new businesses).

    • steve_wildstrom

      Analysis of Amazon’s financials have to consider the company as a retailer. Retailers typically earn very thin margins on very large volumes. Amazon’s gross margins are narrower than many tech companies’ net, aqnd that’s normal for the business. But at some point, especially as the need for capex slows, a small increase in net margins can bring in lots of profits. Retailers live and die for a half-point of net.

  • TheDisco

    Bezos is the Walton’s of the internet. I can’t in good conscience shop there.