Amazon's Business Model: A Case Study

Discussion of Amazon’s business model, and the impact of information technology for the internal organisation of work.

What is their business model?

Many academics believe that Amazon’s outstanding success as an Internet retailer compared with many of its rivals has been due largely to its ideal business model and swift response to the changing market since its inception. (Global Market Information Database, 2003) To begin with, Amazon chose the perfect product lines for e-commerce, with products that consumers did not need to handle in person before making a purchase: initially books, but then spreading to DVDs, music and other media. Furthermore, consumers in the book and music categories tend to desire information when they shop online, which Amazon was able to provide on its sites through reviews and recommendations. Amazon consumers appeared willing to pay a little extra for this convenience, although the recent competitiveness of the market has forced the company to cut prices or use other promotional techniques, and shift the focus of its business model from pure quality driven back towards price driven.

Amazon then turned to diversification, and extending its product offer in order to widen its customer base and improve margins, with the result being that the company has focused strongly on building up its product portfolio to offer customers more choice. In 2001, Amazon increased its range of electronics and tripled its kitchen selection, as well as launching computer and magazine subscriptions stores, and set up strategic partnerships with retailers such as Target and Circuit City. In November 2002 Amazon.com announced the launch of a new online apparel store with items from retailers including The Gap, Old Navy, Land’s End, Nordstrom’s, Cole Hahn, Osh Kosh, Spiegel, Eddie Bauer, and Foot Locker, amongst others. This diverse business model has enabled Amazon to grow both its market capitalisation and profitability, and become largely accepted as the world’s leading online retailer (Global Market Information Database, 2003)

The company also concentrates on improving convenience with new features, such as the recently launched ‘Instant Order Update’, which warns customers if they are about to buy the same item twice. Marketing itself as offering Earth’s Biggest Selection, the company aims to be the world’s “most customer-centric company”, operating through its three basic businesses: Online Retail; Marketplace and Other; and Third-party Sellers. Amazon also recently began to target the institutional market as well as consumers expanding its business model in order to drive a new source of revenue: renting out its site-building services to other companies. It owes much of its relative financial well-being, compared with other pure Internet retailers to the site-building and hosting services it has sold to clients such as Borders and Toys “R” Us. (Global Market Information Database, 2003)

Indeed, a recent article by Sutton (2005) focuses on Sears Canada Inc., which has recently stated that it will turn over the technology component of its online retail presence to Amazon to capitalize on Amazon’s years of expertise in customer-facing Web sites. “Sears.ca will remain very much a Sears brand,” according to spokesperson Vincent Power, (Sutton, 2005) with little to indicate Amazon’s involvement from a customer’s perspective, and Sears will continue to host the site, using the same internal fulfilment house that handles customer orders from the site and from the Sears catalogues. Amazon Services Inc., a subsidiary of Amazon.com Inc., will handle the arrangement which is only the latest in a series that Amazon has struck with other retailers recently. The idea of retailers, both huge and small, outsourcing their Web sites has gathered momentum in recent years, said retail analyst Jim Okamura with Chicago-based J.C. Williams Group (Sutton, 2005), and Amazon’s business model is now aligning itself to take full advantage of this fact.

Strategic alliances are another integral part of Amazon’s business model, and the company has entered into a number of agreements to expand its range of products and services by allowing selected strategic partners to sell products and services under co-branded sections on the Amazon.com website. These alliances have generally consisted of Amazon making, or having the future right to make, a minority investment in the companies, and the entry into commercial agreements, which vary in scope, from customer advertising activities and links, to recently announced deals involving the sale of products and services on co-branded sections of the Amazon.com website. These alliances have developed from the successful alliances the company forged in 2001, with such companies as America Online and Target in the US, and Virgin Wines in the UK. Amazon also expanded its product offering under its Toysrus.com strategic alliance to include Babiesrus.com and Imaginarium.com co-branded stores at www.amazon.com. In addition, the company entered into strategic alliances with Expedia, Hotwire and National Leisure Group to create its travel store, further fulfilling its diversification aims.

Amazon’s marketing strategy is one of the most typical parts of its business model, being focused on strengthening and broadening the Amazon brand name, increasing customer traffic to its websites, building customer loyalty, encouraging repeat purchases and developing incremental product and service revenue opportunities. However, the unique part of this section of its business is that in order to accomplish this, the company employs tactics such as delivering personalised pages and services and using a variety of other media, business development activities and promotional methods. Amazon also relies on public relations activities, as well as online and traditional advertising, including radio, television and print media, and direct marketing, however one of the primary ways the company directs customers to its websites is through its “Associates Program”. This enables associated websites to make products available to their customers with fulfilment performed by Amazon, and is remarkably successful: by 2001, more than 700,000 websites had enrolled in the Associates Program. (Global Market Information Database, 2003)

What many consider to be the defining characteristic of Amazon’s business model is that the firm has no physical retailing activities, operating only via the Internet. However, its virtual operation is very much underpinned by administrative and service facilities, and in 2001, these consisted of US fulfilment facilities in New Castle, Delaware; Coffeyville, Kansas; Campbellsville and Lexington, Kentucky; Fernley, Nevada; and Grand Forks, North Dakota; as well as a seasonal fulfilment centre, used as necessary, in Seattle, Washington. The company also leases and operates three European fulfilment centres located in the UK, France and Germany and, in Japan, the courier company Nippon Express provides fulfilment services for orders from www.amazon.co.jp. These fulfilment centres comprise in total around four million sq ft of warehouse space, and in addition, Amazon leases four off-site facilities that fluctuate from 340,000 to 710,000 sq ft of space, which support the storage and fulfilment functions of the US centres. (Global Market Information Database, 2003)

What are the technologies used by the organisation in pursuit of competitive advantage?

In Hamid’s (2005) article, he focuses strongly on the fact that Amazon offers many interesting variations on the strategic applications of Internet technology, in order to enhance customer relationship and acquire customer loyalty. Obviously, Amazon’s offerings of personalised services, confirmation of orders in real time and other value added activities substantiated the ability of the Internet as a competitive tool. As the number of internet users is growing rapidly around the world, retailers are under great pressure to take advantage of this huge online market potential. However the challenge is whether online retailers can match up with other, “bricks and mortar” competitors worldwide in terms of services rendered on the Internet. Hamid investigated the level of Internet technology applied by web sites in view of global electronic marketplace competition, finding that many Internet retailers are still lagging behind in fully utilizing the strategic potential of the Internet particularly in enhancing customer relations. However, Amazon is already way ahead of this, using some of the technologies described above, and plans to cement its lead further in the next five to ten years and, in doing so, revolutionise the book business yet again.

Curtis (2005) analyse Amazon’s recent acquisitions of on-demand book printer ‘BookSurge’ and e-book company ‘MobiPocket’, claiming that they may signal a coming transformation of the publishing business, one that includes an end to the industry’s biggest problem: that of returns. Since practical ‘print on demand’ (POD) technology became available in 1998, it offered retailers the vision of a book business driven by demand-and-supply, rather than the current consignment model, and Amazon is ideally placed to turn that vision into reality (Curtis, 2005) Given that the retailer owns or leases well over four million square feet of warehouse space, no small portion of which is devoted to books, and employs 9,000 people to process orders, it would benefit immensely if it could forward orders to a printer to drop-ship books directly to customers.

Not only would this benefit Amazon itself, but also potentially the publishers, helping Amazon develop strong relationships with yet another stakeholder group. One strategy might be for Amazon to print pre-sold books in its own plant which, aside from shifting printing and shipping costs from publishers to the retailer, would also sharply reduce the guesswork for publishers setting print runs. Given current economies of scale for large print runs of big books, it’s likely publishers would, at least for the foreseeable future, continue to print books the traditional way for brick-and-mortar accounts. However, Curtis (2005) claims that even a mix of POD and traditional printing makes more sense than the current reasoning that you can make more money by printing a million copies and selling half of them than you can by printing half a million and selling all of them.

Though POD manufacturing costs are currently far higher than those of traditional long print runs, longer POD print runs, and lower unit costs, will become more common if the number of pre orders on the site continues to rise, and as the technology continues to improve, especially given Amazon’s access to detailed customer data which it can use to predict future retail trends. Equally, Amazon’s acquisition of the e-book retailer, ‘MobiPocket’, enables the company to contemplate developing virtual publishing in its purest form: eliminating hard copies and delivering virtual books electronically to customers at a fraction of the current cost. As Amazon masters these technologies and delivery systems in the coming years, perhaps even becoming a publisher in its own right, it will be harder and harder for traditional publishers to support the outdated consignment model, and potentially giving Amazon its highest ever level of competitive advantage. Indeed, trade publishers may find themselves shifting to a system in which most books are pre-sold, regardless of the channel, further increasing Amazon’s advantage over the traditional stores. Curtis, R. (2005)

What are the implications of this technology on the internal organisation of work?

One of the key implications of the importance of technology to Amazon is that the company has to maintain its edge in technology: an edge that is more critical than ever as Amazon increasingly squares off against sophisticated e-commerce survivors like eBay, whilst controlling the potentially massive costs of said technology. Just two and a half years ago, Amazon spent 11 cents on tech for every $1 in sales, but now the company spends only about 6 cents. All told, Amazon’s tech spending has fallen 25 percent from its September 2000 peak, even as the company added nine new categories to its retail lineup and signed on dozens of new corporate partners. However, despite the need to slash unnecessary costs, at other times, it’s much better to invest your way to efficiency and, as Amazon’s head of technological development claims: “You can’t be cheap for the wrong reasons.” (Thomas, 2003)

As such, Amazon’s internal staff have embraced open-source coding, replacing Sun servers with Linux boxes from Hewlett-Packard, and necessitating a whole new organisational structure for the technological development staff. For every $1 spent on the new hardware, the company saved $10 in license fees, maintenance, and expected hardware upgrades, but also has to learn and adapt to the new processes and systems. The company has also been willing to spend to save, maintaining its own warehouse-management software, which has to be built and maintained by internal staff, even though ready-made alternatives like Logility might cost as little as $375,000. However, with its own software, Amazon can tweak inventory algorithms whenever it wants so that, for example, a book isn’t shipped to New York from a Nevada warehouse when it could be sent faster and cheaper from Delaware, and managers can have greater control over their own warehouse staff. (Thomas, 2003)

Equally, although Amazon’s partners are primarily intended to generate revenue, they are also used to help control internal costs: the company has recently began to invest in Web services and tools that make it easy for partners to hook into applications Amazon had developed for its own use. Now retailers like Nordstrom and Gap can feed their inventory into Amazon’s new apparel store without a lot of custom coding, and freelance programmers can build their own online stores using Amazon’s payment, fulfilment, and customer services, meaning that Amazon’s internal staff only need track these stores and ensure they are using the services correctly, rather than have to handle all the marketing and coding themselves. For example, a Romanian coder created www.simplest-shop.com, which uses Amazon’s Web services tools to extract product data from Amazon and then fashions side by side comparison tables, which is a feature not available on Amazon.com, essentially doing Amazon’s marketing and retailing for it. (Thomas, 2003)

Amazon’s recent shift towards cutting costs has also has an effect on its internal organisation of work: in 2001, Amazon embarked on a restructuring plan which would lead to a reduction in its personnel numbers by some 1,300, or 15% of its workforce. This also involved: the consolidation of Amazon’s corporate office locations in Seattle; the closure of its fulfilment centre in McDonough, Georgia; the operation of its Seattle fulfilment centre on a seasonal basis; the closure of its customer service centres in Seattle, Washington and the Netherlands; and the migration of a large portion of its technology infrastructure to a new hardware and software platform. The company estimated that the restructuring would result in costs during the first half of 2001 exceeding US$150 million relating primarily to severance, fixed asset impairments, continuing lease obligations and other exit costs related to the restructuring. The restructuring has also lead to fundamental changes in the roles of its staff, and the organisational structures within which they work, with many staff taking over greater responsibilities and a greater scope of work. (Global Market Information Database, 2003)

References:

1. Curtis, R. (2005) Gone Today, Gone Tomorrow? Publishers Weekly; Vol. 252, Issue 30, p. 74.
2. Global Market Information Database (2003) Amazon.Com, Inc. Euromonitor International.
3. Hamid, N. R. A. (2005) E-CRM: Are we there yet? Journal of American Academy of Business, Cambridge; Vol. 6, Issue 1, p. 51.
4. Sutton, N. (2005) Sears Canada turns over Web management to Amazon. Computing Canada; Vol. 31, Issue 7, p. 11.
5. Thomas, O. (2003) Amazon’s Tightwad of Tech. Business 2.0; Vol. 4, Issue 1, p. 104.