Amazon: The Most Important Internet Retailer

Introduction:

Amazon.com, Inc (NASDAQ: AMZN) was founded by Jeff Bezos in 1994 and he launched online shop in 1995. The company offered IPO in May 1997. In addition, Amazon.com launched its music store in1998, thus the company became the most important Internet retailer. Its products including computer, music, tools electronics, health and beauty products, videos, toys, housewares, kitchenwares’s, apparel, furniture, food, etc. Amazon has expanded nationally and internationally, and established international websites in UK, Germany, France, Canada, China and Japan. Now it is headquartered in Seattle, Washington, and become the largeste online retailer in the United States ,with about three times the Internet sales revenue of the runner up, Staples, Inc. as of January 2010.

Before answering the questions I think it’s important to understand the the environment of Electronic Commerce market in which Amazon operates. In this paper, I will use Porter’s Five Force to analyze the environment which might can help me to answer these problems.

Describe Amazon.com’s strategy and evaluate its fit with the company’s internal and external environment and its success in creating competitive advantage?

Amazon’s Strategy:

The goal of Amazon is sacrificing short-term profits in order to build long-term growth, market share, and increase stockholders’ value. Its’ internal goal is focusing on extending the market share, expanding product offerings and increasing total revenues. Its mission is to start with the customer-centric company. In addition, the company likes doing the promotional activities including advertising and promotional alliances in order to attract more customers. Also, Jeff Bezos tends to cut expense through producing an operating especially advertising.

External Analysis of Amazon.com

Threats of Substitutes Products or Services

1. Easy to sell in the Internet

2. Products sold in the E-Commerce industry can be sold by other companies that are inside or outside industry

E-commerce Industry Competitors

1. Strong

2. eBay, Yahoo, MSN, Wal-Mart, Barnes&Nobles,etc

Threats of Entrance of New Enterprise

1. Industry is attractive, so not significant barriers to enter into E-commerce industry.

2. The industry adopted a diversification strategy of sell, thus products available to customers are not very differentiated.

Bargaining Power of Suppliers

1. Lower

2. Products existing in E-Commerce Industry are sold by many firms

Bargaining Power Buyers

1. Strong

2. Easy to find other suppliers in the E-Commerce industry

3. No brand loyalty in the industry

4. Cheap price and good quality products

5. Providing with lots of options

Poter’s Five Forces Model of Electronic Commerce Industry

Based on the Poter’s Five Forces Model, we can see Amazon’s competitors including eBay, Yahoo, MSN, Wal-Mart, Barnes & Nobles, etc.

Below I will conclude the external environment of Amazon.com according to the Porter’s Five Forces:

1. Competitive rivalries

Basically, Amazon.com ‘s main competitors are eBay and Barnes & Noble. In the field of bookselling, Barnes & Noble is one of the largest booksellers and receives above six million visitors per month. Although Amazon can provide different kinds of books and build an interactive retailing company beyond books, some customers still like a relaxing environment offered by Barnes & Noble. Like Amazon, Barnes & Noble created its online stores which can provide convenience to the customers.

Another powerful competitor is eBay because it is the largest auction market in the world today. Same as Amazon, consumers almost can find everything for cheap by entering into the auction process. This advantage might take away some customers of Amazon.

2. Bargaining Power of Buyers

According to the model, basically, the power of buyer is strong because each person can use his/her mouse to find what we need online. Thus, we can conclude that Amazon’s power of buyers is strong.

3. Bargaining Power of Suppliers

Amazon has a large customer base and strong competitive advantages such as technology innovations and cost leadership, it is very hard for supplies to raise price because products existing in online shop can be provided by many firms. Also, the orders of Amazon are considerable quantity due to large customers, and suppliers do not want to give up the business. Thus, we can say Amazon’s power of supplier is low.

4. Threats of Entries

The online store is very attractive. That’s why many companies want to join the new market. Although it does not have a high entry barrier into this industry, how to set up a brand loyalty becomes very difficult. That means the company need to consider the convenience to the online shopper, cheap price, a variety of products. In addition, if the company wants to win the competitor, it must invest on IT expertise, on-going technological innovations and other investments. Also, comparing to the price of department stores, the customers now has 40%-50% discount rate. So Amazon has very low threat of entries.

5. Threat of Substitutes

Comparing with traditional bookstores and supermarket, the book sold on Amazon website is 40%-50% cheaper. Also, Amazon provides super save such as free shipping and the customers do not need to pay the tax on the website. That can save a lot of money. Sometimes consumers will choose the traditional department store if the consumers prefer an enjoyable environment to read such as Barnes & Nobles offered, or if the shoppers do not want to wait a long time for the products because generally we need 3-7 days delivery. Basically, Amazon has low to medium threat of substitutes.

Moreover, I want to mention the Economic Environment. The economic crisis has a negative impact on Amazon’s sales due to the declining purchasing power. Also the currency exchanges rates might affect Amazon because it operates online website internationally.

Internal Analysis of Amazon

Relationship between Resources, Capabilities and Competitive Advantage

Strategy

Key Success Factors

Competitive Advantage

Organizational Capabilities

Resources

Tangible Intangible Human

Cash Brand loyalty Jeff Bezos

Website Low Prices with executive

Warehouses Information Technology team

Marketing and Distribution

In order to deeply analyze the internal environment of Amazon, I will use value chain to describe its capabilities.

Value Chain Model:

Value Chain Analysis:

Support Activities

Firm Infrastructure: It provides services to customers, sellers and developers through its retail websites. It also manufactures and sells the kindle e-reader. Amazon offers programs that enable sellers to sell their products on its websites and their own branded websites. The company has organized its operations into two major segments: North America and International.

Human Resource Management: Amazon has an organic organizational structure. The reason is that E-business tends to take on organic properties in order to achieve the necessary flexibilities, speed and openness.

Technology Development: Amazon was built in Seattle because it had a large pool of technical talents. Bezos created innovative software and programming. Amazon is the Customer Service leader among e-tailers using Customer Relationship Management (CRM) and Information Technology (IT) support its business strategy.

Procurement: Amazon adopted e-procurement which brings the experience of Amazon.com to the purchase of academic supplies and equipments.

Primary Activities

Inbound Logistics: Technological development and selective procurement that can filter the choice of product and services from retailers and producers for customers to have more safe transactions. In addition, Amazon has the advantage of avoiding the overhead and carrying lots of inventory due to the book order from the distributors.

Operations: Amazon has organized its operations into two parts including North America and Overseas. Recently, the company purchased Touchco which is a screen technology company in February 2010. Amazon use high-tech efficient warehousing models.

Outbound Logistics: Amazon developed distribution in-house, and used optimum distribution network determined by Supply Chain Strategist software from i2 Technologies In addition, it outsourced some deliveries to UPS and USPS Marketing and sales – Marketing and Sales: Revenue represents an increase in North American division sales because of reduced prices for consumers and higher income from International division.

Services: Using online advertising techniques Service thus can secure shopping experience. Amazon also offers product review and recommendation.

Based on the previous analysis, the core competitive advantages of Amazon lies in two aspects:

1. Low prices: secured by its comparably low costs. The reason is that Amazon’s operational model saves significantly on logistics costs and human resources.

2. Specially customer shopping experience: originated from the knowledge of customer preference and its website and database design.

In order to give a better picture of the internal analysis, I would like to do a swot analysis about Amazon.com.

SWOT Analysis

Helpful to achieving the objective.

Harmful to achieving the objective.

Internal Origin (attributes of the organization)

Strengths

1.Initial location

2. Cheap products

3. Broad product assortment

4. Leader in E-Commerce business

5. Great online-customer service

6. Effective value chain (I mentioned earlier)

7. Strong revenue growth (29% to 37%)

8. Technology development and technological innovation

9. succeed in expanding the international market

10. Strong marketing strategies includig the lower cost operation comparing to B & M

Weakness

1. Limited operating margin

2. Waiting time for customers to receive their books and products

4. Limited services to developing countries including regulated Chinese operations

5. Bad investment decisions

6. Interruptions due to seasonal business

External Origin (attributes of the environment)

Opportunities

1. Bookseller becoming a retailer (from one stop shopping online store for customers)

2. Rapid growth of global Internet users

3. Improvement of Technology

4. Expansion through strategic acquisitions

5. Recovery of the economy

6. Growth of web-based stores

7. Technology development

8. New service offerings to the customers

Threats

1. Increase number of B&M retailers also operate online business

2. Foreign exchange

3. Suppliers sell their products directly to the customers

4. Economic factors such as foreign exchange risk

5. Government regulations

6. Competition from Brick and Mortar Stores such as Wal-Mart.

Source: OneSource Database and Business Source Complete

Amazon’s Competitive Advantage

Here, we can compare Amazon and its main competitor eBay.

Amazon vs. eBay

Amazon

eBay

Position

One of the largest E-Commerce players.

One of the largest E-Commerce players.

Growth Rate

Increased from 29% (Q4 2009) to 34% (Q1 2010)

Grew at 8% in Q1 2010

Performance

Good performance.

Flat performance comparing Q4 2009

Source: OneSource Database

After comparing with its main competitor eBay, we can find some competitive advantage of Amazon. Next, we will talk about Amazon’s competitive advantage.

What Do Customers Want?

How Do the Firm Survive Competition?

Key Success Factors

Cheap price and good quality products

1. Inventory.

2. Economies of scale.

3. Low threat from new entrants.

4. Business performance

1. Good business performance

2. Strong growth rate: 29% (Q409)-37% (Q110).

3. Strong revenue growth.

Good customer service and good experience

1. Offering good service to customer and setting up a good relationship

2. Helping and following up with customer

1. Customer-Centric Business (customize offerings for each customer and create a home page specially for them)

2. Adopting various technologies to make its websites customer friendly

3. Easily cater to the customers’ needs

Reliability of supply and variety in products

1. Good distribution channel

2. Different kinds of products

1. Broad product assortment due to a on-stop shopping environment

2. Building its own distribution centers in different locations and moving the products directly from the factory thus can reduce its marginal costs

Convenience Online Store

1. Opening many online stores including domestic and overseas

1. Amazon has expanded nationally and internationally, and established international websites in UK, Germany, France, Canada, China and Japan.

After analyzing Amazon’s internal and external environment, we can conclude its competitive advantage.

4. Effective implementation

Amazon.com’s Successful Strategy

Strategy

The Firm

*Goals and Values

*Resources and Capabilities

*Structure and Systems

The Industry Environment

*Competitors

*Customers

*Suppliers

1. Long-term, simple and agreed objectives

3. Objective appraisal of resources

2. Profound understanding of the competitive environment

We can look at this model and then make a decision whether Amazon’s strategy fit with its internal and external environment.

We can analyze Amazon’s strategy on the left side. As I mentioned earlier, Amazon’s goals and values are sacrificing short-term profits in order to build long-term growth, market share, and increase stockholders’ value. Its’ internal goal is focusing on extending the market share, expanding product offerings and increasing total revenues. Its mission is to start with the customer-centric company. If we look at them they are long-term, simple and clear objectives. Also, we can make conclusion in the part of resources and capabilities, value chain analysis, five forces analysis and SWOT analysis.

Likewise, we can look at the right side Amazon is surely ahead of its competitors. I compare Amazon and eBay revenue growth from 2009 to 2010 (currently). Amazon’s mission is to start with the customer-centric company, and knows what customers need. The company has a large customer base and make large orders thus the suppliers has less power to raise the price.

In addition, I use SWOT analysis to analyze the external environment of the company. Although experienced the economic downturn, Amazon still has a lot of opportunities.

With the US economy recovery from recession, retail sales are expected to improve in the country which might increase the sales of Amazon. In addition, with the development of science and technology, more and more people like shopping online, and the rapid increase of global Internet users might also increase Amazon’s revenues.

By providing new services to the consumers, Amazon has the chance to increase its sales and build strong relationship with customers. Also, through a serious of strategic acquisition, the company can accelerate its growth prospects. For example, Amazon purchased Touchco which could bring about the cost reduction in its business as the technology used by Touchco mush lesser than touch screen technology used in Apple’s iPad and iPhone.

2) Use your analysis of Amazon’s strategy to evaluate Amazon’s stock price. Does it suggest the stock is overpriced, underpriced or fairly priced?

In order to evaluate Amazon’s stock price, I want to use the method of Discounted Cash Flow.

At first, we need to calculate the WACC of Amazon.com because we need the WACC to calculate the FCF. In addition, I get the data of Rf and Rm from S&P database. Below is my calculation about WACC:

We use the formula:

WACC calculation:

WACC = (1-tcorp)*rD(D/V)+rE*(E/V)

where rE = rf + B*(rM-rf)

After getting the data of WACC, we need to prepare the DCF analysis to evaluate the stock price. Below is my assumption about FCF:

Assumptions:

Growth rate

35%

Operating Margin

4.50%

Tax rate

25%

â-²NWC

-1%

WACC

4.31%

Before doing the DCF calculation, I want to explain why I use these data.

1. Growth Rate.

We can look at the trends of sales in the four segments that Amazon reports:

Source: Annual Report 10K

From this graph we can see Amazon’s domestic and international segment witnessed a sales growth due to several factors. One is Amazon continue to reduce prices for customers including Amazon Prime and super save shipping (Free shipping). Also, Amazon increased its product assortments and inventory which can add value to its total sales. 3P program is very popular.

Also this figure can show Amazon’s competitive advantage of strong growth revenues comparing with E-commerce and retail industry.

Here I download these data from MorningStar Database, and get the average growth rate at about 36%. So my assumption of growth rate is at 36%.

Source: MorningStar Database

2. Tax rate.

Based on the Reuters.com analysis, my assumption of tax rate is at about 25%.

Source: Reuters.com

3. Operating Margin

Although Amazon’s business model looks incredibly scalable, its operating margin isn’t like we expected. Operating margins decreased from 6.4% in 2004 to 5% in 2005. Now is at about 4.6%. However, its asset-light business model and high inventory turnover allows Amazon to generate high returns on invested capital. Here I estimate Amazon’s operating margin remains at about 4.5% in next 5 years.

4. Changes in NWC

Source: OneSource Database

Actually, Amazon.com has a negative working capital but that not means the company does bad performance. The reason is that customers pay rapidly, and Amazon has no problems to raise cash. Also, products are delivered and sold to the customers before the company ever pays for them. The negative working capital can fit Amazon’s advanced inventory management methods. The company can have the ability to negotiate beneficial payment terms with vendors. Moreover, the negative working capital can allow Amazon to avoid the huge capital charges connecting with buying and storing such a broad line of inventory. Here I predict Amazon’s net working capital change rate at about negative 1.2%.

Based on the assumptions, next I will calculate Amazon’s DCF in order to evaluate its stock price.

DCF

Source: OneSource Database

According to the DCF I calculated the stock price is at about $227 per share. So in my point of view, the stock is undervalued and it will continue to go up. Although the company faces the price war with other competitors like Wal-Mart, there are still some opportunities lies in the further modernization of retail sector and gobal markets. In addition, through acqusition, Amazon can enable itself to set up a wide its product base. Also it will help Amazon to offer better service catering to its business strategy cusomer-centric. Also, its strong revenue growth reflects its strong marketing strategies. That’s why I think Amazon’s stock price will increase in the future.

Conclusion:

Basically, Amazon’s primary advantage depends on its low cost operations and offers a great variety of products to customers. Currently, with its infrastructure in place and low the cost to maintain its network, allows Amazon to price below its brick-and-mortar peers while still earning a profit. Also, the company focus on the customer service which means its brand represents the good service and value. Its successful business strategy makes Amazon’s revenue strong growth. However, Amazon now is facing two major threats. First, the implementation of an online sales tax might diminish the firm’s low price advantage. Second, is the digitization of media. Although Amazon has an early lead in the e-book market with the Kindle, it’s hard for Amazon to prevent the company from replicating this model in books, DVDs, video games due to less experience in developing superior hardware and software applications. Amazon can use its strategy to leverage its assets by introducing new product lines, allow third-party merchants to use its infrastructure.

needs to be modified.