Monday, August 6, 2012

Bringing It All Back to Amazon: Summary and What’s Coming



Amazon's Feedback Loop
After six entries in this series, and spreading it out over two weeks, we're finally getting back to Amazon and its feedback loop. I hope you’ve muddled through all this build-up. 

Here’s the quick version of what we’ve covered so far: 

The three variables most important to a retailer’s growth are prices (the lower the better), selection (the wider the better) and convenience (make it easy for the customer to buy your stuff). There are other variables of course, but these three – dubbed the Growth Levers – earn you access to the Broad Middle of the market…that portion with the most customers. By reaching the broad middle, you get high growth. 

The key that gains you entry to the best growth in the broad middle is low price. Sam Walton discovered a power law relationship between lowering prices and increasing sales, the more you lower them the higher your sales volume goes. And it’s not a 1:1 type relationship; Walton found that it was more like 1:3. So Walmart built its business on this premise, even instituting the productivity loop as a way to keep costs down so it could pass those savings on to customers in the form of lower prices. Those lower prices complete the productivity loop by driving an even higher volume of sales. 

Finally, we delved ever so lightly into game theory, putting together a scenario to test former Walmart CEO David Glass’ statement: 
We want everybody to be selling the same stuff, and we want to compete on a price basis, and they will go broke five percent before we will. 
We constructed the Price-Cost Matrix and tested how each quadrant would fare against the others. Our simple logic led to the equally simple conclusion…Low Cost, Low Price is the best competitive advantage because it will win the price wars. For the fanatic willing to lower prices over and over and over again, he will win as long as his cost structure is the lowest, too. The other competitors will go broke five percent before he does. 

And now (FINALLY!) we’re back to Amazon… 

It's all too obvious that Jeff Bezos spent plenty of time internalizing the lessons of Walmart's success, most importantly that low prices strike a chord with consumers. The lower your price, the more your sales grow...in exponential fashion. 

Bezos would also recognize that the right combination of investment in the growth levers would deliver the astute retailer to the broad middle of the consumer market. That fattest portion of the bell curve distribution. That area that offers the greatest potential for growth. 

And Bezos is nothing if not ambitious. Growth is what he wanted from the outset. And he did not face the same limitations as Sam Walton and other retailers in the physical world of selling goods out of storefronts. That need to balance your investments with the bulk going into real estate (location, location, location). Location was far less important when selling goods over the web. Shoppers could access your store from any computer, and you could ship products from any warehouse location. The merchandise would get to the customers all the same. 

The web - theoretically at least - would allow a retailer to push all the growth levers simultaneously. Moreover, the web could allow a SINGLE web-based retailer the ability to offer the lowest prices, the widest selection, and be the most convenient place to shop online. The implications of that are huge (and I believe Bezos understood this intuitively): if Amazon could push all three growth levers further than anyone else, it had the potential to dominate. It could be the sole place shoppers would go when ordering something (anything!) online. It could be so dominant, shoppers would never bother trying other sites at all. It had, in short, the potential to be UBIQUITOUS. 

In the early days of web retail, a time marked by vicious competition in pursuit of staking a claim to various niches on the internet, the real constraint to any player looking to grow was cash. But with the right amount of cash and the right approach to pushing the growth levers, a single web retailer could emerge as the sole winner. It could be so big, develop such an advantage based on the growth levers, that no other retailer could catch up. 

Of course the corollary of that was also true: any retailer with access to cash and this same vision could invest in the growth levers in pursuit of its own ubiquity dream. 

This was the hallmark of the web retailing in the earliest days. And this is what prompted Amazon's land rush approach to growth. But we'll get to that later. First, let's deconstruct the Amazon Feedback Loop and wrap our minds around what exactly it’s meant to convey. That’s next…