Thursday, August 9, 2012

Deconstructing Amazon’s Feedback Loop...A New Series

So far I’ve put the feedback loop out there (twice!) with no real explanation. What a tease! Okay, we’ll dedicate this post to deconstructing that schematic at a high level in preparation for building it back up in greater detail.  This is the first article in what's bound to be a longer series than I currently intend. Unfortunately for readers, the Bard's words are lost on me - brevity is the soul of wit - as I clearly lack both. 

Amazon's Feedback Loop

The nature of a feedback loop is that its outputs don’t escape from the system. They get recycled back in, and this creates a compounding effect as they become the fuel to churn the loop and create even more outputs. Which are again recycled back into the system, and the loop churns ad infinitum. 

It’s recursive. It feeds itself. It’s a perpetual motion machine. 

In the Amazon Feedback Loop, the fuel is cash. And in the simplest sense, it runs like this: 

Amazon feeds cash into the loop, investing in the growth levers – lower prices, wider selection, and enhanced convenience. This earns it a greater portion of the broad middle, bringing more customers to Amazon, producing more sales growth in the form of higher volume (more overall sales) and faster velocity (selling its inventory at a quicker rate). The combination of volume and velocity generate more gross profit dollars (cash) as well as negative working capital dollars (cash) which Amazon can then use as fuel to feed back into the loop. 

And the feedback loop churns and churns. Unless competitors can keep up (unless they can BOTH create cash AND make the decision to invest it in the growth levers), Amazon pulls further away with each repetition of the cycle. 

We’ll spend the next several articles reviewing the individual components as we deconstruct Amazon’s Feedback Loop. Next, we’ll focus on convenience, that growth lever which provides the greatest distinction (in a good sense and a bad sense) between web retailers and traditional retailers.