Amazon and the Showroom Effect

The Little App That Caused So Much Trouble

I have this little app on my smartphone called Amazon Price Check. I can take it into Target, scan the bar code of any item I’m thinking of buying, and Amazon will check its catalog to let me know if it offers the same thing at a better price. If so, I make an instant decision whether to walk out of Target with purchase in hand or wait for Amazon to deliver it to my doorstep, exercising some patience in exchange for saving a little cash. 

This is a ruthless test of how well stores are maintaining the protection of the convenience barrier; how well “have it now” is holding up against the customer decision to delay gratification and wait for delivery. 

The real melee from this little app came last Christmas when Amazon went right for the stores’ jugular. Not only could you conduct the price check, but Amazon would subtract an additional five percent of the purchase price if you bought it from them on the spot. Vicious! 

The promotion created a maelstrom, turning Amazon into a political punching bag as even U.S. Senators weighed in on how this little app might usher in an online retail dystopia. They conjured images of abandoned shopping centers blighting the landscape with legions of unemployed cashiers rattling tin cups for donations as everyone turns to online retailers to buy their stuff. 

The grandstanding brought, of course, loads of media attention which – to Amazon’s resounding pleasure – provided what was sure to be millions of dollars in free publicity for the app, leading to more downloads and wider usage during the holiday season. 

I used it. It made me feel a little sheepish. I would glance furtively around as I scanned some potential gift for my daughter, fearing the judging glare of some Target associate watching me erode some tiny sliver from her means of earning a living. It seemed almost immoral. But the more I did it, the easier it became. The less guilt I felt. Amazon knows this. Amazon understands how habits are formed.

Showrooming 

The practice has been dubbed “showrooming.” Shoppers use the shelf space at Best Buy, Target, or any another traditional store to look at a product, touch it, turn it over in their hands, try it on for size, and then order it for less at Amazon. The store becomes a testing ground for all sorts of merchandise, but never wins the sale. 

It’s been happening for a while, but it’s only with the introduction of simple little apps like Price Check that the practice has become nearly frictionless. Where shoppers used to plan their showroom tours in advance - collecting product and price information online in preparation for their store visits – now they do it without the effort of premeditation. 

All traditional stores have been forced to consider their tactical responses. Target has been most aggressive in its response, treating Amazon’s Christmas promotion as an act of war (which it was). It responded first by pulling the Amazon Kindle line of products from its shelves. And sensing that it’s fighting for its life (which it is) it then upped the ante. Target pulled a page from the Lowe’s vs. Home Depot battle plan and adapted it for the showrooming battle.

Target Learns from Lowes 

Amazon wants to set the agenda for how much selection is presented by retailers and the price at which it’s offered. They want complete, universal selection, and they want the lowest prices. This will bring the shoppers. It’s the low-cost, low-price strategy for winning the patronage of the broad middle of the market. 

But the retail wars do not take place on a fixed field of battle. The players move constantly; the tactics evolve; the momentum swings. The industry is such a brutal place to compete because everyone can see what everyone else is doing. Once a new tactic works, your opponent either adopts it for himself or counteracts it with his own maneuver, negating whatever benefit it provided. 

For example, have you ever felt perplexed by the never-ending tug-o-war between Lowe’s and Home Depot? Both make some form of a low-price guarantee, making assurances you won’t find their competitors offering the same product for less money. If you do, they’ll match the price and perhaps throw in an additional discount to boot. These programs have all the hallmarks of a war of pricing attrition. (Think back to our pricing game theory discussion here.) The consumer certainly benefits, but at what cost to the businesses? 

But these retailers are a cunning bunch. Their price match guarantees are legitimate, but they have taken great pains to offer very little overlapping merchandise. They are masters of stocking items that count as functional equivalents but not exact matches. They get big manufacturers to build special models, or entire product lines, just for them. Lowe’s version is very similar to Home Depot’s, but it’s rarely the same thing. 

Because of their size, the volume of sales they drive for manufacturers, and the sophistication of their merchant operations, the home improvement giants can make demands for tailored products. The practice creates a sort of détente in their ongoing battles. They fight over plenty of other things, but they’ve figured out how to avoid doing grievous harm to each other on the pricing front. 

Target executives are no dummies either, and they have plenty of muscle to throw around with manufacturers. They’ve demanded that suppliers provide them with exclusive items unavailable at any other retailer, most notably Amazon.  I’ve noticed this for some time when looking at, for example, Sesame Street toys for my daughters. An increasing number of the Elmo products come in packaging with the distinct Target bulls eye stamped prominently on the front with the words “Only at Target.” 

These items brings with them unique barcodes. Using the Price Check app or not, you won’t find this Elmo in the Amazon catalog. Much like the price guarantees with the home improvement stores, there won’t be an exact match to spark a pricing war.

Fighting Showrooming By Playing a Different Game 

Expect more and more of this from Target and other traditional retailers. Because they move such high volumes of product for all the national brands, they can exert some pressure to get help in the showrooming war with Amazon. 

Target is a grizzled veteran in fighting companies with wider selection and better means of offering lower prices. They’ve managed to co-exist with Walmart (not as happy neighbors mind you, but they co-exist nonetheless) despite the latter’s firm commitment to what I’ll call the Glass Doctrine…that statement of intent from former Walmart CEO David Glass: 

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.

If Walmart wants to commoditize everything and sell it for less, Target (in addition to pushing its “upscale discount” corporate brand approach that we featured in an article here) will source alternatives to the nationally branded products. It will (and has) invest heavily in its own store brands, price them for less, and give shoppers a choice. It won’t be able to beat Walmart on the price of Tide detergent on a day-in, day-out basis, but it will provide its Up & Up alternative at a nice discount. 

As an aside, this can be a tremendously effective approach to differentiate your selection from the competition, escaping the deep wounds suffered in toe-to-toe pricing battles. Think Trader Joe’s. Its entire business is built on the idea that a store can be stocked almost exclusively with its own brands. Trader Joe’s IS the brand. It doesn’t carry Tide, Oreo’s or Wheat Thins, so customers can’t make direct comparisons on price against national brands. This has proved an effective way to avoid the Glass Doctrine altogether. Just refuse to play the game by another retailer’s rules. 

Perhaps this becomes the model for fighting the showrooming effect…Don’t play their game; make up your own rules. 

Back to Amazon 

Amazon will continue its push toward universal selection and cheaper prices. It will find brilliant tactics to help consumers compare its offers against the same items being offered at stores. But don’t expect the stores to cede their advantages without a major fight. 

They will work hard to impede Amazon’s attempts to commoditize everything, to offer everything at a lower price, to adopt the Glass Doctrine as its own. There’s a long history of fighting the selection wars this way, and Target is leading the defense now. 

Expect retailers to look for similar ways to frustrate Amazon’s attempt to offer universal selection and win on price.

Amazon’s Inflection Point and Lessons from Brer Rabbit

To close out our discussion of Amazon’s convenience infrastructure, we turn now to current events and consider how collecting sales tax might be the biggest boon to Amazon’s retail business, a body blow to the stores, and the end of the convenience barrier. 

Of Inflection Points 

Andy Grove’s excellent 1996 memoir, Only the Paranoid Survive, injected the term “strategic inflection point” into popular business parlance. The former leader of chip maker Intel recounts the crossroads in his company’s history where the decisions he made led to momentous, industry-altering outcomes. 

For example, since its founding, Intel had made its name by packing more space onto smaller wafers of silicone in the memory chip business. It did very well in this market until Japanese companies killed them on price and quality in the early-1980’s. They were at an inflection point. Market circumstances had changed. The dynamics of the industry had changed, and Intel simply could not compete. The company was hemorrhaging money and needed a different strategy. 

Groves led his teams to the difficult conclusion that they must get out of the memory chip business altogether. They threw themselves into becoming the leader of microchip processing technology. As the history books tell us, these decisions forever changed the trajectory of Intel as a company as well as that of the entire computer industry. 

Such inflection points are hard to identify in the real-time fog of battle. When looking backwards, however, the events stick out; the specific decisions define the future of the organizations involved. 

But every once in a while the variables line up in such a way that the outcomes seem all but inevitable. We’re now at one of those times with the retail industry…an inflection point that’s sure to force a dramatic shift in market share balance from shopping centers to online stores. 

The Sales Tax Inflection Point 

We’ve discussed in some detail the concept of the convenience barrier, that human desire for immediate gratification that keeps shoppers heading for the stores rather than buying more of our stuff online. For so much of what we buy, we simply don’t have the patience to wait a few days for our favorite web-based sellers to deliver the goods to our doorsteps. We endure the hassle of regular shopping for the pay-off of trotting out of the store with our purchases in hand. 

But the convenience barrier is not as fixed a defense as retailers like Walmart have long assumed. By continually compressing the time it takes to deliver its packages, Amazon has demonstrated a certain gratification continuum whereby any improvement in delivery time leads to more consumers opting for the online option over the tedious experience of heading out to the stores. 

The more Amazon compresses that delivery time, the more shoppers it attracts. That’s why the company invests so heavily in the delivery portion of its convenience infrastructure. By building more warehouses (and improving the efficiency of those facilities), Amazon gets closer to you – its customer – and reduces the lag time between your 1-Click purchase and that package being dropped on your front porch. Those investments to enhance customer convenience are whittling away at the convenience barrier, earning Amazon the business of more consumers in the broad middle and stealing customers from traditional retailers. 

Despite the tremendous growth these investments have wrought over the years, Amazon can do more. The convenience barrier has not yet been breached. It is holding together – albeit tenuously – by the lag between getting your stuff today at Walmart and having to wait an average of two business days when buying on Amazon. The company can do more both in terms of improving delivery speed and in taking more market share. 

What’s holding it back? Oddly enough, it’s tug-o-war with various states over whether Amazon should be compelled to collect sales tax on behalf of its customers. Amazon has long argued, with a zealot’s fervor, that a 1992 Supreme Court ruling prevents any government from forcing a business with no physical presence in the state (like a warehouse) to tag a sales tax levy onto purchases made by residents. It’s the responsibility of the shopper to tax himself, self-report it to his local department of revenue, and cut the government a check every quarter of so. Not surprisingly, only the most earnest of Boy Scouts ever follow the rules. 

Amazon has enjoyed this loophole exemption since its founding, and it has used the five, six, seven percent “rebate” as a pricing advantage over store-based retailers. This has long infuriated the stores, and they’ve lobbied the states and Congress to change the law. Amazon has fought those attempts. But with budgets in such perilous condition these past few years, states have upped the ante. They’ve been pressuring Amazon in every way imaginable to start contributing to the coffers. 

And Amazon has begun capitulating, negotiating agreements with various governments to start collecting in return for incentives to build fulfillment centers and create new jobs. In the meantime, Amazon lobbyists are walking the halls of Congress, pressing for a national, uniform sales tax. 

Herein lies the sales tax inflection point. Amazon wants to build those fulfillment centers. As we discussed previously, it takes the warehouses from rural areas (cheaper land, cheaper labor) and puts them right against the perimeters of the largest U.S metropolitan markets. Los Angeles, San Francisco are likely to join New York City, Philadelphia, Chicago, Boston, Phoenix, and others as cities in which Amazon offers same-day Local Express Delivery. 

By paying sales tax, Amazon can operate freely in states with lots of paying customers. It will be able to build many more fulfillment centers in close proximity to those customers and work hard to improve its delivery speeds. Sure, the total price of its goods will go up, but the company seems confident it can weather that problem. (Indeed, it’s not hard to imagine Amazon suffering lower margins for a time in order to minimize the impact of sales tax on its prices.) Because ultimately, these fulfillment centers will put Amazon within striking distance of achieving nirvana for web retail convenience: delivering a product to customers as quickly as they could get in the car, drive to the store, and buy it themselves. 

The sales tax inflection point doesn’t require Amazon to reach the nirvana state. The convenience barrier is breached, I believe, when a critical mass of consumers can get their orders delivered overnight. 

Brer Rabbit Begs, “Please! Not the Briar Patch!” 

The great irony with the sales tax is how hard the traditional retailers are lobbying Congress and state legislatures to bring Amazon to account. They see it as a matter of price, not of convenience. They believe Amazon will finally lose its pricing edge and hardly worry what it means in terms of Amazon taking full advantage to provide faster delivery and better convenience. 

They seen an opportunity inflict pain on their web-based foes, and they’re blind to the unintended consequences of their campaign. In particular, they’re blind to what it means for their own best competitive advantage, the convenience barrier. 

I’m reminded of the Uncle Remus story of Brer Fox and Brer Rabbit. Fox was keen on catching rabbit and teaching him a fatal lesson for outwitting him one too many times. Fox concocted an elaborate ruse involving a tar baby, and managed to snare Rabbit in the trap. Once caught, Rabbit begged for mercy: 

“Drown me! Roast me! Hang me! Do whatever you please," said Brer Rabbit. "Only please, Brer Fox, please don't throw me into the briar patch." 

Fox, imagining his enemy being torn to pieces, tossed Rabbit into the thorns with the bitterest contempt, and cocked his ear to listen for the sounds of anguish. 

He heard nothing. 

Then Brer Fox heard someone calling his name. He turned around and looked up the hill. Brer Rabbit was sitting on a log combing the tar out of his fur with a wood chip and looking smug. 

"I was bred and born in the briar patch, Brer Fox," he called. "Born and bred in the briar patch." 

And Brer Rabbit skipped away as merry as a cricket while Brer Fox ground his teeth in rage and went home.

Amazon Whittling Away at the Convenience Barrier

Amazon’s Fulfillment Center Binge

Amazon is on a construction binge, building fulfillment center after fulfillment center in a seeming reckless abandon of its bottom line. It added 17 warehouses in 2011, a 32 percent increase that brought its global total to 70. And it’s showing no signs of slowing this year. 

In the U.S., the new FC’s are going up all over the place. A handful of them follow Amazon’s old model in which the company finds cheap land to build mammoth facilities and staffs them with an abundance of laborers desperate for any wage, no matter how low. That’s a reasonable approach for an internet retailer. Given the growing sophistication of the delivery companies – UPS and FedEx in particular – you can ship your goods from anywhere and know they’ll reach their destination within two business days. So, it would make sense to build the biggest warehouses possible in the places you can take full advantage of cheap labor and cheap wages. The bigger the FC with cheap costs, so the thinking goes, the better the economies of scale. Which is why Amazon has built clusters of warehouses in the rural, post-industrial (i.e., high unemployment) corridors of places like Kentucky and Pennsylvania. 

To be sure, Amazon continues to follow that model. Many of the newest facilities are popping up in corporate-friendly South Carolina and Tennessee after the company has extracted favorable tax guarantees and other incentives from state and local governments. It’s easy to make sense of these. They follow Amazon’s long-heeded playbook. 

But then we have FC’s going up on pricy real estate on the outskirts of Los Angeles, San Francisco, and New York City. Under the domains of the notoriously business-wary, high-tax collecting states of California and New Jersey. This is a clear departure from the playbook. Surely Amazon doesn’t need to spend the kind of cash required to build and run warehouses near major metropolitan areas. It’s already serving those markets with its popular two-day delivery services plus its overnight options. 

Unless Amazon is signaling to the world that two-day delivery isn’t good enough…that it’s investing in this portion of its convenience infrastructure because it wants us to get those boxes, adorned with the Amazon smile, much, much more quickly. 

The Convenience Barrier and Walmart’s Blind Spot 

I’m going to make a bold assumption about the minds of retail executives following the dot-com collapse of 2000 and 2001. 

They believed the online threat made its best attack in the heady days of 1998 and 1999 when every niche idea was being funded as the web’s answer to Walmart. And since it failed to take away much of their business (indeed, most of the companies were liquidated in bankruptcy proceedings…the ultimate sign of failure), the traditional retailers lulled themselves into the belief that their stores had little to fear from the internet. 

Even in the best of times, they concluded, the web guys were running into the toughest headwind a retailer could imagine. Companies like Amazon were trying to sell products with a built-in three- to five-business day delivery delay to customers who were used to walking out of a store with packages under their arms. Shoppers were used to immediate gratification, and Amazon required them to delay the pleasure of instant consumption. The web guys were running into the headwind whose force emanated from human nature. 

A heavy dose of hedonism pervades the shopping public. They want what they want, and they want it now. It’s a human nature thing. If your success depends on their patience, you’re unlikely to earn access to that broad middle part of the market. This is the essence of the convenience barrier. Despite all the inconvenience of driving to shopping centers, parking, navigating the stores, and standing in check-out lines, at the end of it all you walk out with that thing you came to buy. 

So the retail executives thought the web would be, at best, relegated to the domain of niche products that would never fit on their shelves anyway. The internet would certainly never be able to overcome all that protection afforded by the convenience barrier. As a protection against the competition, they thought the convenience barrier – because it is rooted in that human desire for immediate gratification– is as fixed as they come. 

And so, after the dot-com implosion, the retail executives stopped investing their cash and energy into game plans for competing against Amazon. They wrote-off the internet and went back to battling each other. In doing so they created a blind spot in which Amazon was able to whittle away, ever so slowly and ever so methodically, at that convenience barrier with hardly a notice from the likes of Walmart, Target, and other big-time retailers. 

The Gratification Continuum 

The teams at Amazon never saw the convenience barrier as unassailable because they never saw shoppers’ desire for immediate gratification as a simple matter of yes or no. True, shoppers have a deep streak of hedonism. They prefer their stuff sooner rather than later. But when weighing the convenience benefits of shopping online versus in-store, consumers are willing to make trade-offs. They will demonstrate some patience in order to avoid the hassles of trips to the store. 

The desire for immediate gratification existed, therefore, on a continuum. The precise amount of time Amazon made them wait was critical in the shoppers’ decision to forego traditional stores, which meant the convenience barrier was far more fungible than it was fixed. 

That digital camera you want? If Amazon takes five business days to deliver it, you would probably head over the Best Buy and get it today. But if Amazon delivers it in three days, you’re more likely to avoid a trip to the big box. 

Those diaper bin liners you need for the nursery? You’d suffer through a trip to Walmart if, otherwise, Amazon required you to wait three days. But if Amazon can get them to you in two days… 

And that bag of Starbucks French Roast coffee you need so desperately for your caffeine fix early tomorrow morning? You’ll run to the nearest Kroger to get it this afternoon…unless Amazon could get it to you before you go to sleep tonight. 

Amazon never had to match the immediate gratification shoppers get from walking out of a store with package in hand. If they met customers just part of the way on that gratification continuum, shoppers would choose them over the stores. And in growing numbers the more Amazon compressed that wait time. So Amazon whittled away at the convenience barrier, putting cash to work building more fulfillment centers, eliminating defects to speed up warehouse pick and pack routines, and working painstakingly to optimize the hand-off of goods to UPS, FedEx and other delivery partners. 

And they did much of it while still in the comfortable anonymity of Walmart’s (and other retailers’) blind spot. 

The Progress of Amazon Delivery and a Glimpse into the Future 

Over the decade, Amazon has systematically dropped the time it takes to get packages from digital shopping cart to real-world doorstep. They reduced it from five business days to a three-day standard. Then they took away delivery charges. Then they offered Amazon Prime and made two-day delivery the standard. Then they added the ability to ship overnight for a modest additional fee. 

Now Amazon has placed a box on my porch on a Saturday morning, and I’ve heard others surprised by the same thing.* And its Local Delivery Express is providing same day delivery in ten of the largest U.S. metropolitan areas that are, not surprisingly, nearest to its fulfillment centers. They’re piloting same-day grocery delivery in Seattle. And, at the extreme, they’re already managing last mile delivery in many Chinese markets. 

The ambition is mind boggling. Amazon is not satisfied with two-day deliveries. They will continue investing in this arm of the convenience infrastructure. They have benefited from understanding the gratification continuum, but they haven’t stopped compressing it. One suspects they’re pushing to hit convenience nirvana wherein Amazon can get goods to you faster than you could get in the car and go to the store for it yourself. 

So, that fulfillment center binge that has Amazon constructing on the pricey land outside of San Francisco, LA and NYC? I think we can expect many follow-on stories to the recent reports of New Yorkers ordering from Amazon in the morning and finding the packages delivered by end of day. 

Amazon is pressing the convenience lever with a mighty force as the store-based retailers watch that “unassailable” convenience barrier get slowly reduced to rubble. 

Where does it all stop? Perhaps this video gives us a glimpse into the future. Perhaps it all leads us inevitably the Amazon Yesterday program! 

* Just imagine how much Amazon hates that it can rarely get those boxes to you on Saturdays and Sundays because UPS just won’t run the brown trucks on the weekend and FedEx charges a huge premium for weekend delivery. But you know Bezos’ brain trust in Seattle is scheming ways around this. I was surprised several weeks ago to get a FedEx box on my doorstep late one Saturday morning. It was an Amazon package slated for Monday delivery. I suspect Amazon is testing out some ways open up this weekend window; to improve even further this arm of its convenience infrastructure. And I’m sure the tests come at considerable expense. Most importantly, until their delivery partners help open this window, you can believe that Amazon views them with the sort of contempt it reserves for any middlemen that set up roadblocks between its services and its customers. 

Re: Google vs. Your Boys (but really about amazon)

We had a very pleasant lunch, as we always do. He is an old and good friend. He was amused by my unhealthy fixation with Amazon. And so he sends me this gentle barb a few days later:  Google is coming! [Links to WSJ article.] 

Uh-oh, a threat to Amazon's AWS cloud computing service. I get these challenges with some frequency from people that have learned of my obsession. I love them. Not so much because it offers a chance for debate and I consider myself the superior debater. I'm not. It's more because the challenges keeps me honest. 

It reminds me of the verse from Rudyard Kipling's "If": 

...If you can trust yourself when all men doubt you,

But make allowance for their doubting, too...

It's the only way to keep a kernel of intellectual integrity in his game of investing...look for challenges to your theses. Not to fight back and counterpoint the opposing argument, but for the strength and the wisdom the challenge could bring, giving you the opportunity to improve your models, test your reasoning. It's possible to find something nearing sublime in approaching the debate with philosophical detachment, shunning dogma as best as our bloated egos allow.

Unfortunately, our tendency is to seek out those of like-minded opinions, forming echo chambers for our views and doubling down on the risk of our wrongness being compounded in a confirmation marketplace.

Below is my reply to my good lunch friend:

Thanks for passing this on, T. I'm fascinated by this impending convergence of the major tech giants. They're all sitting on these enormous and valuable assets, mainly large customer bases and some combination of tech gear, tech infrastructure, and customer captivity. As a sort of manifest destiny, they are all compelled to extend and expand the use of their infrastructure...those assets. It's inevitable, as if the combination of management ego and economic drive for higher profits, creates a siren's song for the businesses to expand. I've started calling it the growth imperative, a set of behaviors I've noted in other industries, too.

So it becomes interesting with Amazon, Apple, Facebook, and Google. [See The Great Tech War of 2012 by Farhad Manjoo in Fast Company back in October 2012.] Their markets, as they expand, are overlapping more and more. They must compete, not only to grow, but also to make sure one of the competitors doesn't gain some advantage that allows them to attack their core markets....sort of like offense is the best defense.

A theory I've considering works something like this: cloud computing is a huge market that Amazon entered early and has pretty much controlled. Amazon is taking great pains to commoditize the industry - making the services non-branded - so it will be defined by who can offer computing at the cheapest price to customers. Amazon has demonstrated its willingness to make AWS (its cloud computing) cheaper and cheaper, having lowered prices 20 times since launching. Jeff Bezos has thrown down a gauntlet and dared others - IBM, Microsoft, a slew of tiny players, and now Google - to follow. Amazon has said it will make it all about price.

That creates a fascinating dynamic, and this is where the theory part kicks in. What company can afford to offer cloud computing the cheapest? Both Amazon and Google have deep cash reserves, so they can duke it out on low price there while subsidizing any losses with their own cash. That could be a painful war, and we must ask who would win.

My bet would be with Amazon, and for a simple reason...Amazon has demonstrated both an indifference to how the stock market perceives it as it pursues long-term dominance of an industry, and it has demonstrated a capacity to suffer while its stock price is getting killed because it is losing money in pursuit of dominance. Jeff Bezos frequently says he's comfortable being misunderstood for long periods of time.

So let's consider this like a game theory scenario...you have two giants pressing on the gas, hurling their dragsters at each other in a business that one of them (amazon) is willing to define by price. They will both take losses. The more they fight, the deeper those losses will be, and the more likely their stocks will tank as long as the war persists.

Jeff Bezos is fond of saying something to the effect of ..we want to sell the same thing as everyone else, but because we run more efficiently than they do, we can sell it cheaper. So if they want to have a price war, they'll go broke 5 percent before we do.

He's signaled to the world his intentions and his willingness to be a fanatic in pursuit of them. Now, how crazy is google willing to be as it enters the cloud computing market? How deep is its capacity to suffer? And remember, there's a lot of catching up to do since Amazon has been in the market since 2006.

In this game theory game of chicken, my vote is with crazy Jeff Bezos. That dude's a fanatic!

Amazon Entering Smartphone Game...Why?

Bloomberg reported this morning that Amazon has its own smartphone in development, that the company is working with Foxconn in China for production, and that it has actively been acquiring wireless technology-related patents in advance of the launch. See the story here. 

Even more so than its decision to challenge Apple's dominance of the tablet market by introducing the Kindle Fire, this move into smartphones is likely to leave a lot of consumers and investors scratching their heads. What business does Amazon - a web retailer - have getting into the phone market? 

Let me take a stab at that...

Convergence of the Tech Giants

Though Jeff Bezos will deny it until he's blue in the face, this is a classic move of defense by playing offense.  

There's a convergence going on in technology.  Apple, Google, Facebook, and Amazon are quickly converging on the same base of customers. To be sure, there is a growth imperative at play, too. Each of these companies has become accustomed to growing at a rapid clip, and each has the ambition (and gall) to believe it should continue growing. And as each runs out of room to expand in its core markets, it will seek new growth by introducing services that poach customers from the other tech giants. The spheres in which they operate, once so placidly independent of each other, are beginning to overlap. If you put a Venn diagram of their markets on time-lapse video, the shaded areas of market overlap would grow darker and darker with each passing year. Convergence is happening.

And in a converging marketplace, if you don't play offense by actively growing into your competitors' markets, you run the risk that they will grow into yours in the near future. Offense becomes the best form of defense. It compels you to grow, thus the growth "imperative."

(To put this in the appropriate context, you should take a look at Farhad Manjoo's The Great Tech War of 2012, published in Fast Company back in October 2012.)

An Aside on Google

Google has been the most interesting case study for both the growth imperative and how a company reacts to convergence. For the time being, Google is spinning like a dervish. It seems to believe it must compete with each of these giants...and NOW. Its rivalry with Facebook has been well-documented with Google+. (See James Whittaker's Why I Left Google blog entry.) That's a competition for the future of advertising dominance, and I think it makes sense.

What makes far less sense to me is Google's foray into retail with its "Prime" one-day delivery deal with bricks-and-mortar shops (see this WSJ blog description and the best overview from amazonstrategies.com here). Google benefits from competition among lots of retailers selling the same products and bidding up adword search prices to get premier listing on the search engine. But with Amazon becoming the ubiquitous web retailer, more consumers are skipping Google altogether and just going straight to Amazon for searches. This is costly for the search engine. And so it goes on the offensive, putting its considerable clout (and resources) behind an attempt at a competitive retail offering.

According to a Walter Isaacson (the Steve Jobs biographer) HBR.org essay back in April, Larry Page visited Jobs in his dying days looking for advice. Jobs asked him..."What are the five products you want to focus on? Get rid of the rest, because they’re dragging you down. They’re turning you into Microsoft. They’re causing you to turn out products that are adequate but not great.”...FOCUS! Isaacson credits Page with taking the advice to heart. I think there's plenty of evidence to the contrary.

Amazon Devices to Prevent Apple iTunes Dominance

But back to Amazon and the smartphones. Amazon dips its toes in the water a lot. It's renown for its constant A/B testing and its devotion to running with winning concepts while ditching the losers. So once it decides on a strategy, Bezos brings the company all-in. 

In that regard, the smartphones can viewed as an extension of the reasons Amazon developed the Kindle Fire. A sizable chunk of its business is electronic media (songs, games, apps, movies, and books), and that media is being consumed more and more on mobile platforms. Apple gained an early lead in the market for those platforms with iPod, iPhone and iPad, creating a close-looped ecosystem of content to boot. Jobs and company might let others sell their content on iTunes, but they extracted a pound of flesh in return. This was problematic for Bezos and Amazon. To prevent total dominance by iOS, he had to present an alternative.

So we received the first iteration of Kindle Fire. But we know that electronic media is consumed on other devices as well, so it's only logical that Amazon continues its all-in philosophy to ensure it gets a piece of that action, too. I would expect more (and better) tablets in the future. I would expect better links into television sets (Amazon branded set-top boxes). I would expect music players. And I'm not surprised by the smartphones.

So What Should We Anticipate from the Amazon Move?

First, lots of hiccups. We saw this with the early Kindles and with the Kindle Fire. It's unavoidable when entering a sophisticated new market with complicated electronic technology. Amazon was not a device manufacturer a few years ago, but it is nothing if not a learning organization. Expect it to build on its experience, constantly improve, and ruthlessly eliminate defects. So, hiccups at first, but Amazon will only get better. 

Second, a low price. Amazon is committed to the low-margin/high-volume business model. It has the capacity to suffer, a willingness to take losses on the early batches of inventory while it grabs market share and improves its cost structure. 

Third, potential volatility in its stock price. Going all-in on phones - while juggling lots of other growth initiatives simultaneously - has the potential to move Amazon from profits to losses. And Bezos is not afraid of letting his company lose money for a while if he believes it will pay off in the long-term. The market, however, will not take kindly to this. It's reasonable to anticipate bad financial press and a hit to its stock price if the company sports losses over multiple quarterly earnings reports.  

Return of the Land Rush Metaphor

In 2001 Bezos told Charlie Rose (here) that Amazon understood the early days of web retailing (especially 1998 through 2000) through the heuristic of a land rush metaphor. That era was also dominated by a growth imperative. If Amazon didn't move at an almost reckless pace to establish scaled operations, expand its product selection, and improve its technology, it risked another retailer - fueled by a steady stream of venture capital cash - converging on its markets and earning the trust (and the habits) of customers. 

Bezos recognized the risk of being outflanked, so he engaged in the land rush. He bought into every niche retailer that sold a product that he thought Amazon might want to sell someday, better to bring your enemies close than let them flourish outside your control. He invested heavily in technology and distribution infrastructure. He priced his selection as aggressively as he could to attract customers. He bled cash, almost recklessly, because it kept Amazon in front of the pack and reduced the risk that another retailer could gain a toehold in its market. 

That land rush mentality came from Bezos' survey of the landscape at the time telling him that a convergence was afoot then, too. We see what he did to ensure he came out of the convergence as the dominant power.  Indeed, he came out of the dot-com bubble burst as the sole hegemonic power of web retailing. Despite the Amazon stock price falling from $106 to $6, despite losing countless hundreds of millions in equity investments in competing web retailers, and despite losing upwards of $500 million in personal fortune as the stock plummeted...the bursting of that bubble took all the outside cash out of the web retail industry. Everyone had to fend for themselves, and Amazon was the only one that could. Bezos did alright through it all.

If he's reading the current technology situation with a mind to his experience in the early days of web retailing, I think we can expect him to turn to a page from his old playbook. He will compete ferociously, bordering on recklessness. He will lean heavily into his investments. He will play to dominate the markets. 

This post was originally published here on Adjacent Progression.

The Most Significant Battle in Amazon History (Why Bezos Celebrated the Bubble Popping)

On June 27, 2001 Jeff Bezos sat down for an interview with Charlie Rose. His comments over the course of 30 minutes provide much of what you need to understand the retail business of Amazon.com. We featured it originally in a post here. (And you can watch the full broadcast of the video here.) 

To remind you of the context, the interview corresponds with the steepest part of the dot-com collapse. Amazon's stock price had been in free-fall for 18 months, declining from $106 in December 1999 to $14 when he sat down with Charlie. And its drop wouldn't end until shortly after 9/11 when it hit a $6 bottom. Bezos own net worth dropped by half a billion dollars (reference here).  

And yet Jeff Bezos was doing all he could to hide his ebullience. 

Bezos welcomed the end of the internet-telecom bubble of 1998-99 for the simple reason that Amazon had reached scale and achieved a level of capital self-sufficiency that meant the company no longer depended on the goodwill of Wall Street for cash to grow operations. It was sitting on plenty of it and could generate more from operations.

The same was not true for other web retailers in the process of scaling up. They needed more funding to sustain themselves and grow. They had received a steady flow of it from venture capital firms willing and able to invest large sums in unproven businesses, confident they would recoup by bringing their seedling companies public in short time. But with the bubble popping, that all went away. It took down pets.com, wine.com, toys.com and countless other companies with which Amazon competed and (more interestingly) in which Amazon had made investments. 

Bezos had this to say about it with Charlie Rose:

So all these companies could get funded. And that's what created one of the imperatives for moving so quickly. Because there were so many start-up companies getting $60 million or more in venture capital. And those companies with that much capital, if that financing environment had continued for any extended period of time...many of those companies might have been able to build the scale to be successful.

Losing its investments in online competitors hurt Amazon, but only in the most superficial and temporary sense. Amazon invested in these businesses as a hedge. Bezos was already working toward the lofty goal of being the ubiquitous force in online retail...the only place people would shop. That meant he would expand Amazon into every conceivable product category, offering universal selection. Of course he couldn't get there immediately. He had to prioritize where the company invested its money and time. So he adopted the land rush mentality, investing in a broad swath of developing web retailers in early stages of growth. 

If the competitors could reach any sort of scale - with their software, merchandising expertise, and distribution capabilities - they could begin expanding into adjacencies. It didn't matter what product niche they specialized in to launch themselves, they could use the infrastructure to expand. They could threaten Amazon's objective to be ubiquitous. So Bezos bought the competition or invested in them, holding his enemies closer than his friends. 

One of the things we were very convinced of, and indeed was definitely true in the earlier days, is that there was a land rush phase to the internet. And so, when we saw product categories that we thought were important to our future at some point, but they weren't the ones we were going to do first...Pets.com, wine.com, etc....there were a bunch of things that we were invested in that didn't work out. We knew we weren't going to do those things anytime soon, but we wanted placeholders  in those industries so that later, perhaps, we could fold these industries back into Amazon.com. So that was driven by...a land rush mentality...It's hard to put a precise date on it, but I believe that for the first four years of our existence, that land rush mentality was correct. And the only reason we exist today is because we...behaved that way.

Then the crash came. The talking heads wanted to focus on Amazon's foolish investments in all these dot-com bombs, the value of which evaporated in a slew of bankruptcies. No doubt it hurt Bezos, but he had confidence in the bigger picture of what was happening. Why weep over these investments gone bad? They were hedges. The bigger bet was paying off. Your competition was gone, you didn't need Wall Street for more money, and you had scale.

Bezos was ebullient because he recognized, despite the stock price going down in flames, that he had just won the most significant battle in Amazon history. He was the last man standing. 

And so we can understand the confidence behind his statements in the closing minutes of the interview with Rose (emphasis is mine):

In the early days, that's when the company's destiny is really not in its own control. At this point in time, with the brand name that we have...we have so many assets now, now it really is under our control. We don't worry about externalities now. What we worry about now is that we don't do our job. And I'll tell you one of the things in this period that I kind of like is that it's a lot easier in the year 2001 for Amazon.com as a company to be humble, working our butts off, than it was in 1999 when the world believed we couldn't lose.

And this conclusion:

Charlie Rose: [Paraphrased] There are two schools of thought. One is that Amazon will become the most spectacular retailer of all time. The other is that Amazon may become the most spectacular failure of the internet era. What's the odds of the first being true versus the second?

Jeff Bezos: Let's put it this way: we get to decide, nobody outside the company can decide that. 

Jeff Bezos was history's happiest man for losing $500 million in personal fortune in 2001. He had long ago separated the concepts of the value the stock market places on his business versus the value contained within the actual operating business...the intrinsic value. Bezos knew how temporary that loss would be and the great path it set for Amazon's future.

This post was originally published here on Adjacent Progression.

Pricing Power Part I: Apple (AAPL) Demands a Premium

There are two forms of pricing power: the ability to raise prices and the ability to lower prices. The following is the first of a (two part? three part) series on pricing power as a competitive business advantage. 

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The ability to raise prices for your offerings, or demanding a premium over competitive products based on some perceived superiority of your offering, is an excellent indication that your business offers some form of competitive advantage. If you sell clothing, you must be appealing to some fashion sensibility. If you peddle electronic devices, your technology must address some consumer want. 

Having the ability to charge high prices can be very nice. Of course you must ask WHY you can charge the high price and whether the cause is defensible and durable for the long-term...or whether it's fleeting and likely to dissipate with time.

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I can't stop thinking about Apple (AAPL) as an example. It is the clear leader in consumer electronics. It has created beautiful products with elegant simplicity and the content ecosystem that gives users reason to keep on using. It is a beloved brand. Iconic even. So it is no surprise that Apple charges a tremendous premium for its products and does so unflinchingly.

Apple rolls out innovation after innovation. One can easily be lulled into believing that this string of successes portends a trend that will go far into the future, that each new cycle of the iPhone and iPad will demonstrate another "wow!" and send consumers running to Apple stores to secure their upgrade.

But what happens if Apple disappoints? Sustained innovation - staying at the lead of this pack - is very, VERY difficult. Expectations are incredibly high (Shleifer Effect anyone?). Competitors are emulating the technology and it would seem they're narrowing Apple's lead with each product cycle.

And the competitors are eager to charge a lower price. Think Amazon. Think about selling Kindle Fire at a loss. Think of Kindle Fire getting just a little bit closer to the iPad with each new generation. Think how Amazon offers an equivalent content ecosystem to keep users using...but often at a cheaper price. Think how difficult it will be to get price sensitive consumers to justify paying that premium as Kindle Fire gets better and better. 

Apple will just lower its price, you might argue. Or it will offer a scaled back set of devices to compete with Amazon. They have plenty of margin to give and still be plenty profitable. Right?

Perhaps. but what does Apple lose in the process? Certainly the high ground of being a premium-only device provider; one that refuses to sacrifice quality; one that seeks the sublime in its designs. That is the sacrosanct brand of Apple, that which Steve Jobs dedicated a life to creating.  Changing it would be a substantial change to the culture of the company.  Indeed, a big change to its image of itself.

Were it to accept lower margins for its products, it also presents a revised economic model to its investors. Can we imagine investors reacting well to a product line with lower margins that likely cannibalizes its much more profitable existing product line? That certainly changes the earnings profile of the business.  One might easily argue that such a move would create additional new unit sales for Apple, generating more revenue by bringing in the price sensitive buyers who want iPods and iPads and iPhones but cannot afford them today. Perhaps. That is a plausible scenario. But I suspect that Apple will have a hard time dumbing down its products enough to make them price competitive with Kindles. This just goes against the DNA passed down from Jobs. And if Amazon is willing to sell Kindles at break-even or lower...

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I suspect that Apple has painted itself into a corner. In no way is that comment meant to denigrate the company...its achievements are extraordinary; its products are remarkable. But from a competitive perspective and an investor perspective, I think it has a tough trail in front of it. I mean...

Customers have sky high expectations that each new release will make strides over the last. Apple must continue its track record of innovation (which is probably unmatched in the annals of consumer electronics) in perpetuity (or at the very least, only allow minor setbacks) to satisfy those high expectations.

This while carrying the banner of lead innovator, holding it high and proud for all the competition to see. This is hard! It's like holding the lead at the Tour de France. You cut into the wind for everyone behind you. They get the benefit of drafting. They can watch your every design move, tear apart each new release to learn how you did it, study your supply chain tactics...emulate your every move and pull closer to you with each cycle. 

That banner of innovation, and that grinding into the wind, gets harder and harder the longer you do it! The peloton drags you back in.

Finally, whether it comes from a lapse in innovation for a new product release or the decision to cut margins by moving downstream with a "value" product, earnings will suffer. And investors DO NOT suffer declining earnings happily. 

In light of how the market rewards Apples long string of record-breaking earnings - by giving it a multiple around 16 times its trailing results at a time when they should be at the height of their optimism - one must ask how investors react if these earnings slow down or shrink. (Actually, for the sake of the Shleifer Effect, it could present a good investing opportunity!)

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So Apple is my example of a firm able to raise prices and/or charge a big premium. At the outset I suggest that we must inquire whether the advantage(s) that gives the company the ability to charge a premium is defensible and enduring. We must understand this in assessing the strength of its competitive advantage. 

I believe Apple's is based on continuous superior innovation leading to excellent products and brand cachet. If the innovation slips, its reputation becomes scarred and competitors will step in on short notice to fill any breech. And innovation is hard. What Apple has done to date is extraordinary. But at some point do the pressures cause them to revert to a mean? At some point, do they tire and stumble? Perhaps not. But I wouldn't bet on it.

This post was originally published here on Adjacent Progression.