Costco and Paradox of Choice vs. the Growth Levers

Tweet About Growth Levers Post

After tweeting about my post The Growth Levers in Retail: Price, Selection, Convenience, I received the following reply:

Tweet Reply

I'm pretty sure Mike is referring to the CNBC special, The Costco Craze (it originally aired in late-April) in which a marketing expert explains to host Carl Quintanilla the concept of "paradox of choice." It was popularized several years ago by psychologist Barry Schwartz who authored a book with the same name. The idea is this: while people tend to believe that options are great (and the more you have the better), the reality is that we tend to be overwhelmed by too many. It creates stress. In many cases we would prefer not to have a choice; that our decisions be made for us. In the shopping environment, that stress can lead to indecision and consumers walking away from a purchase altogether. Mike is absolutely right about that.

Marketing Experts Like New Marketing Ideas

Retail dogma has long held that the more selection you can make available to customers, the better. Schwartz's research encouraged us to revisit that concept from the shopper's perspective. 

Now marketing experts love a novel concept, and when they find a new theory they tend to go looking for places to either a.) apply it, or b.) prove it. That has certainly been the case with the paradox of choice. Many an expert has sought out retail examples to prove the point that limited selection leads to a better shopping experience and more sales.  Their favorite cases to cite are Costco, Trader Joe's and Aldi's.

Costco carries about 3,800 individual stock keeping units (SKUs) per store, Trader Joe's carries about 3,000, and Aldi carries 1,400.* 

By contrast, Walmart Supercenters carry upwards of 150,000 and the average large-chain grocery store, like Kroger, carries 30,000 to 52,000 SKUs.

Average sales per SKU (calculated by dividing number of SKUs into gross sales and a good signal for efficiency and how quickly they sell their stuff), are $18.4 million for Costco, nearly $3 million for Trader Joe's, and $5 million for Aldi.  

For Kroger it's around $2.6 million, and for Walmart it's about $2.5 million.** 

Marketing experts see those numbers and are quick to give credit to the paradox of choice, their theory du jour, for the low-selection retailers racking up such high sales per item. Especially with Costco. Less selection, they argue, leads to a more pleasant shopping experience that drives higher sales. But I think they're too quick to go with the sexy theory when the numbers - and the rational for these retailers opting for a low-selection strategy - are adequately explained by the concept of the growth levers (the retail dogma). And especially by the importance of price.

Retailers Must Decide Which Levers Get Their Investment Resources

More About Lower Price Than Beating the Paradox of Choice

Consider the following quote from recently retired Costco CEO James Sinegal:* 

We carry a 325 bottle of Advil for $15.25. Lots of customers don't want to buy 325. If you had ten customers come in to buy Advil, how many are not going to buy any because you just have one size? Maybe one or two. We refer to that as the intelligent loss of sales. We are prepared to give up that one customer. But if we had four or five sizes of Advil, as grocery stores do, it would make our business more difficult to manage. Our business can only succeed if we are efficient. You can't go on selling at these margins if you are not.

Those margins to which he refers are 11 percent gross and three percent net, meaning operating expenses account for only eight percent of revenue. That's insanely low.  (Yes, Costco's profit margin is only three percent!) Contrast that to Walmart's 24 percent gross margin and 19 percent operating expenses.

The only way Costco can survive on those margins is if it buys in bulk. And it can only buy in bulk if it can sell in bulk. And it can only sell in bulk if it limits its selection to a handful of items. This allows Costco to offer the absolute cheapest prices on its items.

But because it relies on a narrow selection, Costco will never be the place you go for everyday shopping.  That's the trade-off in investing in one growth lever over the others. This is not a critique of its business. They embrace this fact, even if they're constantly priming their selection to find ways to get you in the door more. My family makes one Costco run a month, grabbing some things in bulk to save a few bucks on our weekly Trader Joe's runs. Costco can't replace Trader Joe's for us because Trader Joe's offers a wider food selection. They both serve their role. They co-exist quite well. And they're both excellent businesses. 

Walmart serves its role too, with the objective to be the place for one-stop shopping. It will not be able to compete with Costco on price for the same items because its selection is so much wider, its purchasing volume per SKU so much lower, and therefore its costs per item higher. But because it has so much more selection, it's more likely to get you in the door on a more frequent basis than Costco. 

(I should disclose that we've found no overall cost-savings in our grocery bill since adding Costco to our rotation about a year ago. Indeed, we spend just as much at Trader Joe's, so Costco has just made our bill go up 20 percent a month. Oh well. We like their almond butter.)

Concluding Thoughts

Mike's objection is an important one to raise. Let's challenge the dogma of retail's traditional growth levers.   But in this case, I think the marketing expert's enthusiasm for the paradox of choice is being applied ex post facto in an attempt to explain why Costco offers a lower selection. The reduced selection is not the reason for their success. The success stems from the low prices they're able to offer by virtue of having less inventory to buy, handle and store.

But paradox of choice remains a very cool theory, and I'm certain the marketing experts will find many more scenarios upon which they can graft it.

* Information provided by Barry Berman's Competing in Tough Times.

**These are 2008 or 2009 numbers (also gleaned from Berman's book) but I'm sure they hold approximately true today, too. A more important note is what a rough calculation this represents. SKUs are calculated on a per store basis, but most retail chains will offer items at certain stores but not others. This probably has much more impact for Walmart and Kroger than it does for Costco, Trader Joe's and Aldi. Still, I think the illustration has merit.) 

EBay, Mr. Market, and Amazon's Q2 Results

Mr. Market is a funny dude. At this writing AMZN is trading up about five percent on the day. The reason? eBay.

Well, eBay plus lofty expectations that Amazon's current positive trend continues through its Q2 earnings announcement next Thursday. A look over the last few quarters of the relationship among earnings expectations, actual earnings, and Mr. Market's reaction...let's just say it shows an interesting dynamic.

The eBay Angle

eBay announced its Q2 results last night and exceeded every consensus expectation on the metrics Wall Street uses to gauge its performance. (See Scot Wingo's always well-informed discussion of the results at eBay Strategies here.) Mr. Market has pushed its price up over 10 percent on the day, touching - ever so briefly - its own 52-week high.

One of those important Wall Street metrics is eBay's Gross Merchandise Value (more or less its auction and marketplace revenue) growing at 15 percent, which pretty much matches the growth rate of the overall e-commerce market.

So here comes Mr. Market's logic...

Since Amazon has been crushing the e-commerce growth rate, outpacing it 2:1 with Q1 results in April when Amazon increased revenue 34 percent. And...with eBay showing it can match industry growth in the most recent quarter, then there must be some good tailwinds for e-commerce right now. Ergo...Amazon is going to kill it with Q2 results next Thursday! So let's bet on Amazon! 

Well, Mr. Market, you may be right. I'll grant that Amazon will probably outpace industry growth yet again. But what happens if earnings - once again - don't follow revenue growth? Moreover, what if earnings  (gasp!) disappear altogether for Q2 as Amazon has suggested is a distinct possibility?

Going Back in Time (But Just a Little)

Let's go back in time to look at Mr. Market's previous reactions to Amazon's earnings. We'll use some charts based on Wall Street analyst estimates of Amazon's performance (provided here by Businessweek) and go backwards from most recent.

Last quarter, Q1 results, Amazon surprised Mr. Market by earning .28 cents per share. This after his consensus estimate was .07. The stock shot up about 15 percent in the two trading sessions immediately following the news. It was the second such positive report, which leads us to...

Q4 of 2011 Amazon reported .38 cents per share. Mr. Market has expected .18. A 110 percent upside surprise. The stock actually fell seven percent on the news. Maybe that's because Mr. Market still had not recuperated from the hangover caused by the previous quarter's different kind of surprise...

In Q3 of 2011 Mr. Market had high hopes for Amazon. He was expecting .25 per share after Amazon had posted a hefty .41 cents per share in the previous period. He was hoping for the trend to continue, and in anticipation of it he had run up the stock price by about ten percent since the last earnings announcement. Amazon only earned .14 cents per share. Mr. Market's great hopes were dashed, and he punished Amazon, sending its stock price plummeting from about $225 to about $200 within a couple days. It went as low as $173 before starting to climb back up again.

Over this past year, Amazon has been nothing if not volatile. Google Finance is quick to highlight its 52-week range as 166.97 - 246.71. That's a wide spread, indicative of Mr. Market and this game of expectations he likes to play...and the bi-polar extremes that take over depending on whether Amazon has lived up to his expectations.

Q2 2012 and the Profitability Bias

Well Mr. Market's expectations for next week's results are not too lofty. At least as conveyed by the consensus estimates. It's at .03 cents per share (though the range is quite wide: .17 cents on the high side and .23 LOSS on the low side).

But the reaction today to eBay's results suggest to me that there exists loftier expectations than he's letting on to with the estimates. I think he secretly expects HUGE revenue numbers that will wow investors into paying even more for the privilege of owning shares.

I wouldn't bet against that happening. But even if the big revenue numbers come in and earnings disappoint, this faith in Amazon's upward performance trend is going to be dashed. And Amazon losing money in Q2 is a very real possibility. (Its guidance from the Q1 press release said this: "Operating income (loss) is expected to be between $(260) million and $40 million, or between 229% decline and 80% decline compared with second quarter 2011.") We know how heavily the company is investing in growth, and how willing it is to let those growth costs eat up profits. (See Amazon's Rapid Sales Growth...Buying the New Business?)

So, even if revenue growth blows us away, losses tend to shake investors' faith. Why? The profitability bias. It's almost as if we have an instinctive visceral reaction to seeing losses in a business that was previously showing earnings. We just can't help but think more losses are coming, that there's something wrong with the company, and that the losses will extend into future quarters. We have very weak stomachs for these things. Even if we know the business has staying power, is investing heavily in initiatives to make even better profits in the future, or is just going through a temporary funk. We just get spooked. We overreact and send the price down.


That's the basis for the Shleifer Effect (discussed in such detail on Adjacent Progression). 

Note that I'm making no predictions for Amazon's results next week. I am, however, highlighting the appearance of high expectations combined with the POSSIBILITY (nothing more than that) of Amazon not satisfying those expectations. Plus, we've seen what happens to the stock price when Mr. Market's expectations are dashed.

I'll end with this incredibly inappropriate teaser...

Amazon finished today at 226.17. That's almost exactly where it was immediately prior to the Q3 2011 update when it disappointed and proceeded to fall to its year lows over the next three months.

The Growth Levers in Retail: Price, Selection, Convenience

Amazon's Feedback Loop

If we were forced to reduce the secret of Amazon's success to one simple concept, this would be it: Amazon churning hard on the Feedback Loop featured above. 

This is absolutely critical to understanding Amazon. And not just retail. I mean every business line it's in. So I'll dedicate several posts to breaking it down, and then building it back up again. 

Stick with me on this. It will be worth it. 

The Growth Levers in Retail: Price, Selection, Convenience

In the world of retailing three variables are responsible for driving the lion’s share of growth. Price, Selection, and Convenience. Price is self-evident. When comparing apples to apples, customers want the lower-priced apple. Selection means the retailer offers the products the customer wants. And convenience means the shopping experience is streamlined, not confusing, not complex, and requires as little exertion from the customer as is humanly possible. 

Growth Levers in Retail

Think of these variables as levers a retailer can push, but that pushing each lever requires an investment of capital and other resources (e.g., management attention, supply chain capabilities, real estate acquisition, etc.) that diminishes your ability to invest in the other levers. You can choose to invest heavily in lowering the price of your products, marking them up less than your competitors. But that leaves you fewer resources to invest in having the widest selection possible or the most convenient shopping locations. Since capital and other resources are limited, each retailer must decide which lever to push the hardest making it a game of priorities and compromise. There are always trade-offs. 

See the red X's in the diagram below showing (in simplistic form) how retailers might choose to push their levers. At the far left, price gets the biggest investment, but selection is narrow and convenience is low. In this scenario (think discount grocer Aldi), the retailer is betting the very low price gets customers in the door even if they have to drive further to the store or have fewer items on the shelves to select from. 

In the middle, the retailer only pushes any of the levers so far, aiming for balance instead of a big bet on any individual lever. This might be the case for a grocery store like Kroger. It wants to find the real estate that makes its store locations more convenient to customers so they won't drive another five miles to Safeway or ten miles to a Walmart Supercenter. It will keep a wide selection to meet your full week of grocery needs without making trips to other stores. And it will charge the highest price it can without forcing customers to seek cheaper (but less convenient) alternatives. 

And on the right we have the retailer that forfeits price investments in favor of a very wide selection and a high degree of convenience for its customers. This might be the Whole Foods approach.

Retailers Must Decide Which Levers Get Their Investment Resources

Why do we call them the growth levers? I'll get to that next.

Amazon Sellers Competing With Amazon...On Amazon

A couple weeks ago Greg Bensinger wrote a worthwhile read in the Wall Street Journal, Competing With Amazon on Amazon. The gist is this: Amazon has a nasty habit of poaching the highest volume products from its third party sellers, opting to compete with them by selling the same thing in its marketplace rather than just sitting back and collecting the fees it gets from letting the partner make the sell. 

It's a solid story from Greg. What it misses, but something I'm certain Greg is thinking about, is why would Amazon be simultaneously pushing its third party seller program while poaching best selling products from those partners? That's befuddling. 

First, let me take a stab at the simple answer: Follow the money. 

In the fourth quarter of 2011, Amazon did $10 billion in sales from third-party merchants. Against this it charged somewhere in the ballpark of 13 percent fees. (That's an average of all fees charged, though it ranges pretty dramatically from category to category and can go up or down depending on which of Amazon's services sellers take advantage of.) It gets 80 percent gross margin for that business, so the whole thing netted Amazon about $1 billion in gross profits. That's cold hard cash it extracts from sellers in exchange for using the Amazon platform to get access to their customers. 

But what could Amazon make in gross profit dollars if it sold that same $10 billion of its own inventory instead of taking the third party merchant commissions?  Its gross margins tend to be a little better than 20 percent, so we'll go with that number. $10 billion times 20 percent is $2 billion in gross profit. 

Twice as much. Amazon would have made a lot more selling that $10 billion itself.

But conventional wisdom seems to be that Amazon is more about its marketplace than it is about being a retailer that buys and sells its own inventory. In Greg's article, he quotes Piper Jaffray analyst Gene Munster who forecasts that these third party sales could grow from 36 percent of Amazon's business to as much as 55 percent within five years. Amazon wants third parties to be a bigger piece of its business, he suggests.

A marketplace can be a great business. That 13 percent gross profit is particularly nice when you don't have to invest money in inventory to get it. It reduces overall capital needs, freeing up cash to be used in other parts of the business or to pay out to investors. Once you have the marketplace infrastructure in place (e-commerce technology, customer service, distribution capabilities, and a large base of returning customers), the profit is almost frictionless. You can earn more and more by just signing up additional sellers for the marketplace and making sure customers stay happy.

(Related: Read this post about Overstock.com's use of the marketplace concept to generate high returns on invested capital.)

What seems to fly in the face of that conventional wisdom is that Amazon continues to build its internal merchant infrastructure at a torrid pace. If it were truly satisfied with the third-party marketplace model, it doesn't make sense to me that it would keep hiring buyers to build new web stores (with Amazon-owned inventory) in an ever-growing list of product categories.

What seems more realistic is that Amazon is using third parties to accelerate its goal to offer the widest selection possible (a proven way to attract all those customers). But, as Greg's interviews suggest, that it watches the sales data closely to see which products are most popular and can be folded into its existing merchant operations. When you're selling toys, have lots of existing relationship with toy manufacturers, and have lots of toy buyers, it's not that hard to - going with one of Greg's examples - run to the original manufacturer of NFL pillow pets and get your own supply. And most certainly at a cheaper price than your third-party seller got. Amazon seems to have done just that upon noting that Collectible Supplies of California was selling 100 or more of these items every day. From the article:

Sales of Collectible Supplies' Pillow Pets soon fell to 20 a day "because Amazon was offering it," Mr. Peterson said. "I tried lowering the prices, but Amazon would always match my price or go lower until I eventually gave up" and set it at the manufacturer's suggested price, he added. Prices fluctuate, but Amazon was recently selling a Baltimore Ravens Pillow Pet for $12 with free shipping, while Mr. Peterson is again offering the product for $29.99.

My own two cents are these: Amazon is not wed to the marketplace idea where it serves as neutral arbiter of commerce. Despite the high returns on invested capital from running an inventory-free retail operation, Amazon is nothing if not confident about its ability to generate a lot of volume through its infrastructure. Meaning, Amazon believes it can score a nice flow of cash from buying, storing, and selling its own inventory at 20 percent gross profit. And it would prefer 20 percent to 13 percent.

But having wide product selection is the rub. Amazon wants all web shoppers to come to its site for anything they want or need. It wants shoppers to think first of Amazon for whatever they want to buy, and it wants shoppers to trust that Amazon will have the best price. They would then stop shopping around for best price. They would just go to Amazon and be done with it. And once those shopping habits are set, it's hard for a new competitor to break them.

So Amazon is glad to use third party sellers to help it build out selection. And while they help, Amazon is taking that 13 percent fee and using it to pay for its growing network of fulfillment centers, subsidizing shipping costs to enhance the customer experience further, and expanding the products it buys and puts in inventory. 

The third party sellers are fueling Amazon's growth and, for many of them at least, putting themselves out of business one fast-moving product at a time.

Why Has Amazon Blacked Out Its 2012 Shareholder Meeting Presentation?

Granted, Amazon is not renowned for transparency. Quite the opposite. In some regards, I'm okay with that.  I respect that a business with grand growth ambitions might want to hold its strategy cards close to the vest. Jeff Bezos and crew have an outstanding track record of keeping new initiatives under wraps until they're ready to launch. And they notch up more victories than losses with these schemes. I imagine the practice helps keep the teams focused while giving Amazon the upper hand - keeping competitors in the dark - when they bring new stuff into the market. 

But the stinginess with information can be frustrating, too, for those eager to understand Amazon.

In those rare moments when Bezos decides to make public pronouncements, he can be surprisingly forthcoming. I relish the opportunity to learn from each sit-down he has with Charlie Rose; each Q&A with Steven Levy. 

But the best resource has been the presentation and webcast of each annual meeting of shareholders. Each year Bezos waxes philosophic on the business of Amazon, providing nuggets of insight into what he considers the most important traits, the biggest challenges, the guiding initiatives. In the 2011 question and answer session, he provided a brilliant response to a question from shareholder Evan Jacobs (transcribed by GeekWire and posted here), speaking eloquently on what it means to be misunderstood.

Those presentations have been made available each year on Amazon's investor relations website. But not so this year, even six weeks after the meeting and despite direct requests of Amazon's IR staff to make them available. We've been blacked out!

This is troubling even to someone (like me) who has a high degree of tolerance for Amazon's silence. I suppose (though am not positive) that providing meeting transcripts of shareholder meetings is left to the company's discretion and whim, not an SEC requirement. Still, as a public company, we have reasonable expectations that important information about the business that is made available to a few shareholders (those able to attend the meeting) be available to all shareholders. 

What information I've been able to gather has come from bloggers and reporters attending the meeting or monitoring it from outside (see this GeekWire coverage, this from the Seattle Times, and this from Xconomy). It seems like a tumultuous meeting at which protesters were eager for attention and willing to disrupt the proceedings. Police were there to escort disruptive and unruly activists out of the meeting. Curt Woodward of Xconomy described the CEO thusly: 

From his place at center stage, founder and CEO Jeff Bezos seemed to watch the antics as if an alien species had landed in the room.

He stood onstage, head cocked to the side, as the made-for-news-media spectacle unfolded. Once the noise died down, Bezos made sure he got the last word: “l’d like to thank all of you for coming, and we’ll see you next year.”

I suppose there were embarrassing moments. I imagine the Q&A is far less interesting when you have rabble rousers seeking attention for their agendas rather than shareholders picking the great brain of Bezos. Be assured, as Amazon becomes more dominant in its respective markets, this attention will only grow. You can't shy away from basic communication just because others are leaching off your megaphone. 

The presentation was intended for the consumption of shareholders. Amazon has made a habit of sharing it in the past. And they should make it available this year, too.

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.