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. 

The Difference in Scale: More Amazon v. Walmart

This is the third post in a series about deconstructing Amazon's Feedback Loop, an attempt to understand how its components work both as individual units and together as a collective system. See the previous posts, Convenience (and Diaper Stench): Amazon v. Walmart and All Convenience Infrastructures Not Created Equal. 

The Feedback Loop is about pressing those levers (price, selection, convenience) for the purpose of earning the patronage of millions of shoppers that comprise the broad middle. It’s about driving growth. 

Here’s the big difference between being a web retailer as opposed to a traditional one; an Amazon versus a Walmart: 

To become more convenient and attract more shoppers, Walmart must build ever more stores. It must go where the customer is. Proximity between seller and buyer is a function of how far a shopper must drive to reach a supercenter. 

To become more convenient and attract more shoppers, Amazon benefits from more consumers being connected to the internet with each passing day. Proximity between seller and buyer is a function of how many steps a shopper must take between his seat on the couch and the nearest web-enabled device. 

The same forces that bring more people onto the internet every day bring those people to Amazon. It must simply be prepared for their business.

Scalability and the Check-Out Scenario

Those are the starkest of contrasts when considering the factors that drive convenience in the physical world versus the digital realm. And while differences in cost are big, the implications for scaling – increasing sales faster than infrastructure – are staggering. 

Consider the programming logic that turns the gears behind Amazon’s 1-Click check-out process. While that code base was enormously expensive to develop, requiring high-salaried programmers to build it, test it, and improve it over months of iterated effort, it now sits on an Amazon server. It may require occasional maintenance tweaks, but by and large that digital instruction manual can facilitate millions of check-outs each day about as easily as it can conduct just one. 

More importantly, that code can facilitate thousands upon thousands of check-outs simultaneously without slowing down the flow of commerce, the speed of transactions, or the convenience of quick turnarounds for shoppers. 

That is ultimate scalability. The kind you get when you depend on a convenience infrastructure built on technology. 

To keep picking on Walmart, let’s consider the contrast of store-based retail scalability. Its cashiers are cheap on an individual basis. Each is paid a piddling hourly wage, but each can only facilitate the check-out of one customer at a time. 

If it wants to be able to check-out 100 shoppers at the same store simultaneously, it must have 100 different check-out aisles with 100 different cashiers working 100 different cash registers at the same time. Since that’s impractical, it permits long lines to form at each register during peak hours, thereby reducing its convenience to customers. 

Scaling its convenience infrastructure is – for Walmart and its ilk – always constrained by physical world limitations. In the physical world it’s difficult to scale many of your convenience factors too far beyond that one-to-one ratio (like one cashier to one shopper). In the digital realm, scaling seems nearer to one-to-infinity (theoretically at least) than that one-to-one ratio.

The 1:1 Ratio Rears Its Head Again

Consider this other constraint of store-based retailing… 

In 2010 Walmart added about 1,400 stores to its existing world-wide base of 10,000 (give or take a few). All that additional real estate – those stores that brought Walmart closer to more shoppers – funded a nearly ten percent increase in revenue, taking the business to $447 billion in sales. If we assume each new store cost, on average, somewhere around $10 million (to build, equip and stock each), it means Walmart invested $14 billion in the main component of its convenience infrastructure. 

So, to increase revenue ten percent, it invested $14 billion and grew its number of physical locations by about 14 percent. This suggests something pretty close to a one-to-one relationship between opening new stores and growing revenue.* And while that ratio is not a precise formula for Walmart’s growth, it does highlight the natural constraints that exist for growing your business under the rules of a physical world: you have to invest significant cash to build more stores to access more customers and (finally) to grow your revenue. 

This puts to a cap on how quickly Walmart can grow because everything is governed both by how much cash it has to plow back into its convenience infrastructure and how many new stores it can possibly open in a 365-day span of time. 

It’s almost like a gravitational pull that keeps its ability to scale in check, making it difficult for traditional retailers to get much beyond that one-to-one ratio of having to increase its base of stores by (for example) ten percent in order to increase its revenue by about the same amount.

Walmart’s Rate of Growth Anchor

Those physical world limitations create an anchor on rate of growth as the base of legacy stores (those that have been open for more than a year) gets bigger and bigger. 

Let’s consider that 1,400 new store openings push the upper limit of what Walmart (or any retailer for that matter) could do in a given year. That’s a lot of construction, requiring a lot of resources in the way of cash, management attention, and use of supply chain bandwidth. They could probably do more (in fact, I believe they have done more in previous years), but I doubt they could do considerably more on a sustained basis. 

When calculating rate of growth (a percentage), new stores are the numerator and the base of legacy stores is the denominator. If 1,400 is the max new stores in a given year, the numerator is pretty much a fixed number. But the denominator grows larger with each passing year. Those 10,000 or so from 2010 become 11,400 after 2011, 12,800 after 2012, 14,200 after 2013 and so on. So, for each of those years, 1,400 divided by the growing legacy base gives us a smaller percentage (14 percent drops to 12.3 percent then 11 percent then 9.9 percent, etc.) as time passes. 

The rate of growth slows. The ability to get to ever more customers is bounded by the constraint of only being able to open so many new stores in a given year. 

Now this is mostly theorizing. I’ll grant that the numbers are likely a decent-sized understatement of reality. Walmart can probably open more than 1,400 stores a year if it wanted to. But not a dramatically higher number. So the general rule stands true: the base of existing stores creates an anchor on rate of growth. It will slow as the legacy base gets bigger. Trees can’t grow to the sky. 

Conclusion and Segue to Convenience Barriers

The point is that Walmart operates in a world of limits, and while we can quibble about the exact numbers, the facts remain that the limits approximate (at least roughly) 1.) that one-to-one ratio for new stores to revenue, and 2.) the rate of growth slowing with a fixed numerator being anchored down by an expanding denominator. 

Web retailers don’t have that same challenge. Investing in technology – those pieces of code whose logic churn across millions of server processors to transact millions of transactions – is much less expensive and much more scalable. 

Over the long haul, this scale difference has a compounding effect. Much like the difference of a few (seemingly) small interest rate points for savings accounts may not amount to much over a few years’ time, the difference is amplified to dramatic proportions as time marches on and the effects of compounding take hold. 

Amazon’s advantage of lower convenience infrastructure expense and better scalability means it can take those savings and invest them in making up for any deficiencies it might have in the competitive struggle with traditional retailers. 

And Amazon has been very disciplined in making these investments both in the other growth levers (lower prices and wider selection) and also in attacking the bulwark of the best convenience defense store-based retailers retain against web competitors; namely, the ability to satisfy customers’ desire for immediate gratification, that ability to walk out of a store with purchase in hand. 

That’s the convenience barrier, and Amazon’s has been whittling away at it over the years. 

* Note that this is the roughest of calculations on several fronts, the most important of which is that Walmart’s revenue growth does not only come from new store sales. In most years, the lion’s share of growth comes from selling more through its existing base of stores (a better scaling proposition because they don’t have to invest much more in the existing stores to drive more sales volume through them). However, given how anemic same store sales growth was in fiscal years 2010 and 2011, it’s fair to conclude that new stores were responsible for most of its added revenue. 

The bigger point is, however, that there exists some sort of gravitational pull – governed by the natural constraints of a physical world – that pulls store-based retailers back toward that 1:1 limitation on scale. Even if they do better than 1:1 for some time (say a ten percent increase in number of stores increases revenue 50 percent), gravity will pull down that ratio over the long haul. 

All Convenience Infrastructures Not Created Equal

This is the second post in a series about deconstructing Amazon's Feedback Loop, an attempt to understand how its components work both as individual units and together as a collective system. See also the previous post, Convenience (and Diaper Stench): Amazon v. Walmart.

All retailers must invest in a convenience infrastructure, plowing cash into those components of their businesses that make it easier for consumers to shop with them. 

But not all convenience infrastructures are created equal. 

For traditional retailers like Walmart, that infrastructure is composed overwhelmingly of stores. And to enhance the convenience it offers customers it must build more and more stores plus staff them, stock them, and maintain them to some reasonable aesthetic and hygienic standard. While this has been a lucrative business for Walmart investors over the years, having an infrastructure rooted in real estate – an inflating asset whose costs increase over time – is pricey. Especially when compared to the alternative. 

For web-based retailers like Amazon, convenience is a much different proposition. It’s driven by technology (software, hardware, internet connectivity, etc.) and the speed with which it can deliver packages to shoppers. 

To build on our Amazon Feedback Loop schematic, here’s the convenience infrastructure addition: 

With such a chunk of its convenience being based on technology, Amazon has a tremendous cost advantage over retailers that are forced to plow so much cash into real estate in order to grow. As we’ll discuss in this article, a convenience infrastructure that depends on technology investment is inherently less expensive and much, much more scalable. 

Convenience through Technology 

We outlined in the previous article how web retailers (and Amazon specifically) use technology to enhance the convenience of their services to shoppers. In my close call with being overwhelmed by diaper stench, I needed bin liners quickly to stave wafting odors from my daughter’s nursery. Amazon made the process of buying them convenient, using technology to: 

1. Provide quick ACCESS to Amazon’s website through various internet-enabled devices. 

I just grabbed the Kindle Fire, pressed the “on” button, slid the Android hibernate bar across the screen, and clicked on the Amazon shopping app icon. This all took about three seconds. 

Amazon could just as easily (and almost as quickly) grant me access through my laptop, iTouch, smartphone, and a host of other devices that connect to the web. Therein lies its commitment to providing the easiest access to its products by taking advantage of any one of the host of rapidly proliferating devices that connect to an ever-faster moving internet. 

A few years ago, the only option would be booting up a computer, clicking on a browser, and typing in the Amazon URL. Which is pretty fast, too, but Amazon wants access to its shopping experience to move as quickly as the fastest device available. And it has spent years investing in that convenience factor. 

To that point, Amazon’s commitment to providing access through a wide variety of internet-connected devices is nothing new. Anyone remember the Palm VII? (Um, for that matter, I should ask whether anyone even remembers Palm now.) It was a digital handheld organizer, a clunk of gray plastic – in terms of design aesthetic, decidedly unsexy – with Palm’s calendar and contact features. This particular model happened to have a flimsy antenna that, when flipped upright, provided spotty mobile access to the web using an even spottier browser. Well, way back in 1999, Amazon was stretching its innovation muscles with a service called “Amazon Anywhere.” (You can read the Amazon press release about it here.) You could actually log-on to Amazon and place a mobile order more than thirteen years ago! 

Amazon has long been prepared for this concept of shopping its stores using apps on mobile devices. 

2. Quickly SEARCH Amazon’s wide catalog for the specific product I needed. 

I knew I needed those specific diaper bin liners, and all I had to do was type the brand name into the search box and hit “Go.” Even with a product catalog that easily tops many millions of items, Amazon served back the option I wanted with sub-second speed. 

One might assume that whether the search results come back in one second or a half-second wouldn’t affect the shopping experience too much either way. Amazon disagrees. The company has invested countless resources organizing its catalog, streamlining its databases, and increasing its server processing power for the sole purpose of shaving milliseconds off your search. It deems search speed that important a convenience factor. 

In 2004, Amazon showed the world how serious it was about investing in heavy duty search capabilities. It took all the algorithms it had built for searching on its site, and offered a service for searching the full web. A9, as it was called, was among Amazon’s first attempts to spin-out its internal innovations for use by wider audiences. It wanted to test whether that market so dominated by Google and Yahoo! was open to an alternative. It wasn’t successful outside of Amazon, but those investments continue to reap benefits by enhancing the convenience factor for customers searching for products on Amazon.com. (You can read more about the A9 launch here.)  

3. CHECK-OUT quickly and easily. 

When Amazon sent my Kindle Fire several months ago, the company did me the favor of pre-connecting it to my account. I take it this adds layers of complexity to the various steps of prepping and shipping each of these devices to customers. And while I won’t suggest Amazon is benevolent for choosing to do this, it sure made my life easier. More importantly for them, it reduced the likelihood that I (or any Kindle Fire buyer) would be too lazy (or so lacking in technical skill) to make that connection myself. 

In buying those liners, it made the check-out process quick and easy. Once the product was in my cart, I had maybe two additional clicks until the transaction was complete. No delays, no extra steps, and therefore fewer chances for me to change my mind. 

That’s present day e-commerce shopping. Let your mind wander back nearly 20 years to the dawn of web retailing. While internet usage was famously growing at the breakneck annualized rate of 2300 percent, it was far from clear that it would be a medium consumers would trust for shopping. At that point, shoppers guarded their credit cards as if they were cash. I remember traditional stores often required an ID for a credit card purchase, verifying the identity of the buyer each time out of fear of penalty from Visa or American Express if fraud occurred on its watch. This paranoia with person-to-person transactions was amplified when making a catalog purchase over the phone. It was not at all clear that consumers or card issuers were going to be comfortable with the risk of punching their credit information into a keyboard, transmitting them across a dial-up modem into the great unknown of the internet. 

What nefarious agents might be lurking in the web’s shadows, eager and ready to nab your credit card digits and run up a big bill on your tab? 

In this brave new world, Amazon managed to convince shoppers to store their credit information on its servers, to link it to their usernames, and to keep a shipping address on file. Amazon called it the “1-Click” process, launching it in 1997 and patenting it in 1999. (Reference Amazon's press release about it here.) All so Amazon could help them check out more quickly, thereby increasing the convenience factor and losing fewer sales to the dreaded abandoned cart. 

How Moore’s Law Makes Amazon More Convenient for Less Money 

Despite all these investments in technology improvements to make the shopping experience more convenient, the very nature of technology as a driver of convenience (and hence a driver of growth) makes the process of growing much, much less expensive. 

Convenience is different for web retailers than it is for traditional stores. As we’ve discussed, stores rely so heavily on location to customers as their primary means of being “convenient.” Real estate is inherently expensive, its price tag tends to expand with time, and each new store brings with it the need to constantly stock it, staff it, and maintain it. 

Not so on the internet. 

For web retailers, convenience is more a matter of the factors we explored above. How quick and how easy it is to access the web store? How quick and how easy is it to search for the product the shopper wants? And how quick and how easy is it to check-out? 

Each of those is a function of technology, and herein lies an advantage for web-retailers over those operating out of stores. While traditional retailers are pouring cash into real estate as they push the convenience growth lever and seek more shoppers, web-retailers are enhancing their convenience factors by investing in technology. 

To that point, Jeff Bezos sat down with Charlie Rose in 2001 and had this insight to share: (You can watch the interview here.) 

One of the things that’s totally different about e-commerce from physical world commerce is that real estate doesn’t obey Moore’s Law. Moore’s Law says that microprocessor performance doubles for the same price point every 18 months. That’s held true for more than a decade. What you’re finding now is disk space is getting twice as cheap every 12 months. And bandwidth is getting twice as cheap every nine months. So if you take the bandwidth doubling rate of nine months and assume it holds constant for the next five years, that means that we can spend the same amount of money on bandwidth per customer that we spend today five years from now but use 60 times as much bandwidth. That’s a big deal!* 

As microprocessor speed doubles every 18 months, it powers the Amazon technology for even easier product searches and faster check-outs. As disk space is getting twice as cheap every 12 months, Amazon can provide more rich content supporting its products and still help customers search through all the information quickly. And as bandwidth is getting twice as cheap every nine months, Amazon is ensured that more customers get online and get easy access to its website. No matter if they’re at home, work, or out about, the internet is nearly ubiquitous and fewer shoppers are ever without some sort of device that connects them to the web. 

To harness technology, Amazon must invest in software developers, database designers, system architects, and the like. These professionals are expensive. But the work they do is scalable. A single piece of well-written code can perform its function for all of Amazon’s 200 million customers with the same amount of effort and investment as it could to do the same thing for one customer. That makes the first customer very expensive to Amazon, but the additional 199 million quite cheap. 

Contrast that to traditional retailers. While Walmart’s hourly workers at each store might be inexpensive on an individual basis, the company requires a lot of them in order to serve customers. And a single worker can only help so many customers in any given period of time. Unlike that piece of code sitting on an Amazon server, that worker is decidedly un-scalable. 

It’s a big deal, indeed, when an asset that helps drive growth depreciates in cost over time (technology) rather than appreciates (real estate). To reach more customers, retailers like Walmart must constantly build new stores. The cost of which only grows over time. For Amazon to reach more customers, it must only make sure the bandwidth is sufficient, server processor speeds fast enough, and disk storage space deep enough to handle the exchange of data. That particular cost of growth is significantly lower for a web-based retailer. 

But Wait, Says Walmart, We Have an Ace up Our Sleeve…the Convenience Barrier 

In my experience shopping for diaper-bin liners, I mentioned one convenience advantage that Walmart held over Amazon: If I wanted those liners immediately, if I couldn’t postpone the gratification of holding my new purchase in my hands immediately, then Walmart would have won my business. 

This is the convenience barrier, and it has been the most important piece of protection the traditional retailers have had to keep Amazon and its ilk at bay. The need for immediate gratification – to get what you want now versus waiting three to five business days – is a big deal to shoppers. 

Amazon, however, has counted delivery time as part of its convenience infrastructure, investing heavily in it over the past several years. In the next article we’ll discuss how these investments have whittled away at Walmart’s convenience barrier advantage and what that might mean for the future of both companies. 

* For an interesting read on Moore’s Law, see the article Was Moore’s Law Inevitable? 

Convenience (and Diaper Stench): Amazon v. Walmart

This is the first post in a series about deconstructing Amazon's Feedback Loop in an attempt to understand both how its components work as individual units and together as a collective system. 

We’ll begin deconstructing the Amazon Feedback Loop by focusing on the Convenience Growth Lever.

When retailers invest in the Convenience Growth Lever, we’re talking about the infrastructure that makes the shopping experience as quick, simple, and hassle-free as possible for customers. The better job you do taking away the headaches of shopping, goes the logic, the more consumers will want to spend money with you. And you grow. 

The convenience infrastructure for traditional retailers revolves around placing stores as near as possible to the greatest mass of shoppers and then supporting those stores with staff, stock, and maintenance to keep them in good working order. It’s largely steeped in real-estate, an asset that tends to get costlier with time. 

For web-based retailers, it’s a different set of variables based largely on technology and the ability to deliver goods to customers as quickly as possible. Technology tends to cost less through its cycles of innovation, allowing users to do more with it at a cheaper price as time marches on. 

Let’s start the convenience discussion with a contemplation of diaper stench. 

Walmart vs. Amazon: A Case Study in Convenience and Diaper Stench

It’s Monday afternoon and my wife informs me that we’re running low on those special fresh-scented garbage bags that line the sides of the diaper-genie device in the baby’s nursery. Given that we’ve recently introduced our seven-month old daughter to the pleasure of solid foods, that they often don’t agree with her little system and therefore wreak havoc on her little outputs, we’re going through a lot of diapers. And keeping those liners in stock is of some importance to our family’s collective olfactory wellbeing. 

Stench Defenders

Walmart is only a ten minute drive away. But I severely dislike going to Walmart. I can only tolerate it if I know we’re going to fill the cart to its brim and thereby not have to go back for several more weeks. But to buy just one item? This could put me in an ill mood for hours. 

So I grab the Kindle Fire, do a quick product search, and buy exactly what we need from Amazon. For a reasonable premium, I get it delivered the next day. The stench crisis is averted. The nursery shall remain an inviting environment for all. 

Herein lies a crucial tension between web and physical retailers when it comes to convenience. I prefer not to step foot in a store at all. And though my wife doesn’t fully concur, she’s quickly learning the advantages of an Amazon Prime membership. Where we find common ground is in some rough calculus of how many items we need at the moment, multiplied by the number of miles we must drive to get to the shopping outlet, times the traffic at the moment, raised to the power of the number of different stores we’ll have to visit to check all the items off our list. 

The bigger the number, the more likely we are to just buy what we need online. 

Convenience for traditional retailers is largely a function of proximity to their shoppers (and number of parking spaces available immediately next to the door). For traditional retailers to grow, gaining access to more customers, they must invest in more and better locations. It is indeed about location, location, location. 

Of course there is a limited supply of good places to build stores, so that real estate becomes a hot commodity, appreciating in value in direct proportion to the number of companies bidding on the spot. 

And stores are costly to staff with workers, stock with inventory, and maintain to reasonable aesthetic and hygienic standards. 

It’s different on the web. Consider these major drivers that define convenience for shopping on the web (and contrast it with the alternative of having to go to Walmart) in context of my own experience buying diaper bin liners for my daughter’s nursery: 

1. Convenience in accessing Amazon’s web site. 

I picked up the Kindle Fire, turned on the screen, and was shopping. Convenience in this sense is a function of proximity to an internet-connected device. I used the Kindle, but I could have just as easily used the iPhone with its Amazon app, my wife’s iTouch, or my laptop. We have an abundance of options for connecting to the web in my house, and that’s a characteristic shared by more and more shoppers. 

Contrast this to the alternative of getting in the car, driving ten miles, parking, walking from the car to the front door, traversing the aisles in search of a specific product, waiting in line at checkout, walking back to the car, and driving home. 

Even if Walmart decided to be more convenient to me specifically, building a full-service store only a mile from my house, I would still have to go through all these steps. My drive would be shorter, but it hardly reduces the overall effort. 

2. Convenience in finding the liners with ease. 

In the search field of the Amazon shopping app on the Kindle, I typed in the name of the liners. In less than a second I saw the specific product I needed along with several alternatives for my consideration. 

Contrast this with the alternative experience at Walmart. I must navigate the store by department, understanding from experience (this is my second child after all) that diaper bin liners are NOT with regular trash bags, they’re with the baby things. Walk to the back corner of the store to find that department, then walk up and down its six aisles until I spot the specific item. It’s not there. There seems to be a generic alternative. Will that work? I better ask a worker. But none are close. Ah, there’s one! She says she has no idea. Great. Guess I better buy it, try it, and if it doesn’t work I’ll return it (another trip to Walmart). 

Amazon seems to know that you buy diaper liners on a repeat basis. While its awareness of my purchase needs can be a little creepy, it’s also convenient that Amazon reminds me of these liners a few months later, right when it’s time to stock back up. This makes the search process even more convenient by eliminating it altogether. 

3. Convenience of my speedy purchase transaction. 

My Kindle Fire came pre-loaded with my Amazon account information, its direct link to my credit card, and the shipping address for getting the order to me. So when I bought the liners, I clicked one button to complete the transaction. The whole thing, from turning on the Kindle to searching for the product to receiving confirmation that my order was received took maybe three minutes. Had I gone through my laptop, it might have taken an additional moment or two. 

If there are more than two people in front of me in a Walmart check-out queue (and there always are more), I’m anxiously scanning all the other lines in search of a faster path to buy my stuff and get out of the store. My blood pressure remains elevated for hours after waiting in those lines. 

4. Convenience of how quickly the liners are delivered. 

I placed the order on Monday, paid a few extra bucks, and had it delivered to my front door by the end of day Tuesday. 

Walmart is open early in the morning, late at night, and all times in between. Had I needed those liners any more quickly, Walmart would have won the convenience battle and earned my business. For customers that need (or want) immediate gratification – and there are many – Amazon and web retailers will never satisfy that need. Indeed, our family shopping trips to Walmart are defined more and more by our own procrastination, putting off buying something until it’s urgent and requires that inconvenient trip. 

Here the point goes to Walmart and store-based retailers in general. They have been protected from web shops taking over more of the turf by what we’ll call the Convenience Barrier: I need those liners, I drive to Walmart, I buy them, and I walk out the door with liners in hand. No delay. Instant gratification. 

Only a few years ago, Amazon would have required three to five days to get the liners to me. Now I can get them next day, and there are reports of people placing orders early in the morning and having the stuff delivered by the time they get home from work. (See a story about that here.) Amazon and its web-based compatriots are clearly making progress here. Though they’ll never provide the instant gratification of store-based retailers (unless they begin to offer that option, too…of opening physical stores), it’s clear they’re working hard to get orders processed and delivered as quickly as possible. 

Conclusions 

So, Walmart’s convenience is driven largely by real estate and location and it must therefore invest in more stores to increase the convenience factor and grow. (And even then, there are pretty much the same steps required to get to the store one mile away as to get to the one ten miles away. The convenience is enhanced over other store-based retailers that are farther away, but building a store nearer to me has only marginal additional convenience when I’m comparing it to a web-based shopping experience.) 

Three of the convenience factors listed above for Amazon are driven by technology (access to its website, ease of searching for products, and speed of transaction). The fourth – how quickly the product is delivered to you – is largely a function of real estate in that Amazon can improve delivery speed by building fulfillment centers nearer to its customers. 

In the next couple of articles we’ll dig deeper into Amazon’s convenience factors by breaking them down between technology and the speed with which it delivers orders to your doorstep.

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

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

Amazon's Feedback Loop

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

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

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

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

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

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

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

This is the seventh post in a series about Amazon's Feedback Loop, the mechanism most responsible for the company's success. See also the previous posts, The Growth Levers in Retail: Price, Selection, Convenience; Unlocking the Broad Middle (Hint: Price Is the Key); Sam Walton, Panties and Power Laws; The Productivity Loop (Walmart's Feedback Loop); Why Is Price the Ultimate Competitive Advantage? (Playing Games); and Sophie the Giraffe and the Productivity Loop.

Amazon's Feedback Loop

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

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

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

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

Finally, we delved ever so lightly into game theory, putting together a scenario to test former Walmart CEO David Glass’ statement: 

We want everybody to be selling the same stuff, and we want to compete on a price basis, and they will go broke five percent before we will. 

We constructed the Price-Cost Matrix and tested how each quadrant would fare against the others. Our simple logic led to the equally simple conclusion…Low Cost, Low Price is the best competitive advantage because it will win the price wars. For the fanatic willing to lower prices over and over and over again, he will win as long as his cost structure is the lowest, too. The other competitors will go broke five percent before he does. 

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

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

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

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

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

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

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

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

Sophie the Giraffe and the Productivity Loop

This is the sixth post in a series about Amazon's Feedback Loop, the mechanism most responsible for the company's success. See also the previous posts, The Growth Levers in Retail: Price, Selection, Convenience; Unlocking the Broad Middle (Hint: Price Is the Key); Sam Walton, Panties and Power Laws; The Productivity Loop (Walmart's Feedback Loop); and Why Is Price the Ultimate Competitive Advantage? (Playing Games).

To demonstrate Walmart's productivity loop, let's use a hypothetical example. Let's say Walmart begins selling Sophie the Giraffe teething toys, those over-priced French rubbery things so many moms insist on buying for their tykes (my wife included).  Boutique shops sell them for about $24. I'll assume they buy the toys wholesale for $16 and slap on a 50 percent markup.  (These boutiques are aiming for the less price sensitive customers, those on the right-hand side of our consumer bell curve.)

Sophie the Giraffe

Walmart starts off with a small order in which they pay the standard wholesale price and mark it up 30 percent. Their Sophie now costs about $21, a nice discount to the boutiques, and Walmart sells through the first lot pretty quickly. Seeing some customer demand for the toy, the Walmart merchant now goes back to the manufacturer, Vulli, and places an order for 100,000. They require a 20 percent discount - $12.80 per toy instead of $16 -  in return for the bulk purchase. As you wish, says Vulli, and fills the request.

Even though they sold through the previous order at $21, Walmart sticks with their30 percent markup. They sell the new batch of Sophies at $16.64 and advertise to all the young moms of the world that they have the best price. Moms can't pass it up, and they sell out within days.

Walmart now goes back to Vulli and asks for an order of one million Sophies, but it wants a 30 percent discount this time in exchange for the massive bulk purchase. Vulli complies, Walmart gets it for $11.20 per unit, marks it up (30 percent) to $14.56, and sells out again.

Walmart is churning the price part of the productivity loop, and boutique owners are pulling out their hair as they watch Walmart sell the giraffe for less than they can buy it wholesale. But even if they could buy it at the same price as Walmart, they couldn't afford to mark it up only 30 percent. That wouldn't provide enough gross profit to pay overhead expenses for high rent (convenient location), fancy in-store fixtures, marketing, and management salaries. Their expense structure ties them to the 50 percent markup. They need to charge the higher price; they must get that fat gross profit. They need it to pay their more expensive bills.

So Walmart wins the battle of Sophie the Giraffe on two fronts, both victories stemming from the productivity loop. First, its low price creates large demand, moving the product off shelves in high volumes. This high volume lets Walmart go back to Vulli, order more Sophies, and extract a discount that allows them to sell it even cheaper in the next cycle. Second, Walmart can afford to mark it up for 30 percent because it keeps the overhead low, which makes the sales price even cheaper and helps drive even higher volume sales.

Low price drives much higher volume. The higher volume allows Walmart to buy goods in bulk for a lower cost. And because Walmart has lower overhead, it can afford a lower markup on its merchandise, creating an even lower price and driving even higher volume.

Walmart churns this loop every day across hundreds of thousands of items, constantly widening the price gap and making it harder and harder for competition to catch up.

That's the essence of the productivity loop, whether it's practiced by Walmart or any other retailer.

I think it's fair to assume that, at some point before starting Amazon, Jeff Bezos studied Walton's success in some detail. He made himself intimately familiar with the model of the feedback loop. And he was ready to apply it in his company when he launched Amazon in 1995.


Next, we'll (finally!) get back to Amazon and discuss its feedback loop.