Amazon's core "strength" may actually be its biggest weakness
A lot of things seem to be going Amazon's way these days. It boasts the best-selling e-reader, two-thirds of the ebook market, a foothold in the tablet market, a growing library of video titles (including home-brewed programs), and, possibly in the future, a smartphone and a music-subscription service. Not to mention hundreds of thousands of Amazon Web Services customers.
Over the past year, however, there has been a growing area of vulnerability at Amazon, and it's a big one: Its core retail operation. That's right: The business that serves as the foundation and core of Amazon's success is showing signs of trouble. And that could present some problems for Amazon's investors and its management in the future.
Three years ago, Amazon's revenue was growing at a 43-percent rate. Last quarter, it was growing at 20 percent and early indications are it could be closer to 18 percent this quarter. Amazon's growth is slowing, just as you'd expect from a large company, but it's slowing faster than many were expecting, and most of the slowdown appears to be coming in the core retail business.
Ecommerce has never been an area of high profit growth, but investors have long given Amazon's retail operations a pass because the company sacrificed potential profits to invest in future growth. In the future, Amazon's growth will come from AWS and other new areas of business. If growth in Amazon's ecommerce is limited, does it still make sense for Amazon to keep discounting retail and shipping costs so aggressively?
The limitations of online retail are well known. Last summer at a PandoMonthly talk, Fred Wilson of Union Square Ventures was asked what he thought about ecommerce. Wilson answered bluntly:
I don't like ecommerce. I think it's a low-margin business with high capital costs and high customer-acquisition costs. Most ecommerce companies fool themselves into thinking that the lifetime value of their customer is in excess of their acquisition costs when it's not... Then the whole thing is revealed to be an emperor that has no clothes. And then they really, really struggle.”Wilson was speaking about ecommerce startups, not Amazon. For nearly two decades Amazon was the exception to this rule because it could leverage economies of scale and pressure publishers and suppliers into lowering prices to lure shoppers with the lowest prices on the Web.
But what if Amazon isn't that different in the end? What if customers aren't necessarily loyal? What if the high costs Amazon has been paying for their loyalty don't pay off? Given the high multiple of Amazon's stock, based on the premise that Amazon will keep growing, these are questions worth asking in 2014.
For years, shoppers could take for granted that Amazon would offer the lowest price, or close to it. Over the past year or so, just as Amazon's revenue growth rate began to slow dramatically, that stopped being the case. It's not just big retailers like Target and Best Buy offering to match Amazon's prices, other retail chains are beating it without appearing to try.
It's never been unusual to find, somewhere, a lower price than Amazon offered. But it's growing commonplace. Several of the products on The Wirecutter link to Amazon with warnings that prices have risen since the site wrote a review (the “best $500 TV” is now $599 on Amazon), and can be bought for less on other brand-name sites.
When my own TV recently died, I ended up finding a set that was 20 percent cheaper than Amazon's price at, of all places, Sears. Without a second thought, I drove to Sears and set it up that day. I've also noticed more and more retailers on Amazon Marketplace keep other shops on eBay that not only offer lower prices, but will ship orders under $35 for free (and without the three days of foot-dragging Amazon often requires to process a free, non-Prime order).
Why does this matter? Isn't Amazon already so huge that its customers won't stray to other retailers? Not necessarily. Online shoppers have been conditioned, by Amazon and others, to regard price a major factor, if not the biggest, in choosing a retailer. Early on, Amazon was popular because it was always reliable and it was always cheap. As fraud became less of a threat on major sites, and as many traditional retailers learned how to sell online, reliability offered Amazon less of an advantage.
Now Amazon is losing its cost advantage as well. Amazon's net shipping costs have risen steadily by about 25 percent a year, reaching $3.5 billion in 2013. Shipping costs are now rising faster than Amazon's total revenue, an unsustainable gap. Something has to give. One thing that's giving is Amazon's passion about offering the lowest price. And that shift could send many customers elsewhere.
In 2005, Amazon Prime was introduced to avoid this scenario. At first, the service offered free two-day and discounted overnight shipping and now includes ebook perks like a Kindle lending library and free access to 40,000 movies and TV episodes. Amazon recently raised Prime's annual fee to $99 from $79. Analysts are split over whether this will help or hurt. It's unlikely to drive away many older Amazon loyalists, but it may deter potential new ones.
The higher fee is roughly in line with inflation ($79 in 2005 is $95 in 2014), but it's not the only change Amazon has imposed on its members. In recent months Prime users have also been griping about higher overnight shipping costs for heavier shipments, two-day orders that arrive several days late, and a confusing "add-on" program that limits many two-day shipments to orders over $25.
For now, most of Prime's 20 million members aren't ruffled by these changes – on average, they spend $1,300 a year on the site. And Amazon may sweeten the pot further with music-subscriptions and grocery delivery. If so, for $99 a year, they'll have streaming video and music in addition to Prime shipping benefits. Netflix superior video catalog costs $96 a year. Netflix and Spotify costs $216. So Prime could become a bargain even without the shipping benefits.
Here's Amazon's ideal scenario: If the company brings in millions of new Prime members, they could buy more through Amazon because of the savings on fast delivery, which would revive its overall revenue growth. Amazon could then afford to not be the cheapest retailer all the time. It will engage customers with its brand, Prime's digital-content offerings, and other perks.
And here's the not-so-happy scenario: Amazon realizes it can't keep losing money on buying customer loyalty. Amazon Prime is already driving up overall shipping costs, which will in turn add to Amazon's delivery costs, prompting higher Prime fees. If that happens, Prime looks less and less like a bargain. Shoppers find better bargains on other sites and opt for the discount over Amazon's fast shipping. In that case, revenue growth keeps slowing, while shipping and digital-content costs rise.
So it's not so much that Amazon's revenue growth is slowing, it's why. If it's something Prime can reverse, Amazon's future looks bright. If not, it will mean customer loyalty may be too slippery a thing even for Amazon to grasp for long. The quest for the best deal may be more powerful than Amazon realizes. So Amazon spends and spends, but it's not enough to keep enough shoppers coming back.
Buying a costumer for life, if it can be done at all, is an expensive proposition. Maybe too expensive even for Amazon to afford.
[Image via Thinkstock]