Amazon: ‘The Everything Store’ – Driving Long-Tale Strategy with Superior Supply-Chain Management
By developing superior supply-chain management, building strong relationships with vendors and distributors, and providing a seamless online experience for shoppers, Amazon has grown to be the world’s biggest online retailer.
Amazon is an example of exceptional effectiveness at driving alignment between the business and operating models (please note that this post refers solely to Amazon’s e-commerce business). By developing superior supply-chain management, building strong relationships with vendors and distributors, and providing a seamless online experience for shoppers, Amazon has created (and captured) significant value for all players involved, on its way to become the world’s biggest online retailer.
Business Model: Creating value with ‘Long-Tail’, Low Price, and Fast Delivery Service
Founded in 1995 as an online bookstore, Amazon.com has expended over the years to offer the “Earth’s Biggest Selection” of products available, including (among others) music, movies, electronics and household goods[1]. From its inception, the company adopted a ‘long-tail’ strategy[2] under which ‘hit items’ were offered alongside a wide selection of ‘non-hit items’, i.e. items that are non-frequently searched for and sold in small quantities. While other online bookstores limited their offerings to their own inventory items, Amazon’s seller marketplace allowed it to offer books – new or used – from any partner bookstore without having to hold inventory, and for only a small markup. As a result, Amazon has been able to offer highly competitive prices for consumers and attract vast online traffic, which translated into increased sales volume for vendors. Furthermore, the company’s explicit ‘zero profits’ strategy[3] has allowed it to re-invest its revenue in improving its supply chain infrastructure, which in turn reduced costs, price to end-consumer, and delivery time, resulting in increased customer satisfaction[4].
Operating Model: Inventory and Superior Supply Chain Management
To support its long-tail, low price, fast delivery business, Amazon ships orders to consumers in two ways:
- ‘Non-hit /long-tail items’ are usually shipped directly from the vendor’s warehouse, releasing Amazon from the need to stock slower-selling products, thus assuring that it only maintain fast inventory turnover. Under this method, advertising and shipping costs are incurred solely by the vendor. This allows Amazon to expand its available product selection online without a corresponding increase in overhead costs[5].
- ‘Hit items‘ (i.e. more frequently sold products) are usually shipped to consumers from one of Amazon’s 168 distribution centers around the world[6]. Amazon’s extensive investment in warehouse management technology and automation[7], along with its ability to leverage economies of scale, allow it to ship “the right products in the right quantity to the right place at the right time” while reducing costs for both the company and its customers. Under this supply chain method, vendors have complete control over which products to store at Amazon’s distribution centers. To optimize their decisions, Amazons provides vendors with advanced online inventory management tools and analytics, which take into account factors such the speed of inventory turnover, market prices and seasonality[8]. Products stored at Amazon are eligible for Amazon Prime (a two-day delivery shipping), and consequently rank higher on Amazon’s website search-results, further increasing the chance of a purchase. Distribution center locations are chosen based on proximity to customers, to reduce delivery time to minimum. Products shipped by Amazon are delivered by UPS, the U.S. Postal Service or other delivery services. Recently, however, the company indicated its desire to increase its control over the ‘last mile delivery’ to the customer, which would allow it to further reduce costs and delivery time (with the aim to reach same-day-delivery as an operation standard). As part of these efforts, Amazon plans to launch its own shipping network “sometime in 2016”[9], and has already launched Amazon Flex – a new, on-demand service that pays part-time drivers in exchange for delivering packages[10] (similar to Uber, which reduced the cost of traveling by taxi).
Complete Alignment:
Amazon’s operating model is fascinating as it demonstrates how a world leading company can optimize every step of its supply chain management – from relations with vendors to last-mile delivery – in order to increase customer value. By continually innovating (now considering delivery with drones![11]), driving constant improvements, and maintaining strong relations with its vendors and distributors, Amazon has created great value for consumers, vendors, distributors, its own shareholders (in the form of increase in share value), and the economy as a whole. The company’s business and operating models are highly aligned – focusing on cost reduction and providing a viable solution for a ‘long-tail’ need that was not addressed prior to Amazon’s existence.
Resources:
[1] Analysis of Amazon’s Business Model, Eric Noren, July 8th 2013 (http://www.digitalbusinessmodelguru.com/2013/07/analysis-of-amazon-business-model.html)
[2] http://www.newmarketsadvisors.com/blog/bid/36296/Long-tail-business-models-Amazon-on-offense-and-defense
[3] ‘Former Amazon Employee Explains How The Company’s Business Model Really Works’, Jay Yarow, Oct. 28 2013, see: http://www.businessinsider.com/amazons-profits-what-people-dont-understand-2013-10
[4] Nolan, footnote 2.
[5] http://www.investopedia.com/articles/investing/061215/difference-between-amazon-and-alibabas-business-models.asp
[6] See MWPVL International: Amazon Global Fulfillment Center Network http://www.mwpvl.com/html/amazon_com.html
[7] Amazon’s inventory management secrets, by Nancy Master on Tue, Nov 27, 2012 http://www.rfgen.com/blog/bid/246924/Amazon-s-inventory-management-secrets)
[8] http://services.amazon.com/fulfillment-by-amazon/benefits.htm
[9] ‘Amazon may be secretly building a team that will help it replace FedEx and UPS’
http://www.businessinsider.com/amazon-building-in-house-delivery-team-2015-10
[10] ‘Amazon will now pay you to deliver packages’, The Verge, By Amar Toor on September 29, 2015, http://www.theverge.com/2015/9/29/9413787/amazon-flex-package-delivery-seattle
[11] http://dealnews.com/features/Amazon-Gives-Us-a-Peek-at-Actual-Delivery-Drones-in-This-New-Video/1536571.html
Ita! Thanks for a great post. That video was fascinating — the value that Amazon has created for customers is truly unparalleled. I was picking up a package in the mail center at HBS the other day and realized that about 90% of the boxes piled up against the wall displayed the familiar Amazon label. People (including myself) continue to purchase more and more everyday items from Amazon due in large part to their effective delivery services.
That said, Amazon has also faced numerous charges of mistreating their employees (both warehouse workers and those at corporate headquarters). I’ve listed a couple of related news articles below which contain additional detail. This makes me wonder if their operating model is predicated on what has been called a “ruthless” and “oppressive” work culture. I agree that Amazon has done a great job of creating and capturing value for shareholders, customers, vendors, and distributors but it’s not clear they’ve done the same for their workers!
http://www.salon.com/2014/02/23/worse_than_wal_mart_amazons_sick_brutality_and_secret_history_of_ruthlessly_intimidating_workers/
http://qz.com/481235/amazon-treats-its-employees-the-way-it-does-because-of-us/
http://www.nytimes.com/2015/08/16/technology/inside-amazon-wrestling-big-ideas-in-a-bruising-workplace.html?_r=0
Anyways, I thought it was interesting to think about the trade-offs in terms of WHICH actors capture the value that a company creates. Thanks again for a really interesting overview of a company we use so frequently!
Kyla, this is such a good point! I completely missed it in my analysis.
You are absolutely right that value to employees is no less important than to any other ‘player’.
In economic theory, with emphasis on ‘theory’, Amazon is competing both in the consumer market and the employee market. And if it wants attract and retain good employees, it must offer better value than its competitors (value meaning salary, feeling of empowerment, feeling of community, future job opportunities etc). And if Amazon is treating its employees badly, they would eventually leave, or not join at the first place, because they have a choice.
And that’s exactly what I’m struggling with: do employees – specifically blue-collar employees – have a real choice? can they leave an employer and incur the price of looking for a new job while not earning money for whatever it takes to find that new job? Or – if they live in a small town where unemployment rate is high – will they be able to find an alternative employer AT ALL? I am not so sure what the answer is, but my general outlook is that employees always have a choice, they can always leave. And if they decide to stay despite everything – perhaps there’s some good value in it for them as well.
Thanks for your important comment, would love to continue discussing this offline.
Ita,
You are on point when explaining the core of Amazon’s success: Being able to offer everything while only stocking popular items, and reinvesting is profits to further develop it’s business. I believe your post opens the door to discussing one particularly interesting topic regarding how Amazon operates: the implication of Amazon not being a profit making business, which is it has never distributed dividends among it’s stockholders.
The natural question is how long can a zero-profit model last, because the decision of investors to buy and hold stock has to be supported on the rationale of earning dividends eventually. The conclusion seems to be paradoxical: Amazon will have no incentive to end its actual scheme as long as Wallstreet keeps trusting the company (which has been going on for almost 20 years, since the company’s first IPO in 1997). In the meantime, the current trend were Amazon’s revenue increases and it’s net profit (%) decreases is likely to continue. By doing so it will keep discouraging competition (a company that’s trying to turn a profit simply can’t compete on price with one that isn’t) while still having tremendous levels of cashflow to play with.
For further reading on this issue, visit the following link: http://www.slate.com/articles/business/moneybox/2014/01/amazon_earnings_how_jeff_bezos_gets_investors_to_believe_in_him.1.html
Max,
This is a FASCINATING point!
Yes, I was thinking about the same thing – how long can this model go on without generating any profit? how long would investors support the stock if they can never extract any tangible value from it?
But you can also think about it another way: how is this model different than companies that do generate profit, and then – as a policy – re-invest everything in the business? you could argue that Amazon is doing the exact same thing, and the only difference is that their profits do not show in the financials’ bottom line but rather in increased PP&E, R&D or increased sales volume (meaning – the company has reinvested profits before they were even generated).
Not all companies pay dividends to their investors, and yet many of these companies are traded for high market cap. So why do investors hold them? to be honest, I don’t know. Would be super-interesting to discuss this offline, and hopefully in FIN 2.
Thanks for a great comment!