CIFM03 TUTORIAL AMAZON CASE STUDY

Introduction
Amazon.com, the brainchild of Jeff Bezos, set out to become the worlds largest online bookseller, at a time (1994) when the traditional model consisted of a high street outlet carrying shelves of books which customers could browse. In breaking with this tradition, Bezos has forced others to emulate him, or lose custom, and to create innovative stores that act as much like a coffee house/meeting place as a repository for hard copy books. Amazon does more than offer cheap books. It allows readers to post reviews of books, to sell second hand ones or search for those willing to sell their own. It gives the book lover access to endless catalogues to browse, organises books by type and author, and even includes pictures of dust-covers. All of this has to compensate for the lack of a real product to pick up, leaf through, feel the weight. Every on-line service has the same problem. Can customers really judge the product from a picture and a sample paragraph or two? On the plus side, of course, Amazon addresses a world-wide audience and never shuts. So it offers convenience, one-stop shopping for those difficult to find authors, and low price. Since its inception, Amazon has blossomed out into other products. In part this has been driven by the low margins on books, and the increasing competition from the traditional outlets, and copycats. It has yet to make a profit, despite ever-growing turnover, but argues that profit comes at the end of a long growth period, once a strong market share has been secured. Facts and Figures In 2000 U.K. booksales totalled about 2 billion. Sales in the U.S.A. reached 20 billion. Paperbacks drive the majority of sales, with texts and technical books limited to a handful of sales. Libraries act as competition, since they are not averse to stocking paperbacks to lower costs and increase readership. Why buy when you can borrow? Publishers carry the risks in the sector, paying authors in advance of sales, and taking unsold copies back from outlets. Up to 30% of books can be returned, though the average is 20%. The consequence is that they carry stocks. Distribution consists of a wide variety of outlets. In America large book superstores exist, often combining book sales with music sales. The largest chains are Barnes and Noble, and Borders, and these are expanding into the U.K. In the U.K. Waterstones/Dillons is the market leader, with WH Smith trailing in second place. However, WH Smith does have a stranglehold on airports and railway station outlets. Another layer of outlets is offered by the smaller, independent bookshops. They are supplied by wholesalers, and sometimes directly by publishers. Supermarkets now offer a limited range of books and magazines. Readers can join a bookclub, or a library. University bookshops (Waterstones is the U.K. leader) provide specialist books to students. And finally, all the large outlets, and a number of specialist firms, have a web presence.

Books are nowadays typically sold at a discount on the recommended retail price. This hits the publisher, as can be seen from the typical figures given below. a) b) c) d) e) Manufacturing cost Overheads inc advts. Return and allowances Author payments Operating profit 20% of selling price 30% 20% 10-20% 5-15%

Bearing in mind that other costs may need to be borne (bank interest, dividends, tax, etc) the final return can be derisory. Add to this that the growth experienced in the 1990s is not expected to continue into the new century, and the picture is not a happy on.

Jeff Bezos
Jeff Bezos left a successful career in Wall St. as an investment banker (youngest ever senior vice president at D.E.Shaw) because he saw the startling growth of the internet as a major business opportunity. The only question was the type of business to start. Jeff started with a list of 20 possibilities and narrowed them down to music, and books. He appreciated that in each case the number of available titles far exceeded the capacity of any retailer to carry. In books, for instance, some 1.5 million Englishlanguage books were in print, with an equivalent number in other languages. Yet the largest outlet carried only(!) 175,000 titles. Jeff set out to offer a single point of sale for book lovers, at wafer thin margins, in the hope that eventually volume would yield a profit. Choice of location was important too. Jeff had a number of criteria to satisfy: a) b) c) An attractive place to live Access to highly qualified people in the locality A small State (since people living in it would be charged a sales tax, but those outside would not)

The lot fell on Seattle.

The Early Company

As is traditional with new IT companies, Amazon started in a garage. Ironically, he used the coffee shop of a nearby bookstore to interview staff. Venture capital of several million dollars allowed him to take a modest office, and trading began in July 1995. Within six weeks he needed to move to larger premises (200 sq. m) and six months later he took over a twelve story former hospital. In the first year of trading Amazon enjoyed an income of $5 million, about equal to a book superstore. Five years later it had still to make a profit. It went public in 1997, suffers from a volatile share price, and has in its time been valued at $27 billion: a truly extraordinary figure. Early in 2002 this valuation had dropped to $5.3 billion, based on sales of $3.1 billion in 2001. A long way from the garage

What Amazon Offers

Amazon offers convenience, selection, service, and low prices. Their book catalogue is one million titles, and the browser can search by topic and author. Short descriptions are provided, as well as reviews by readers, specialists, and Amazons own staff. Once the customer finds an item they like, it can be ordered by credit card. As an alternative, customers can reserve books on the website, and then phone in credit card details. Amazon does not carry large stocks of books: instead they order from a wholesaler or publisher, except for best sellers where a small stock is kept. This ordering system allows same-day despatch of best sellers, and delivery of others within a week or so. Discounts on best sellers are usually 30%, though sometimes this rises to 50% to compete with offers from competitors. Other books enjoy a discount of 10% of the cover price. Amazon can offer these discounts because it does not have to cover high stock-holding costs. By contrast, a typical high street store carries about three months worth of books all the time. However, Amazon must advertise (though less so now it is well known), whereas the high street store need not. In addition, Amazon has shipping charges to cover. On the plus side, it carries no salespeople. Amazon hopes that the buying experience is so helpful and painless that customers will return again and again. It is much easier to sell to an existing customer than to attract new ones. Amazon helps this process along by offering a weekly prize for the most amusing and obscure titles ordered. Past winners include Training Goldfish Using Dolphin Training Techniques, and How to Start Your Own Country.

Running the Business

Amazon was not the first internet company to sell books on the internet, but it aims to be the biggest and the most successful. It also sets out to be welcoming and easy to use. Seventy percent of those who visit the site become regular customers. Over the years, though, Amazon has changed from bookseller to anything seller. In part this is due to the recognition that a website is really a place through which any product or service can be sold. It offers electronic greeting cards, music, videos, pharmaceuticals, pet supplies, toys, tools, film processing, health and beauty products, handcrafted items and more. Some of this comes from acquisition of ecommerce businesses, the rest from closer relationships with manufacturers. Amazon provides the core competence of site management, and customer focus, offering potential partners easy access to millions of potential buyers. Admin. Amazon has five divisions: marketing, operations (handling order processing and warehousing), business expansion (new products and markets), and editorial (website design and content). His five vice presidents are all from senior positions in industry, and elsewhere (Black and Decker, Barnes and Noble booksellers, a man who launched PC Magazine on the web, someone from Cinnabon World Famous Cinnamon Rolls, and a hardware and software expert). In 1999 Amazon ran five warehouses in the U.S. and one in the U.K.

Making Money?
By 2000 Amazon had grown to be the internets third largest bookseller, without ever having made a profit. Twelve million customer accounts and a brand name that is well known have led to a company that can now market anything. Bezos boasts that he now offers the worlds largest selection of goods. In so doing, of course, he has entered a different competitive arena. From its inception Amazon has seen astonishing sales growth. Initially, sales doubled every ten weeks. In 1996 sales amounted to $16 million. In 1997 they rose to $150 million, and in 1998 they were nearly four times that. 1999 broke the billion barrier, to return sales of $1.64 billion, but losses of $390 million. Barnes and Noble, by contrast, enjoyed sales of $3 billion in this period. The table below compares Amazon with its two larger rivals, using a percentage of sales formulation for results in 1997.

Sales Cost of goods sold Gross margin % Overheads Profit/(Loss) %

Amazon 100 80.5 19.5 39.3 (19.8)

Borders 100 72.1 27.9 24.3 3.6

Barnes & Noble 100 72.2 27.8 22.0 5.8

The overheads in Amazons case are largely marketing and product development, costs which are not borne by the competitors. Notice, too, the high cost of goods sold in Amazons case. Note also that the profits made by even the largest companies are single figure percentages. In 2000 Amazon continued its growth, producing sales in the first six months nearly double those for the same period in 1999. However, this growth did not come from the core products of books, music and video, which rose only 38%. The suggestion arose that Amazons strategy needed a re-think.

Strategic Developments
Senior people at Amazon knew full well that the internet would allow a multitude of small, low-operating-cost companies to appear, some of whom would compete with, or be complementary to Amazon. Its strategy, therefore was to absorb some of these, and to form alliances with others. This means that customers visiting an Amazon Associate company can link to the home Amazon site. There were some 60,000 Associate sites in 2000. An example would be a good food site linking to books on cooking, or outdoor clothing linking to books on guides, maps, and so on. Amazon pays the Associates between 5 and 15% of sales value for such referral. Late in 1999 Amazon opened its site, and customers to products being sold by other companies. It became, in essence a doorway to a large number of businesses. This is the reverse of the Associate idea, and Amazon charges a small monthly fee and 25% of sales for the service. Beauty products, pet foods, branded sports wear and antiquarian books were among the early adopters of this approach. Amazon went further, and bought shares in these businesses to strengthen the relationship.

Also in 1999 Amazon entered the electronic auction arena. It provides a venue for people who wish to auction goods on the internet. There are, of course, others who provide such a service, but Amazon has the advantage of a large, ready-made customer base. In August 2000 Amazon formed a ten year strategic alliance with Toys R Us, the worlds largest toy store chain. In this case, Amazon would actually provide warehousing space for toys, and the distribution network. It would act as the shop window, service the customers, and be supported by Toys R Us, which would select, purchase, and manage the inventory. For this service Toys R Us pays Amazon a fee. Amazon also agreed with Microsoft to distribute electronic books based on Microsofts Reader software.

A Risky Business
Growing and diversifying was tried as a strategy many years ago in the age of the conglomerate. The danger is that investment must precede return (so profits continue to recede into the future), and no management can run a large portfolio of different businesses with different cycles, advertising needs, customer peculiarities, etc. So we could see a growing Amazon that never ever makes a profit. Margins in books are very low, and Amazon is giving some of theirs away to Associates. Can they afford this? Again, Amazon may lose its core business of books if it is seen as no more that an internet supermarket. Jeff Bezos recognises this and said: Customers are loyal right up to the point somebody offers them a better service. Tutorial Tasks Do this exercise within a group of 3-4 students. Your group should be prepared to give a five minute overview of your findings and be able to respond to questions that arise from the body of the class. 1. How would you characterise Amazons strategy? 2. Carry out a SWOT analysis on Amazon as described in the case.

3. Work in small groups to apply Porters Five Forces approach to the case. 4. Prepare a presentation to report on Amazons changing strategy

This case study is base on material in Thompson, JL. 2001: Strategic Management 4th ed., Thompson Learning, Great Britain