How Did Amazon Build Its ‘Sustainable Competitive Advantage’? -Business Strategy and The Key Success Factors
“One Million Titles, Consistently Low prices” — The blue underlined text in Amazon’s first homepage in 1995, announced the reason how they were different from others.
Tom Alberg, a former executive at McCaw cellular could not believe that the idea of buying books online through this ugly looking website would work as he loved the beauty of browsing in bookstores.
The first Amazon website had a rudimentary search engine. People were worried about sharing credit card details wondering if their data would be safe. Many had no idea of how a virtual shopping basket worked. Also, the book would take a few days and sometimes weeks, if the title was rare, to arrive. But… two decades later Amazon has redefined the way the world shops — the company has grown to dizzying heights and is today the undisputed leader in online retailing worldwide. And it is not that the existing offline behemoth did not put up a stiff fight — however, Amazon prevailed and how!
How did Amazon build such a strong sustainable competitive advantage?
Note: The below content is part of the following book.
POSITIONING — TARGETING A NICHE
The first and foremost factor for a sustainable competitive advantage is to position your brand in a consumer’s mind. The ways to enter the mind is by:
a) Becoming a leader in an existing product/service category(This would need huge investments in terms of money, effort & time and so not a practical option for everyone)
b) Becoming the first entrant in any new product/service category. In other words, you need to create a new category that differentiates you from the rest of the market.
FINDING A NICHE MARKET
Start small. Focus on a particular need, work on it, make your product distinctive and dominate the niche market. Smaller the segment, the easier it is for the company to focus and meet its customer needs, wants and desires. Once you become a leader in the niche market, you can spread your footprints in larger markets.
In 1994, Jeff Bezos, jolted by Internet’s 2300 percent annual growth rate, began thinking of building a true ‘everything store’ online. But he knew that such a venture would be seen as impractical, at least in the beginning. So, to position his service in people’s minds, he had to focus on a niche. How to choose a niche? He made a list of twenty possible categories — Computer software, office supplies, apparel, music, etc… One interesting option popped up — Books!
WHY BOOKS? — Bezos chose the ‘Books’ category for the following reasons:
- Books was a $10 billion industry in the United States in the year 1994. A considerable percentage of people had already been buying books through mail order or postal services — so there existed a potential customer base with a need for convenience.
- Generally, most of us would have a “Fear Of Failure” while trying out any new things. Consumers at that time had little exposure to online buying. They were worried about the quality of products sold online. But books were pure commodities and their quality would not change whether you bought it from an online or offline store. So, the customers had no “Fear of Unknown”. They knew what they would get.
- At that time, books were primarily supplied by two major distributors and Bezos could save time because he did not have to approach individual publishers.
- Millions of books in print worldwide, and no matter how large a bookstore, it did not have the capacity to stock all of them — too many SKUs — a potential advantage for an online store since it had no such limitation to deal with. Though initially, Jeff Bezos could not build an ‘Everything store’ he did get a sense of direction of where his online venture would take him.
POSITIONING — THE DIFFERENCE
As Amazon began to sell books online, it also began to find ways to establish and preserve the difference in experience in a consumer’s mind and this laid the foundation to build a sustainable advantage.
According to Bezos, Amazon’s value propositions would be to provide greater value to customers through a combination of extraordinary convenience, instant access, and comprehensive selection. These differences would have been sufficient to build a competitive advantage but Jeff had another idea. He decided that his foremost value proposition (UVP) would be ‘ Low Price’. Amazon would provide both value and low price.
Why Low Prices? Jeff had his own reasons to believe that Amazon would have a natural advantage in selling products with low-profit margin.
Bezos “I didn’t want to repeat the mistake made by Steve Jobs that is pricing the iPhone in a way that was so fantastically profitable that the smartphone market became a magnet for competition.”
He was of the opinion that high-profit margins justified rivals’ investments in research and development and attracted more competition, while low margins attracted more customers and were more defensible.
UNIQUE SET OF ACTIVITIES
Amazon has been performing hundreds of activities to ensure its unique value propositions to customers. The company customizes these activities to meet its low price guarantee and a greater value of convenience to the customers. Over a period of time, those activities became unique to Amazon and laid the foundation for sustainable competitive advantage. Let us look at some of these activities in detail.
CUSTOMER FRIENDLY 30 DAY RETURN POLICY
FEAR OF FAILURE -When Amazon launched its services in 1995, online shopping was new to many and as is usually the case, it was met with resistance given the insecurities that customers had to accept in online shopping. Amazon, therefore, had to look for ways to inspire consumer confidence and overcome their fear of the quality of products on sale. To help consumers overcome the fear of ‘Unknown Quality’ and to position its service in the consumer’s minds, Amazon introduced the concept of ‘30-day return policy’.
Easy to Return -Amazon also made it effortless and quick to return a product in case the consumer was not satisfied with it. The company used best web design practices and made it easy for consumers to locate the ‘Return & Replacements’ menu and submit return requests in easy to follow steps. Besides, it clearly specified terms for return and refunds and also added an FAQ section to answer common customer queries. Each aspect of the web design and activities was thought out to the last detail from the customer’s perspective.
Why? -The biggest pain point for customers in the pre-Amazon era was not having enough information about the products on sale on websites, which left them with many unanswered questions. To alleviate this pain and build their confidence, Bezos introduced ‘User-Generated Reviews’ on Amazon.
How? — In the early years, Amazon’s employees wrote the reviews. Some of the user reviews were negative and invited angry reactions from the sellers. Bezos received angry letters from publishers condemning him that his job was to sell the products and not to trash them. But he believed that if Amazon had more user-generated reviews than any other site, it would give the company a massive competitive advantage.
Bezos “We don’t make money when we sell things. We make money when we help customers make purchase decisions”.
TRUST IS EARNED -In a recent survey of e-commerce consumers, 55% of respondents had cited ‘Volume of Authentic Customer Reviews’ on Amazon as the reason for their recent online purchase. Consumers trust the authenticity of Amazon’s ‘user-generated content’. Honesty is expected but Trust has to be earned. Trust is intimate and engaging. It takes time to build trust. Amazon’s return policy and the User reviews helped the company build consumer trust over a period of time. It would be tough for any competitor to generate that amount of ‘Authentic User Reviews’ in a short time to compete with Amazon.
One of the reasons for Amazon’s dominance in the online space is its ability to personalize the customer experience throughout their shopping journey. Amazon had introduced this concept in the1990s when no other e-commerce company had ever thought about it.
ENHANCE THE EXPERIENCE -In 1996, Bezos introduced ‘Bookmatch’ that required customers to rate a few dozen books and then generate recommendations based on their tastes. However, he found that customers were reluctant to make the extra effort to evaluate books. So Bezos fought for a simpler personalization system that could provide recommendations based on customers’ browsing history, past purchases and data of other users with shared behaviour. The algorithm pointed customers towards books they would not have found otherwise. This was one of the biggest advantages that Amazon had on offline retailers. Sales increased dramatically and thus Amazon’s personalization system captured users’ imagination and gave a major fillip to its sales.
Now Amazon’s algorithms are advanced and understand users’ unanticipated needs, desires, wants and customize the shopping experience for every individual by leveraging the data of massive users. ‘User-to-User and Item-to-Item’ collaborative filtering algorithms, along with ‘Social Proof’ psychology heavily customize the shopping experience for returning customers.
A recent survey notes that more than one-fourth of Amazon’s sales came from Amazon’s personal recommendations.
The sustainable competitive advantage lies in deliberately choosing a different set of activities from your competitor to deliver a unique mix of value — Michael Porter.
EVERYDAY LOW PRICE
In early 2001, Amazon’s business was struggling and Bezos had to reluctantly agree to increase the prices of some of the products & services on the advice of his team.
One day, Bezos had a chance meeting with Jim Sinegal, founder of Costco who told him how he had built ‘Customer Loyalty’ by keeping their product prices lower than anybody else. He also told him that he never advertised his products and this helped him to keep his product prices in control. He also explained how Costco’s lower prices generated heavy volumes of sales and the company used its size to demand the best possible deals from suppliers and further lower the prices to consumers.
Learning from Costco’s success, Bezos decided that like his competitors, Walmart and Costco, Amazon too would ensure ‘everyday low prices’. He believed that if Amazon could stay competitive on the price, it could win the day by providing its customers with unlimited selection, and the convenience of shopping it afforded to its customers. Besides, it could also establish a massive competitive edge.
Bezos, “There are two kinds of retailers; Folks who work to figure how to charge more and there are companies that work to figure how to charge less, and we are going to be the second, full-stop”.
One of the main pillars of success for Amazon has been the lower price it offers to its customers.
DEEPENING THE STRATEGIC POSITION THAN BROADENING IT — REINFORCING ACTIVITIES
Amazon has designed its activities in such a way that not only do they complement each other but also reinforce one another and thus helping the brand to build a competitive advantage. These reinforcing activities cut across many functional areas and strengthen the whole system. Fit among activities reduces cost and increases differentiation.
What are some of these reinforcing activities?
THE REAL ‘EVERYTHING STORE’
In 1998, Jeff came to realize that Amazon still had scope to further lower the product prices and improve the convenience factor it provided to its customers. Besides he could also keep competition at bay, particularly from offline giant retailers. To achieve this, he had to invest in a modern technological distribution system and warehousing but for this, he needed volume to justify the investment.
Jeff realized that books alone would not bring that kind of sales volume and the only option he had was to expand his business into other categories. He chose Music and DVDs as his next target, as they had high SKUs and too many varieties and so it was not possible for any offline store to stack a massive volume of choice. Moreover, Amazon could use its existing value network profitably to meet the needs of the customers in those new categories. Expansion into selling music and DVD in 1998 went well. Amazon then expanded into ‘Toys’ and ‘Electronics’. Thus it slowly but steadily moved towards its mission to be ‘The Real Everything Store’ — The Earth’s Biggest Selection.
This expansion took retailers such as Barnes & Noble by surprise as they were left guessing with whom and what they were competing with.
WAREHOUSING AND DISTRIBUTION SYSTEM
Amazon witnessed rapid expansion in the first half of the 2000s. Larger in size it became, the more complex became the warehousing and distribution structure. The addition of new product categories burdened the existing system resulting in frequent outages. It became harder to coordinate and communicate. Non-standard packages going to countless destinations began to pose a huge challenge in handling, movement, and delivery. The company required an efficient system in place to match the sales which were growing at 300 percent every year. The company tried out a series of permutations and combinations to efficiently meet the growing demand but in vain. None of the existing systems were able to meet the demand. Amazon realized it needed a customized solution — customized infrastructure and software, which needed a massive investment. A decision had to be made.
IS IT A CORE STRATEGY? -Bezos team asked itself a very fundamental question — Should Amazon begin to store and distribute its products in a way many other e-commerce websites like eBay, Zappos was doing, that is, dropping shipping to customers directly from the manufacturers and distributors. Was distribution a commodity or a core competency? If it was a commodity, did it make sense to invest in it? And when we grow, do we continue to do it on our own or do we outsource it? These were the questions that Bezos had to answer.
After a series of analyses, Jeff realized that Amazon’s quality of service(Core Value Proposition) was largely dependent on efficient distribution and if he decided to outsource this, the quality of products could be compromised. He was clear that he would at no cost compromise on the quality and the value Amazon offered to its customers. Also because there was no standard solution at hand, Amazon needed to create its own and this could prove to be a major competitive advantage.
SYSTEM DESIGN -While building the distribution system, Bezos asked his team to rationalize every expense, every activity in terms of the value it offered to the customers. Amazon’s executive, Wilke was in-charge of designing a system that could store handle and ship anything. Instead of hiring experienced retail distribution veterans, Wilke hired scientists and engineers. They questioned the prevailing retail distribution concepts and rewrote all the software code. These new supply chain algorithms became one of the strongest competitive advantages for Amazon making it difficult for competitors to match.
The algorithms plan where, when and how to stock particular products, how to most effectively combine various items in a customer’s order and so on. They also match demand to the right ‘Distribution Center’. The algorithms also allow any employee to stop operations at each floor if they spot a defect or a problem — a concept similar to the Japanese manufacturing processes in the 1980s. This put ownership and responsibility for quality shipment to the people who were most involved in the process. Employees felt a sense of pride when they helped to fix a problem. This resulted in improved quality and continuous improvement of the system. Instead of calling the facilities, distribution or warehouses, Amazon called them Fulfilment Centers.
THE BENEFITS -The innovative and efficiently controlled distribution enabled Amazon to provide quicker deliveries, assure the exact delivery date and keep its promises on product quality & delivery. As Amazon opened more and more FCs, the volume of shipments handled exponentially increased. As the output grew, the company’s cost per unit of shipment fell and the benefit was passed on to the customer. Time for shipping too fell from days to hours. For an extra fee, Amazon could provide delivery within 4–6 hours, overnight delivery, one day or two-day delivery.
Inspired by Apple’s software platform where developers, programmers can deploy their products to reach customers, Amazon executives began to explore the possibility of building a platform where small retailers could sell their products to Amazon’s customers. Amazon earlier tried this idea with Amazon Auctions and Z-Shops but both failed. But Bezos had learned from his previous marketplace and was more determined than ever to implement the Amazon Marketplace.
SELECTION AND THE LOW PRICE
This effort started with used books. Sellers were invited to advertise their own wares relative to the content of the book on Amazon’s book pages. If a seller gained an order, Amazon would get a commission from the sales. There were protests, discontent but Bezos didn’t care as long as it offered more choices to the customers and in the process, gave Amazon a great selection of products.
“If somebody else can sell it cheaper than us, we should let them and figure out how they are able to do it” -Bezos.
Sellers got an easy exposure to Amazon’s active customers and they were also able to save the marketing and promotional costs, and time. With Fulfilled by Amazon(FBA) service, a seller could ship his bulk inventory to Amazon. The company stored this inventory in one of its FC and shipped the product to the customer whenever the order was placed. The company also handled the returns and replacements. This enabled sellers to spend more time on their products and not on shipments. Customers too gained in terms of unlimited selection with lower prices and assured quality.
A Credit Suisse report predicts that by 2020, Amazon’s marketplace would grow to $259 billion and be bigger than the e-commerce market of most countries.
In the late 90s, Bezos realized that one of the biggest hurdles the company was facing in online shopping was the shipping costs. It was clear that consumers were not willing to pay for packing, handling, and shipping is given that they didn’t have to while shopping from offline retail stores.
In the early 2000s, Amazon announced free shipping to customers who placed orders of a hundred dollars or more and to their surprise the sales exploded. The company later brought down the free shipping offer to items costing more than $25. The FCs helped the company to cut down the losses while offering free shipping as the algorithm could combine orders and shipments. The company further went ahead and made free shipping permanent for customers willing to wait a few extra days for their order. However, it would charge shipping for ‘time-sensitive’ clients.
According to some surveys (Article in Inc.com by Peter Roesler), more than 70% of online consumers are more likely to shop on a site if it offers free shipping and returns.
THREAT OF ENTRY
Amazon’s music category business was going well until Apple entered with iTunes and disrupted the market. Amazon was shaken. Bezos realized that well-established players from other Industries could leverage their existing capabilities & cash flows, and disrupt his market. It was important to build entry barriers. ‘Every Day Low Price’ and Amazon’s FCs are part of those entry barriers to new players who plan to enter online retailing. But then these were not enough. The barriers needed to be higher.
It is a well-known fact that ‘high customer loyalty’ presents an insurmountable entry barrier for a new entrant wanting to build a viable scale in a new market.
In 2004, one of Amazon’s employees made a proposal — Amazon had been providing free shipping to people who were not in a hurry to receive goods very quickly. His idea was that the company could target the opposite type of customer, the time-sensitive customers by charging a monthly fee for expedited shipping similar to a music club with a monthly charge. Bezos immediately liked the idea. He had already experienced how Costco earned good profits through their annual membership fee. He went ahead with the idea and thus, Amazon Prime was born.
The Hook — The Prime service was introduced at the price of $79 with unlimited free shipping offers. The sales exploded. The company had taken an enormous risk as the free shipping was expensive to run if a client ordered many items in a calendar year but Bezos went ahead. The customized Fulfillment centres enabled Amazon to realize this dream efficiently.
Developing a Habit — The service turned customers into Amazon addicts as they wanted their items shipped to them without delay. Prime exploited human desire to maximize the benefits from any investment, sometimes at the cost of additional effort, time and money(The Endowment Effect).
Amazon Prime members showed up time and again on its website to shop and all this the company managed to achieve without investing any extra time, money and effort or on expensive marketing. The more the time Prime members invested the more they valued the service. The higher frequency of use turned many as word of mouth references who brought in more customers to the company without any additional costs.
The Rewards — Amazon makes almost double the money from a Prime member than a non-member and thus increases its value by driving higher customer lifetime value. This is one of the main reasons why Amazon spends a considerable amount of money on acquiring new Prime members. Amazon benefitted from a higher volume of sales and got more out of its assets. It also managed to achieve better inventory management and further lower the prices of the products it sold to its consumers.
Amazon’s competitors tried to build their own Prime-like subscription service but the plan didn’t work as expected and many were forced to scrap it.
SUPPLY-SIDE ECONOMICS OF SCALE
When Amazon was new to the market, it didn’t have the leverage to negotiate with powerful suppliers. As the company’s sales volume grew dramatically, it forced suppliers to offer a better price.
One example is the ‘UPS’ — The shipping service provider — Amazon had been shipping their products through UPS and their contract was due for renewal in 2002. Amazon’s volume of shipments ran into millions per day. The e-commerce company wanted lower prices for their shipments but UPS was adamant about not deviating from their standard rates. Amazon threatened them by using FedEx and U.S Postal service for a couple of days even though their service was expensive. UPS executives caved in and gave the company discounted prices. Similarly, Amazon pushed every vendor to offer products at prices lower than anywhere else. Due to the volume of sales and Amazon’s massive customer base, vendors were in no position to refuse the terms.
To cross Amazon’s ‘Supply Side Economics’ barrier, an aspiring entrant would have to come into the industry either on a large scale volume or accept a cost disadvantage.
As the number of consumers increased, the perceived value of Amazon’s service too increased, prompting more non-consumers to try the product. This further helped to build trust among the existing consumers. As Amazon attracted more consumers, a lot of third-party sellers were willing to sell their wares through it. As third-party sellers multiplied, the product varieties and their availability increased. As product varieties swell, more people jumped the bandwagon to use Amazon. The more users, the more the data, the better the user experience, and more recommendations.
Unless a new competitor builds up a large base of customers, it would be tough for it to attract sellers. They can attract consumers only when they have an unlimited variety of goods to offer and that at lower prices.
Network Effects discourages potential competitors.
As of May 2018(mwpvl.com), Amazon’s global distribution infrastructure was around 193,293,566 square feet and still expanding. The company runs different types of fulfilment and distribution centres like large sortable, small sortable, large non-sortable, specialty apparel and footwear, speciality small parts, returns & processing centre, and 3PL outsourced facilities. It has heavily invested in warehouse automation and customized software. It also has an efficient inventory management system. Any new entrant would need large financial resources, sufficient time and effort to build their own distribution infrastructure in order to compete with Amazon. This would limit likely entrants.
A competitor’s decision to enter a new market is influenced by how an incumbent would react. If the incumbent responds aggressively and sustains the reaction for a longer period of time, the competitor’s losses would mount for a considerable amount of time. Amazon possesses substantial resources to fight back any competitor that tries to encroach upon its space. The company will slash prices or take some other aggressive route to retain its market share.
When Barnes and Noble launched their website with the assertion that they were offering a better selection of goods at lower prices, Amazon fought back by slashing prices of its books and also ramping up efforts to find and add to its inventory rare and out-of-print books.
In the late 2000s, a company named Quidsi launched Diapers.com and was gradually expanding its market until it came to the notice of Jeff. Amazon, which until that time had not been selling diapers, entered the arena with prices 30% lower than the market prices. Quidsi was left with no choice but to fight back but to no avail. Amazon launched another service ‘Amazon Mom’ where the new parents could get a year’s worth of two-day prime shipping free. It also went on to introduce the ‘Subscribe and Save’ service for diapers. It was a death knell for Diapers.com. Finally, Quidsi had to sell their business to Amazon.
The company has and can be brutal to new entrants.
KILL YOUR OWN BUSINESS
Bezos was taken aback when Apple disrupted Amazon’s music business. He was well aware of how great companies failed when they ignored to embrace the new disruptive changes and allowed newcomers to disrupt the market. He had failed to notice the warning signs in the music category and didn’t want to repeat his mistakes. Instead of waiting for someone else to disrupt his market he decided he would disrupt it himself. He set up a team to come up with ideas to kill their own business. He chose ‘Books’ as the first category and asked the team to find ways to disrupt this business. Thus ‘Kindle’ was born which went on to transform the publishing business.
Bezos knew that if he didn’t take lead Apple or Google would lead digital reading. He was willing to bet on long-term growth benefits than satisfying short-term growth requirements.
It is observed that all of Amazon’s activities are well-coordinated and complement each other. This makes it difficult for competition to just pick up some of the pieces to build their business and investing in a system similar to what Amazon has is not a feasible option. Even if they could equal Amazon’s shipping prowess and distribution infrastructure they would find it difficult to create and build the ‘Network Effects’. Amazon has slowly and steadily created a massive lead, taking down competition along the way, making it difficult for others to follow in its giant strides.
Note: The above content is part of the following book.
AVAILABLE ON AMAZON -
References: The content is predominantly taken from ‘The Everything Store’ by Brad Stone, What Is Strategy-HBR article by Michael Porter, The Five Forces Of Competitive Strategy-HBR article by Michael Porter, articles from entrepreneur.com, retailwire.com, Blog by Brenda Barron in Herothemes.com, Article in ‘The Motley Fool’ website by Daniel B. Kline.