Amazon’s New Retail Business Model: Customers Win, Competitors Lose, and Sellers Pay to Play
Retail is, conceptually, quite simple. A retailer buys stock, brands it, and sells it to a customer. When done well, the retailer earns money – enough to pay for business operations, a profit, and items that didn’t sell. This pattern dates back at least 3,000 years, and it is still the dominant pattern today.
Of course, there are variations. Sam’s Club and Costco, for example, charge a modest annual fee, which increases revenue. Large retailers have learned that they can charge (a lot) for a prime location in the store. In some sectors, retailers have imposed sell-or-return policies – publishers know they must offer booksellers the option of returning unsold books if they want those orders to keep flowing. Yet the basics are still quite simple: the vast majority of revenue comes from sales.
Amazon is different. It has developed a new retail model, where sales revenue is just one of four major revenue streams. As a result, customer revenue represents a much smaller percentage of total Amazon Retail revenue, allowing Amazon to charge those customers lower prices. Obviously, this is a huge advantage.
How does this work?
Amazon’s retail operations are effectively two businesses under one roof. It has a huge traditional retail operation (“Amazon Retail”), stemming from its origins in books and then toys and electronics. This traditional retail business generated nearly $200 billion in sales in 2021. In some segments, Amazon dominates – for example, it accounted for more than 50% of all book sales in the United States. But there are only a handful of similar segments. In most cases, Amazon faces significant competition.
The second activity is the Marketplace – the online souk where 2 million active sellers from all over the world connect with Amazon customers. From Amazon’s perspective, the Marketplace is a mall and Amazon is the operator of the mall. Amazon does not buy or own the inventory, which is actually sold by these millions of sellers. Amazon’s job is to facilitate, by acquiring customers, ensuring satisfaction, improving the flow of information (reviews), and of course supporting delivery through its amazing logistics network. And from a customer’s perspective — and by Amazon’s design — it’s hard to tell the difference between the two companies.
Amazon generates huge revenue and operating revenue from the Marketplace in three ways: from a direct commission on all sales, which is mostly 15% of gross sales; the increasingly mandatory need for sellers to advertise (advertisements get you a prime position on Amazon’s search results page); and fees associated with Amazon logistics.
For Marketplace sellers, these logistics fees are generally a bargain, although they are steadily increasing. For small sellers, Amazon logistics is extremely convenient, while large sellers often split their logistics between Amazon and other suppliers (including their own warehouses). Amazon also benefits from the huge economies of scale that come from combining Marketplace and Amazon Retail, which together now account for more package deliveries than FedEx.
But while little operating revenue returns to Amazon from logistics, neither does advertising revenue or annual Amazon Prime subscription fees. In addition to commissions generated through the Marketplace, advertising and Prime heavily subsidize the nominal price charged by Amazon Retail.
What is the amount of this grant?
Amazon’s financial books are designed to obscure, so Amazon does not directly explain the profitability of each business segment. But it is possible to make good estimates. For 2020 (pre-pandemic), those estimates look like this, after subtracting shipping costs for Amazon Retail and Marketplace (there’s a detailed analysis of Amazon’s financials in my book Behemoth, Amazon Rising):
Amazon makes a modest profit from its retail operations as a whole, but these multiple revenue streams allow Amazon Retail to sell at prices significantly below cost, subsidized by Prime, advertising, and Marketplace revenue. In fact, Amazon Retail’s revenue only covered about 60% of Amazon Retail’s costs in 2020, and that share has been steadily declining as Amazon’s new retail model supplants retail. traditional detail:
These types of cross-subsidies have drawn antitrust attention in the United States, dating back to the first trust busters in the late 19and and early 20and centuries. Cross-subsidies can be unfair to competitors who don’t have deep alternative pockets to tap into.
But – again – Amazon can be different. Rather than cross-subsidize unrelated businesses, it has built a complex new retail ecosystem, a new model, in which customers are well served at prices that are driven down, not up, by relentless competition.
Within its platform, Amazon cannot simply eliminate competitors and raise prices like Standard Oil. It is absolutely true that on a micro scale, Amazon is often anti-competitive (see for example Jason Boyce’s testimony that Amazon drove him out of one profitable niche business after another). But on a global level, Amazon operates in a highly competitive environment and creates new opportunities for small retailers that simply did not exist before Amazon emerged with its extraordinarily low barriers to entry and immediate access to hundreds of millions of potential customers. Indeed, the huge lake of red ink at Amazon Retail is indisputable proof that the Amazon platform is deeply competitive.
However, Amazon’s new model presents a huge challenge for other large retailers; none of them have these multiple sources of income to draw on. Prime has more US accounts than US households (172 million and growing). Walmart has Sam’s Club, but which has less than 50 million members and only charges $45/year, while Amazon is set to raise the annual fee for Prime fees by $139.
Similarly, all major retailers charge placement fees in their stores, but these are a drop in the bucket compared to the huge profits from Amazon’s $31 billion in ad business (estimated margin >80% ). And none have significant online advertising activity.
Worse still, other major retailers have totally failed to build a competitive marketplace. This is really detrimental, given that the gross volume of goods in the marketplace is now approaching $400 billion, so Amazon’s commissions must be around $60 billion. As a result, Amazon added more to its total GMV in 2021 ($1.11 trillion) than Walmart and eBay added to total global e-commerce sales combined.
Retail success is often a matter of scale and financial strength. By building an entirely new model for retail, Amazon is benefiting from massive and fast-growing funding inflows for its retail operations. How Amazon chooses to use this remains to be seen (so far much has gone into building logistics and AWS). But that’s ammunition that other retailers simply don’t have and won’t develop.
Written by Robin Gaster Ph.D.
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