NBA 600: Session 8 E-Commerce Amazon 13 February 2003

1. NBA 600: Session 8E-Commerce Amazon.com13 February 2003 Daniel Huttenlocher

2. Today’s Class • Retail electronic commerce • Look at Amazon.com • Where they are today • How they got there • What future holds – shopping platform • Amazon’s focus on user experience (UE) • Leave eBay to communities, not a retailer • Some electronic commerce statistics • Multi channel shoppers • Revisiting some failed businesses • FreshDirect

3. E-Commerce: Amazon.com • Launched in July 1995 with two goals • World’s largest selection of books • High value given large number of titles • Convenience that delights the customer • Now a broad-based online retailer • Core business BMV (books-music-video) • Sales of $3.9B in 2002; Q4 up 33% y-o-y • 17% ROIC, low-teens cost of capital (Lehman) • Company predicts 15% sales growth in 2003 • 25-30M unique visitors per month (Nielsen) • Estimates of about 50M “active customers”

4. What Amazon.com Provides • Online storefront – user experience • For own stores as well as partners and Marketplace merchants • Marketplace is “mall” of independent merchants • 23% of sales in Q1 2002 (Jupiter Media Metrix) • Extensive focus on delightful user experience • Driven many innovations, adopted others • Payment processing • Fulfillment • Via own warehouses and partnerships with distributors • Close ties with shippers (UPS, Fedex)

5. AMZN Dominates Online Retail • In addition to own site, operates sites for • Toys-R-Us, Borders, CDNow, Virgin Megastore, Target, Drugstore.com • These retailers have completely outsourced their online presence • May handle own fulfillment though most don’t • Sales partnerships with about 50 other merchants, including • Gap, Office Depot, Eddie Bauer, Circuit City, Nordstrom • Maintain own separate online presence in addition to one on Amazon’s site

6. How AMZN Got There • Relentless focus on its two main goals • Selection and convenience • Required a certain scale of business to provide selection profitably • In early years pursued growth necessary to achieve that scale • Did not scale business at expense of convenience (delighting the customer) • Grew quickly • $1.64B sales in 1999 • $2.76B sales in 2000

7. What Others Missed • Many saw Amazon’s focus on growth as the goal • It was not; selection and convenience were • Many pursued growth at any cost • Buy.com focus on “lowest prices on earth” • At cost of horrible customer service • Hard to recover from bad reputation • Focus on price without operational means to deliver it profitably • Pets.com sales at below cost of goods • Low value goods with high shipping costs • Amazon did invest in it though

8. AMZN Did Lose Billions • Scaling while providing a delightful user experience was expensive • But losses due to acquisitions, capital investments and operational inefficiencies • Rather than cost of goods • All could, in principle, be controlled over time • Amazon did not engage in destructive focus on price • Price leader relative to other channels, not other Internet sites • Strategy seems to have paid off, Buy.com has (est.) 10% of Amazon’s revenue

9. Building Expensive Infrastructure • Amazon’s initial model was to outsource fulfillment • Largely to Ingram a large book distributor • Found hard to delight customers • Shipping delays were not under their control • Flexibility to ship in pieces, etc. • Potential logistical advantages of operating high volume business • In 1999 opened own distribution centers • Rapidly drove down fulfillment costs (% sales) • 17% Q1‘99, 14% Q1‘01, 12% Q1‘02, 10.6% Q4‘02

10. Capital Markets Forced a Change • Profitability rather than growth as best strategy to achieve goals • Q4 2000 Bezos “March to profitability” • Lehman report questioned whether cash necessary to survive the year, Q1 2001 • Potential problem for supplier credit relations • Critical for operational costs • March became a dash • More open about what was profitable and by what measures • Pursued strategies market allowed

11. AMZN Marketplace • Also in late 2000 started showing goods from independent vendors along side own merchandise • Amazon’s merchandise description and pricing with links to other, generally used, versions • Now also support sales of items not sold by Amazon itself • Brings Amazon and eBay closer in terms of independent merchants and merchandise • Different models – auction versus fixed pricing • eBay experimenting with fixed price • Different consumer populations?

12. A Page from WalMart Playbook • In late 2001 Amazon started focusing more on price – has driven growth • Free shipping on orders over certain size • Many studies show shipping costs are biggest impediment to shopping online • Discounts on certain product categories • E.g., books over $30 • Had achieved scale and operational efficiencies to enable price leadership • Did not make price primary strategy until able • Quickly dropping fulfillment costs; gross sales

13. Affording Free Shipping • Amazon estimates free shipping will cost it $100M in 2003 • Currently available on orders over $25 • Longer shipping times for free delivery • Flexibility to lower cost • Consolidate into one shipment, get vendor to drop-ship, etc. • Dropping TV advertising, relying on print, Internet, word of mouth • Savings of $50M • Resulting sales increase

14. Not Damaging Reputation • Peoples’ expectations for quality of interactions with Amazon are high • Ease of use, selection, rapid delivery • Does slower free shipping disappoint • Expectation of same service even though told it won’t be • Ease of switching shipping options • Focus on cost makes it important to better control inventory, avoid over stocking • Amazon seems to be working bugs out of new approach, WSJ 1/9/03 anecdotal evidence

15. Commonalities: AMZN, FDX, DELL • Exploit three ways that the Internet can deliver more value to customers • Better information, service and selection • Focus on information as value-added component of product or service • Use as differentiator from other channels • As grow, use as differentiator within channel • Avoid competing on price until scale or efficiency allow it • Start with premium product and move down • May need price against established channels

16. Where Online Commerce is Going • Q4 ’02 growth estimated at about 24% • About $13B for the quarter • Figures exclude travel sales • Small portion of overall retail sales • About 1.3% last year • Growing considerably faster than offline • 15-20% per year versus 2-5% per year • At these rates, still only few percent in 5 years • Changing demographics • More closely mirrors overall retail spending • Skewed to coastal cities, NY, LA, SF, DC, Seattle

17. Doubleclick Study • Compared Internet, catalog, retail store • 33% only in stores (down from 36% in ’01) • 10% only online (up from 6% in ’01) • Price decreasing driver of Internet sales • Still primary reason, but lower than ’01 • Better selection increased as factor for online purchases over ’01 • Return policies and price increased as factors for offline purchases over ’01 • Convenience and trying the product decreased but remained most cited reasons

18. User Experience is Everything • Online the brand is the experience • Major part of the offering, e.g. Amazon’s focus • Contrast with kinds of offline brands that are mainly about experience • No overall design to IBM site in late ’90’s • Hard to use, most common requests were “help” button and search box • Re-designed over 10 weeks, over 100 people • Common layout, low download time, graphic design, navigability • First week saw 84% drop in help button, 400% increase in sales (NYT 8/30/99)

19. AMZN Focus on Customer • Company attracts people with customer focus – not just in customer facing roles • Including software developers • Continuous testing in their usability lab • Entire experience, not just Web interaction • Tradeoff of new features versus clutter • Metrics to evaluate each change • Careful evaluation of how changes drive sales • Leading the customer carefully • E.g., with one-click addressing fears by making clear it was easy to cancel

20. Customer Experience at AMZN • Discovery • Searching, browsing, recommendations, relatedness, what you’ve done on site • Community • Reviewers, merchants, spending time making site richer experience • Shopping • The bread and butter, has to be easy and fun • Order monitoring • Sale not over until customer happy with item(s) • At least if want repeat business

21. Revisiting E-Commerce Failures • Some were just too early • Level of comfort with online shopping • E.g., much furniture bought offline not seen • But Living.com didn’t make it • Some didn’t fit online model well • E.g., pet supplies • Low value and high shipping cost items • Some built un-sustainable costs/debt • E.g., Webvan provided value beyond pricing • FreshDirect giving online grocery a try in NYC

22. FreshDirect Online Grocer • Focus is on the food • Modeled on Dell: provide great choice and use Internet to deliver it • With new manufacturing process • Better quality and selection of fresh foods • Prices 10-30% lower than Manhattan stores • Fixed $3.95 delivery fee, minimum $40 order • Deliver only at night and on weekends • Direct from warehouse to customer • Many items prepared in the warehouse • Raised $120M; goal $225M/yr sales by ’04

23. Summary • Importance of user experience on brand • Requires commitment across the company • Requires common site design, navigation • But content needs to be accurate, so best under control of individual business group/team • Selection and convenience are big drivers of online commerce • Price secondary focus for successful firms • Perhaps getting less important for consumers • Online community plays role too