Amazon’s path to compete with the banks and become a Fintech giant
Banking is a business built around data and systems, and where knowing your customer is key. Guess which company is very good at that.
Amazon is a company that, from time to time, makes the headlines. Recently, a lot is being said about its latest acquisition, Whole Foods, a U.S.-based supermarket chain of organic products. This purchase is the largest in Amazon’s history, and there are many discussions about the rationale for the deal and what Amazon may get from it in the future.
Granted, Amazon generates a lot of buzz, so it is no surprise that a press release from the company about its lending business went almost unnoticed a way back. The Financial Times did notice and published an article on the subject, Amazon to ramp up lending in challenge to big banks, speculating on the possibility of Amazon becoming a competitor for traditional banks, quite busy lately trying to figure out how to get ahead of all those annoying Fintech startups. Now, we could ask ourselves: Amazon offering financial services? Is that a good idea? In fact, if we look closely, it could make a lot of sense.
Let’s start by understanding a little how Amazon works. According to Ben Thompson in his terrific article, Amazon’s new customer (if you haven’t read it, do it), Amazon is a service provider that relies on the economies of scale generated by its own activity to expand its reach and increase its offer of services. For starters, the number of companies that use Amazon’s platform, whether to sell their products or not, keeps growing. Every time Amazon enters a new category of product or service, it attracts a multitude of sellers from that market to its marketplace.
Many merchants then become users of the Amazon Web Services (AWS) technology platform, which provides them with robust, scalable and configurable IT services at a great price. However, as companies subscribe to more of these services, barriers to exit rise and make it increasingly difficult to leave the platform. If, on top of this, companies make use of Amazon’s logistical services (Fulfillment by Amazon), the lock-in is almost complete.
There’s another way to fall into the hands of Amazon. Many companies start using AWS services as a technology provider, and end up becoming members of their sales platform when Amazon begins serving its markets. The final result is the same: you get stuck in the Hotel Seattle.
But you can never leave!
Amazon’s ability to scale its services with minimal marginal cost while attracting a majority of suppliers (for many, if you’re not on Amazon, you do not sell), allows the company to increase its product offering to end customers and businesses alike. Preference, of course, is given to those services that generate higher margin and encourage the permanence within Amazon’s platform. From this point of view, the provision of financial services to users of its marketplace and other AWS customers seems a further, logical step in Amazon’s strategy to retain its business customers and extract as much value as possible. In fact, it is already happening.
The company launched its Amazon Lending program in 2011, and to date has granted $3 billion in loans to 20,000 companies from the US, Japan and UK that operate on its sales platform. One third of this amount was lent in the last 12 months, so it seems that the business is slowly gaining traction.
Amazon’s strengths to compete with traditional banks
Know Your Customer is a basic mantra of the banking industry, and for that you need data, which doesn’t seem to be a problem today, having so many possibilities of capturing information with everybody owning a computer at home and carrying a smartphone in their pocket.
Huge and growing volumes of information (Big Data) are being generated every minute, and companies analyze those trying to get as much value for the business as possible. The problem for banks, and is a big problem, lies in the fact that data is increasingly more in the hands of merchants and online sales platforms.
Focusing on business loans, Amazon has a number of strengths that make it a formidable opponent for banks:
- A state-of-the-art technological platform: convenient, robust and scalable.
- A deep knowledge of its customers and potential best-in-class risk management, based on the generation and analysis of customer data:
- Real-time tracking of sales. At any time, Amazon knows how a seller is doing and how much cash is generating.
- Control of sales and [estimated] margins, comparing them with those of other competitors. This is key to anticipate risks.
- Firsthand information on sellers’ customer satisfaction by tracking opinions, claims and product returns. Also a very important indicator, since it is a predictor of the future evolution of a vendor on the platform and, therefore, of its ability to meet payments and keep its finances in check.
- Everything said before helps Amazon to fine-tune its credit scoring for those companies. It also reduces human intervention (subject to biases) and increases the speed in decision making. Credit scoring ceases to be a more or less static tool to become a dynamic KPI, from which conclusions are drawn in real time and business rules are applied.
3. More efficient sales management:
- It is no longer necessary to employ a large sales force that must be trained, encouraged and retained.
- Improved testing. Amazon can afford to launch pilots with control groups, test new algorithms for selected clients, etc. The ability to segment users and customize the offer with minimal cost is difficult to beat.
4. The existence of a prior business relationship:
- As I mentioned before, getting started with Amazon is very easy but, as Dropbox knows too well, leaving is not. This kind of forced loyalty facilitates cross-selling, which in turn increases customer commitment. Banks call this strategy relationship banking, which use to enhance their profitability. By the way, Amazon mentioned in its press release that more than half of the companies that received a loan took another one.
- Sellers’ use of logistics services is particularly convenient to Amazon, as it allows the company to retain merchandise as collateral (it also retains collections) to ensure repayment.
To put things in perspective, roughly half of Amazon’s sales (in terms of units) are made by more than two million independent merchants operating on its sales platform. Small businesses are a gold mine for Amazon to exploit, and the company is targeting them with short-term loan offers (up to 12 months and amounts ranging between $ 1,000 and $ 750,000).
The situation is quite different for banks, which are struggling in this market. According to FT, many large US banks “have reviewed loan books and found that serving small businesses — the engine of the world’s biggest economy — is no longer worth their while”. To illustrate its point, the article explains that “loans of less than $1m accounted for 20 per cent of total loans to commercial and industrial businesses in the US at the end of last year — down a full 10 percentage points since 2007.”
Small-sized firms are quite a big deal. In the U.S they account for 99.7% of all businesses and 48% of the workforce (see PDF), and this happens everywhere: e.g. in Spain those figures amount to 99% and 54% respectively. If we are moving towards a more algorithmic management of this type of financing, Amazon might take a sizable share of the business in every market where it operates. Once again, let’s not forget that Amazon’s sales platform and AWS are literally a magnet for companies.
Are banks going to be able to stop this? It won’t be an easy task, no matter how much money they pour into Fintech startups. Industry analysts, executives and other insiders have been for years warning that competition would come from technology companies (either new startups or big tech). It seems likely for banks to concentrate on ever-larger clients, less prone to software-based management and where they can charge higher margins and do cross-selling of other value-added services, necessary to support their overheads. Investment banking, for instance, is an activity that requires more man-hours, with a profile closer to that of consulting and [for the time being] less likely to applying algorithms.
Truth be told, the future doesn’t look bright for banks, as technological advances may leave less room for some of today’s profitable products, shrinking banks’ product portfolio. The resulting increase in competition would further help reducing margins and turn some financial services into dreadful commodity products.
As far as Amazon is concerned, its offering of financial services is expected to increase little by little, as the firm deepens its knowledge of the new business and companies get to use more Amazon solutions (commercial, logistic, systems, Artificial Intelligence, etc.) and share additional info with Bezos. One can only imagine how Amazon would improve the quality of that information if, for example, it were to offer an ERP solution (in-house solution, acquired or from a third-party) at a reduced price in exchange for access to business data.
Amazon Lending is not the company’s only foray into financial territory. In 2007 it launched Amazon Pay, a service that allows its users to pay in other websites and applications using their Amazon account or to accept payments under those conditions. The service is available in the main markets of the company, although its diffusion seems limited, and we could see it as a first step, attempt or test to build an alternative to compete with payment companies or capture some of their margin.
A world of possibilities
There are other financial services that Amazon could offer in the future, such as consumer loans and installment payments for the purchase of durable goods on its platform. Unlike with companies, Amazon lacks information to accurately calculate its final consumers’ credit risk, but it might make a good enough estimation by focusing on their most loyal customers, all of them Amazon Prime members (an incredible 60 % Of US households).
Also, as Amazon adds new product categories, it refines and fine-tunes its knowledge of customers and can make more accurate inferences about their preferences, socio-economic status, future plans, etc. All this information can then be used by the company to do more efficient cross-selling and to make better decisions on offering new products such as financial services.
On the other hand, it’s very unlikely for Amazon to engage in long-term business financing, which requires reviewing business plans and strategies and too much uncertainty. This is an activity that involves investing more man-hours and allocate funds for extended periods of time, with the corresponding opportunity cost.
The same can be said of other long-term loans for the purchase of assets such as cars or mortgages, where it is necessary to perform valuations of the underlying assets. Although valuations could be automated to a certain degree, there’s still the problem of opportunity cost and uncertainty.
A comparison service for long-term financing would probably make more sense to Amazon, where the company could collect a fee from listing or as a percentage of any deal. In fact, this comparison platform could be used to offer other financial products or other types of services: energy, telecommunications, insurance, etc. As it happens, Amazon.com already has an automotive department with information on all car models for sale in the US. (Amazon Vehicles), where users can check specs, read reviews and make comparisons. They can also add their vehicles to Your Garage, “and ask other owners for tips and advice.”
So far, selling is limited to parts and accessories, but Amazon has opened a window here to watch its users and get information on their preferences in this market. Analyzing this data may lead Amazon to infer if a customer is interested in buying a vehicle and, in the future, make an offer directly or through a brand or dealer [1] on its platform.
While it is true that long-term financing does not seem a suitable business for Amazon, the company could still capture some of the margin out of these operations by becoming an information provider to banks and other financial intermediaries. As we have seen, the company has quality information that could be useful to funders, especially if companies let Amazon access their ERPs.
However, Bezos would need to make sure that banks do not use that information to offer short-term loans that compete with his company’s [2]. One way to avoid this would be to provide banks with small pieces of information about potential borrowers in the form of indicators on their relative position, the scoring assigned to them by Amazon, etc. In summary, data good enough to add value without revealing too much.
Other activities, such as the provision of investment products and sight deposits, should not initially seduce Amazon:
- Investment products. Depending on repayment terms and other conditions, those may have a low risk and be easy to automate. However, it is a very different market, very competitive and in which incumbents might have the upper hand.
- With regard to sight deposits, apart from the low attractiveness of the business, it is an activity with huge regulatory requirements, such as getting a proper authorization, strict capital requirements and changing regulations. Most likely neither Bezos nor its shareholders have any interest in being subject to a permanent supervision from central banks and other state agencies.
Although, as we have just said, the provision of sight deposits would not fit within Amazon’s strategy, having information on its users’ personal finances could be very valuable to the company. Of course, a great way to do this would be to have access to their current accounts, and there lies an opportunity.
Consider the following scenario: Amazon decides to offer its customers, free of charge, a personal financial management application for cards and bank accounts control (a service similar to that of Mint or Fintonic). It could be a smart move for Amazon that, in exchange for the tool, would gain access to a bunch of useful data, so far held by banks, and would allow Bezos’s company to:
- Match its marketing campaigns to the right time for each client and optimize its offering of products and services. Just-in-time offers.
- Improve its inferences and predictions about future purchases.
- Make a more detailed segmentation of customers and better testing.
- Fine-tune the credit scoring of its users, which would give rise to expanding its range of financial services while taking lower risks.
Of course, sharing such sensitive information would be frowned upon by a number of customers, but many would probably end up complying if the user experience and potential benefits prove good enough [3].
In the last two decades we have seen how digitization has blurred the lines between different industries. Think of photography and consumer electronics businesses, merged with the computer sector. Banking is a business built mainly around data and systems, and where knowing your customer is key. Can you think of any company which is good at precisely those?
But there’s also a matter of trust. Unlike the banks it would compete with (perhaps in part as a result of the latest and deep economic crisis), Amazon enjoys a great brand image, is recognized for its excellent customer service and is able to attract top talent. If, apart from the advantages listed so far, trust is a factor to consider, Amazon may have even more to say in the future of the financial sector.
[1] Provided dealers exist by then.
[2] Unless Amazon decides to play middleman.
[3] Online services users routinely agree to long terms and conditions written in legal jargon without reading a single word. AI might change that.
This is an English version of an article I previously published in Spanish on Xataka: Amazon pone en el punto de mira a la banca prestando mil millones de dólares a pequeñas empresas en un año. Y es solo el principio.
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