Understanding Amazon’s Strategic Dominance
Comparing media disruption and ecommerce, and what industry structures can tell us about defensibility against aggregators.
Amazon, in its dominant and destructive prowess, represents all that is good about the internet. What Amazon and the internet have done to retail is foundationally identical to what it has done to music and news media.
In the media industry, by reducing the barriers to market entry, the internet has enabled the proliferation of a vast long tail of products in music and news (independent artists, bloggers, fake news) which were previously hindered by high distribution costs. In turn, the internet toppled or severely damaged the incumbent establishments which relied on such barriers to operate, that is, record labels and newspapers.
As a second order consequence, the realisation of value in these respective industries has moved up the stack, to services that can organise and efficiently allocate the consumption of content, thereby commoditising content creators. In effect, the internet has enabled business models that disconnect production from distribution. Which is why we see people saying things like this:
- Uber, the world’s largest taxi company, owns no vehicles.
- Facebook, the world’s most popular media owner, creates no content.
- Alibaba, the most valuable retailer, has no inventory.
- Airbnb, the world’s largest accomodation provider, owns no real estate.
If the structural changes to entertainment and news media can apply to what is/may happen in retail, then it provides us with a valuable framework to understand how this industry is poised to transform.
All signals seem to point to Amazon assuming the role of the aggregator — much like Facebook for news, and digital streaming services for music. Amazon will simply act as a platform through which retailers can transact. Amazon Marketplace and fulfilment by Amazon (FBA), which offer Amazon’s infrastructure and supply chain as a platform for retailers, is the start of such a strategy.
Through a dominant strategy providing greater selection and lower costs than individual retailers, Amazon Marketplace and FBA is a way of furthering Amazon’s vast economies of scale. The opportunity to be price competitive by using Amazon’s network will be too good for retailers to pass up. Given Amazon’s dominant offering, retailers will be forced to compete on the same platform, effectively eliminating the cost competitiveness that has been gained from using the platform in the first place, reducing them to commodities. At this point, Amazon’s perfect leeching strategy is complete.
A leech, in computing jargon, is any entity that benefits from the information or efforts of others, whilst offering nothing in return. Multi-platform services…are leeches by this definition, as they exploit platforms as a means of delivering services to customers, but as a result of their universal compatibility, offer nothing to enhance the defensibility of the individual platforms they utilise.
In this case, Amazon Marketplace and FBA is the cross-platform service, retailers and producers are the platform. And just like any other industry with a dominant leech, the platforms will do all the work and the leech will make all the money. This has happened in news media where the content producers – newspapers and magazines – have continued to do the heavy lifting, breaking news and reporting stories, but Facebook as a ‘cross-platform’ aggregator of their content has made all of the money.
Leechers not only commoditise elements below the stack by moving value up the chain, but their strategies often come full circle, by eventually offering products that compete against the platforms they exploited initially. Think Facebook Messenger on mobile platforms as a competitor against SMS or platform native OTT messaging applications such as iMessage. Amazon has no interest in destroying retail per se, but rather creating a better retail. Sometimes it’s necessary to destroy to recreate — Amazon this year opened up a physical bookstore, and the POS-less Amazon Go store to much fanfare.
Leeching and aggregation has served as a cautionary tale for many industries. Aggregating video content on singular platforms has proven to be politically difficult because video content producers are terrified of reaching the same fate, and are desperate to hold onto their content for fear of losing any remaining strategic levers they may have. Small wonder Apple’s lofty TV ambitions have so far failed. Disney has announced plans to launch its own content delivery service, removing their content from existing services such as Netflix. Disney, rightfully and clearly, has no desire to become just another commodity content provider on an aggregators’ platform.
With Amazon Marketplace and FBA, Amazon is on the scene with a very similar strategy, and retailers have seen it all before. Naturally, collusive arrangements to avoid Amazon’s FBA platform would be a sound way to avoid falling down the trap, such as what is currently being done to sustain the businesses of video content producers. But it is a classic game theory dilemma, in that colluding entities will always be incentivised to break the cartel. Retailers will have no choice but to adopt Amazon’s ticking time bomb if their competitors are doing the same.
But at the core of this, a collusive arrangement is nigh impossible to achieve because of the fragmented nature of the retail and consumer goods industry. In retail and consumer goods, manufacturing and distribution are more commonly separated than they are integrated. Naturally, coordinating more interested parties is more difficult than coordinating a smaller number. This is just one of several themes that are consistent with industries that are susceptible to becoming victims of aggregation. The ability for industries to be able to defend against being commoditised by aggregators, can be summarised by three factors.
- Product substitutability
This is largely a comment on the intensity of competition in a particular industry, and the height of switching costs for customers. Industries which have products that are unique and difficult to substitute are more likely to have the power to avoid aggregator platforms and use less destructive distribution methods or go direct to consumer. Video content is one such example, movies and TV shows are not easily substitutable, one wouldn’t attempt to replace Game of Thrones with another similar show. The power balance is in the hands of the supplier — in this case HBO — and consumers will be forced to go to the platforms where that show is distributed. It’s interesting that Netflix’s response has been to create its own exclusive original content. After all, the only thing unequivocally scarce is time, and with strength in numbers, if consumers are so busied by Netflix’s own content, they might never have the time to watch anything else at all.
On the other hand, basic consumer goods, electronics, and homewares that are typically sold through retail stores are easily substitutable. Commodity product manufacturers don’t have the luxury of expecting that consumers will seek their goods, the onus is on them to go to where their customers are. Increasingly, that place is becoming online ecommerce platforms, such as Amazon. In retail, what are some products that are not substitutable? Things such as luxury or experiential brands which rely on more intangible value factors are likely to be much more defensible.
2. Differentiation through vertical delivery models and value chain
If there’s anything that large aggregator platforms can’t provide, it’s intimacy and a bespoke experience. It’s impossible by nature to compete against an aggregator on selection and price, but differentiated experiences are something that retailers can look to provide as a safety net. But a differentiated experience is only valuable if its consistent across the entire value chain of a certain product — experiential differentiation at the retail level simply isn’t enough. If it’s frictionless enough, consumers will almost always buy on Amazon, even after trying a product out at a retail store. If there’s something we can count on, it’s that Amazon will continue to work tirelessly to take the friction out of ecommerce: same day delivery, Amazon Prime, AI-generated recommendations, and Alexa are just a few of those things.
Differentiation at the retail level will sustain a retailer if the experiences espoused at the store are consistent with the nature of the brand or product. Apple is a brilliant example, we don’t see people saying that Apple Stores are being threatened by the prevalence of ecommerce, simply because the Apple Store is such an integral part of Apple’s brand promise. Apple retail, and the service it provides is as much a part of Apple’s product value proposition as the features themselves. The same goes for other retailers such as high-fashion and luxury brands, where the retail experience is an integrated aspect of the product. In these scenarios, physical stores are about more than selling. Apple’s recent repositioning of its stores as gathering spaces speaks to this.
This tells us that vertically integrated delivery models, where a brand is responsible for the product ideation, development, and marketing/retail components of the chain, are well-placed to survive the brick and mortar disruption. But this leaves traditional retailers operating in an environment where production and marketing are performed by different entities, in a dangerous position.
3. Supplier bargaining power as a result of market saturation
The saturation of the market is a crucial variable. When an industry is made up of just a small number of players, each with considerable market share, there’s a greater collective power to avoid aggregator disruption. To return to the video content industry, there are relatively few large players which produce much of the film and TV that we see. Because of the relatively large market share of each player, they have enough leverage to go direct to consumer or choose their platforms, instead of relying on dominant platforms such as Netflix to gain access to a larger base of consumers. On the other hand, for many consumer products, there are countless players each with relatively small market share selling commoditised products. Therefore most do not operate at a scale that allows them to access enough customers, and must rely on supplier agnostic ecommerce platforms such as Amazon to distribute.
This factor is likely to have implications in the video content space in the future. As the barriers to entry for content creation become a lot lower and a bounty of new entrants begin to arrive (Netflix, Apple, YouTube, Amazon etc.), we should expect the competitive landscape to evolve. There will be more firms creating video content taking market share from one another, reaching a point where there is a reasonably large number of competing firms each with a level of market share that is too low for use as a strategic lever. Naturally, once the market does become so fragmented, the incentives to aggregate on platforms to reach a larger number of customers will be too great to resist. We know YouTube, Netflix, Apple, and others are all fighting to be that aggregating standard once the industry becomes too broken to stand in siloes.
Conclusions
When looking at the impact of Amazon on retail, it’s important to look at both sides of the equation: manufacturers and retailers. Depending on the nature of the industry, the ecommerce disruption can either be seen as an unassailable threat, or an opportunity to restructure a retail offering around products in more protected industries. In these industries, firms can continue to build the defensive structures not as a way of artificially sustaining retail but as a way to deliver real value outside the superior selection and prices provided by ecommerce aggregators. On the point of vertical integration, this needn’t just be a strategy reserved for individual firms that have traditionally controlled their entire value chain. It could be time for retailers to band with manufacturers in particularly industries to create vertically integrated models that integrate products more deeply with retail offerings. Retailers could negotiate with their suppliers to deliver exclusive bespoke services (warranty, customer service, consistent replacement cycles etc.) on their products that wouldn’t otherwise be available on a platform like Amazon.
We can learn a lot of lessons through what is happening in the media content industry since many of the same structural considerations apply. Of course, there are all of the threats, but also many opportunities if we’re willing to scratch below the surface.
