By Rob McGovern, CEO and Founder of PreciseTarget. Also founder of Careerbuilder.com
The parochial view of Amazon is they’re a high-volume store that struggles with thin profit margins. Water cooler stock experts marvel at its high stock price and crow about its measly profits. Here’s some free advice: don’t listen to the arm-chair experts. There’s a reason Amazon is the world’s most valuable company and it has nothing to do with the margins it makes on products sold on its website. In fact, losing money on products sold is fine with their CFO.
For the purpose of clarity, let’s ignore Amazon’s web business, aka AWS, Wholefoods, Twitch, and its other non-retail businesses. Let’s focus on the Amazon.com business model, its true strategic goals, and what it means for American retailers.
You might be surprised to learn that in the Amazon business model the jeans, shoes, other products on its site aren’t ‘products’ in the conventional sense. The owner of your local hardware store evaluates products for his inventory based on the potential margins he can drive. Can I make money selling this hammer? At Amazon, they’d evaluate the hammer using different criteria. Will it drive clicks? Further, Amazon might be wondering if selling it at a loss will drive even more clicks. If this conversation is confusing you it’ll all become clear in a few paragraphs.
You’ve probably heard the expression ‘click-bait’ to describe salacious or intriguing content. Whether the headline is Kim Kardashian’s Bikini Reveal or the Exclusive Spy Photos of the Next iPhone, the media’s aim is to make you click. Why? The news site will have four to five ads on the destination page which will net them 1 or 2 cents of ad revenue. Clicks drive revenue. Now let’s go back to looking at Amazon. How can they drive higher profits by selling that hammer at a loss? When you view that hammer you may notice there are hammers listed on the page with the ‘sponsored’ notation. What’s this? It’s Amazon’s profit driver.
Amazon’s fastest-growing business is referred to as ‘media sales’, and according to emarketer, 85% of this revenue is generated by sponsored listings. If you’re following the logic, Amazon is fine with a page filled with money-losing hammer products, because it’s going to make up the profits by selling higher-margin sponsored listings. This media business is now over $20 Billion per year of nearly pure profit to Amazon. Which hammers should they carry? Easy, the hammers that will serve as the best clickbait. Amazon lists Stanley and Craftsman hammers that get picked up by Google’s SEO algorithm, and when people land on the Amazon hammer page the profit cash register rings.
What else can you do with this array of bargain-priced products? A smart business student would say “pull a Costco.” Translation: sell subscriptions. Costco, another price leader, drove $3.66 Billion in profits in 2019. Here’s the secret, 91% of their profits were driven by membership fees. Costco is a break-even store racking up profits selling memberships. What about Amazon? Amazon has approximately 126 Million US members in its Prime program, generating nearly $15 Billion in juicy profits. Making money on merchandise is so yesterday.
What does all this mean for American retailers? Most retailers, including the behemoths like Walmart, Target, and Macy’s don’t have a critical mass of visitor traffic to play in the media game. We advise our retail clients that the answer is a different digital strategy. We recommend three areas of focus:
- Re-think Personalization: The goal should be to improve customer experiences not simply recommending products. If you haven’t tried the Sephora app, it’s the ultimate in personalized shopping. Customers can try-on Sephora products virtually using their app. Similarly, Netflix and Spotify survived the movie and music apocalypses using advanced data science to create personalized experiences.
- Smarter Assortment Planning: The old saying in retail is the money is made on the buying, not the selling. Assorting the right products has become increasingly challenging in the higher velocity retail world. A “season” is now 4 weeks and it has become imperative to bolster your assortment planning with advanced data science.
- Staff up for tomorrow’s data-centric retail world. The next generation of retail companies will have more data scientists than merchandisers. We believe data science aptitude will be a predictor of who succeeds in the next phase of retail.
BTW, if you need helping smacking down your office water cooler stock expert, Amazon generated $66 Billion in free cash flow last year, which is almost 2X higher than Google’s.