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Jaws 2017 – Amazon Takes a Bite Out of Another Industry

21st Century / 21 Jun 2017 / By Bill Murray

Just when you thought it was safe to go back in the water … 

The takeover of Whole Foods makes Amazon a credible player in the grocery industry, where it has been experimenting since launching AmazonFresh in 2007.  Following the announcement, as Amazon’s market value rose by more than $10 billion, the shares of giant bricks-and-mortar competitors Walmart and Kroger fell by nearly 5 percent and 10 percent respectively.  European grocery retailers also suffered share price falls. 

The deal has at least four drivers.  First, Whole Foods has a good chilled-goods supply chain, which can accelerate the growth of AmazonFresh.  Second, Whole Foods will give Amazon more data on how grocery consumers shop, how to spot promising brands and how to expand private-label grocery goods.  Third – and crucially – Amazon did not just buy grocery stores; it bought over 400 prime-location distribution points.  NYU business school professor Scott Galloway said that Amazon could close the Whole Foods stores down, use them as warehouses and still justify the price.  And fourth, running Whole Foods gives Amazon the opportunity to learn how to run a full-scale physical grocery chain. 

“This shark, swallow you whole.  Little shakin’, little tenderizin’, an’ down you go”

Amazon has been raising its profile in consumer goods and physical retail for some time.  It operates its own clothing brands, as well as consumer goods grouped under the AmazonBasics label.  It has begun opening bricks-and-mortar bookstores and launched Amazon Go, a prototype check-out-free convenience store.  Groceries are a big problem/opportunity for Amazon.  The problem is that other online/offline grocery retailers – for example, Walmart – can frequently remind customers when they are shopping in stores that they are an e-commerce alternative to Amazon.  However, grocery is also the largest retail category – AmazonFresh was subscale so they had to do something.  The Whole Foods deal means Amazon believes that it can rise to the top of the grocery ‘food chain’ as it has risen to the top of online retail.  That logic relies on a subset of its tried-and-tested strategic advantages:

  • Logistics supremacy.  Amazon delivers hundreds of millions of packages every year.  Recently, its logistics coverage has increased:  44 percent of Americans now live within 20 miles of an Amazon warehouse, compared to just 5 percent in 2015.  It has already built next-generation fulfilment centres with robotics that can handle the complex mixes of items its customers will want.  E-commerce distribution networks have large fixed costs, but reward economies of scale.  Amazon Grocery Services running through Amazon Logistics Services means economies of scale for both.  Stores and home deliveries could be expanded to organizations that need groceries, such as hotels, schools and restaurants.
  • Retail analytics supremacy.  With its unmatched depth and breadth of e-commerce data, Amazon knows which products will resonate with customers.  Furthermore, it can selectively substitute its own-label brands at lower prices and still get higher margins.  Grocery is ripe for own label substitution.
  • The Amazon Prime ‘flywheel’.  As Jeff Bezos has explained in interviews, after joining its ‘Prime’ free delivery programme, a shopper is highly likely to buy more and more goods from Amazon.  Grocery purchases are frequent, so they will not just drive but accelerate the ‘flywheel’, cross-selling between grocery categories and Amazon’s other retail businesses.
  • The ability to invest while deferring profits.  This cannot be matched by traditional businesses – or, in fact, many businesses.  Amazon generates enormous cash flows but its investors are happy to see those returns invested in growing new markets.  Consequently, it can inflict analytics-driven, predatory pricing wars on its competitors to steal their customers.  An example is Diapers.com, the baby products retailer.  Amazon lowered prices, undercut the firm, and then acquired it. 

Because of these advantages, and superb execution, Amazon has an unrivalled ability to enter physical marketplaces and turn them into platform markets that it then dominates.  These platform markets are characterized by network effects and the self-reinforcing advantages of data insights.  Amazon wins them by establishing an early lead, chasing market share and then driving out rivals.  Its sophisticated, predatory pricing campaigns and ability to endure losses (while deferring profits) allows it to capture the market.

Amazon has started building another strategic advantage – tight online/offline coupling.  Moving into physical retail allows Amazon to expand its reach with an offline presence.  Some consumers prefer touching and seeing goods in person.  Through its physical channels for books, groceries and larger items, Amazon can make sales it wouldn’t have made online.  Crucially, it also gives them access to large sets of retail data which through machine learning powers ‘the flywheel’. 

“You’re gonna need a bigger boat”

Amazon understate their strategies.  In Grocery, their ‘Context Specific Gameplay combinations of Logistics, Retail and Prime simultaneously can build economies of scale in each.  My colleague, Simon Wardley,  has predicted and observed the rise of multi-sided platform businesses like Amazon for over a decade.  He notes that they typically reinforce their gameplay by executing against a set of doctrines; basic universal principles of successful firms, applicable to all industries.  Their traditional competitors will buy e-commerce firms to try and catch up, but if they don’t systematically build doctrines in to their business, they will not get the desired results. 

“What we are dealing with here is a perfect engine – an eating machine”

Amazon’s advantage in its increasing access to large sets of data cannot be overstated.  This access powers the ‘flywheel’.  “Data is the next Intel inside” says the insightful William H Janeway, who suggests that machine learning is a new, dynamic source of self-reinforcing competitive advantage for Amazon and the other digerati firms.  “The more data, the better the algorithms.  And the better the algorithms, the better the quality of service offered by Amazon, Facebook or Google.  This is the positive feedback law of machine learning”.

Amazon owns the richest data sets on how consumers consume and how sellers sell, and one of the richest on how developers develop.  These, in turn, enable Amazon to optimize its online shopping experience, its logistics network, and its developer environment (and even its voice AI), which all make Amazon’s offerings even richer.

This is the ‘flywheel’ at heart of the most successful multi-sided platform business models.  Scarily for everyone in its targeted industries, Amazon is arguably the best at running this ‘flywheel’, and the positive feedback law of machine learning means it will pull further ahead.

“Cage goes in the water, you go in the water.  Shark's in the water.”

Amazon is like a Great White shark: 

  • It is a very big predator.  Amazon comprises nearly 90 business entities held across the world, and is aggressively going after e-commerce market share in India and the Middle East. 
  • It has a huge bite radius.  It is taking bites out of retail, logistics, consumer technology, cloud computing, media and entertainment – and now groceries.  It is also a credit lender, a hardware manufacturer and a book publisher. 
  • It is top of its food chains.  Amazon (and its rival Alibaba) are digital conglomerates – multisided platform businesses that have supply-side economies of scale in advanced logistics, cloud and software tools, and an e-commerce ‘flywheel’ powered by demand-side network effects made even more powerful through the application of machine learning.  (Arguably, Amazon is really a technology company, but that’s for another note.)

Amazon and the other digerati are 21st century organizations where most organizations are still in the 20th century.  As Dave Aron says, “They know how to win in a digital world”.  They are making it their digital world; you have to find out how you can win in their digital world.  So, if you’re a 20th century retailer/distributer/bank/smart home device manufacturer, with legacy stores and systems, and an uncompetitive online presence, how are you going to win in their 21st century digital world?

CIOs and Senior Business Leaders join us at our flagship European Executive Forum on 21 November in London where we will showcase our latest research under the theme, The Artist Formerly Known as the IT Organization – Evolving IT to Support 21st Century Businesses.

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CATEGORIES

21st Century
Adaptive Execution
Assets/Capabilities
Identity/Strategy
Proactive, Haptic Sensing
Reimagining the Portfolio
Value Centric Leadership

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