2. 1
Executive Summary
Arguably no other company in the history of Internet ecommerce has enjoyed more largesse
from investors than Amazon which had accumulated $2.86 billion in losses over seven years
before returning its first dollar of profit.
The case study (Pillai 2004) explores the rise of Amazon.com to the year 2003 and argues it
has become an exemplar for successful Internet retailing based on customer service and
supply chain management. It describes the evolution of the Amazon business model and
competitive advantages created by strategically investing in infrastructure, information
systems and value added services.
Some ten years later this case study provides a historical perspective of an early adopter of a
disruptive technology, the Internet and the importance of defining and executing a
competitive strategy whilst remaining responsive to changing market conditions.
It successfully examines the competitive advantages of the Amazon business model and
illustrates the importance of responsive supply chains in creating an efficient and profitable
business. It should be noted however that were it not for an unusual period of investor
optimism in the formative years of Internet ecommerce, it may not have been possible to raise
sufficient investment capital to see this business model come to fruition.
3. 2
Introduction
Internet retailers can dynamically choose the location of inventory because on-line
purchasing is not contingent on the customer and inventory being present at the same place
and time (Bailey & Rabinovich 2005).
Unlike traditional retailers encumbered by geographical locations of retail outlets, decoupling
of inventory and customers makes it possible for Internet retailers to postpone inventory
location and service markets previously protected by high capital costs of establishing
infrastructure such as retail outlets, warehouses and associated distribution networks.
Although on-line customers can potentially choose from a large range products must also be
delivered in a timely manner and the case study describes how Amazon became a successful
Internet retailer and chronicles the critical milestones and business practices between the
periods 1995 to 2003.
Why Books?
When ecommerce was in its infancy it was apparent consumers would be reluctant to order
high value goods especially if product variability of size, colour or other physical
characteristics would make selection difficult. Books however have no variability and all
retailers sell the same product and depending on inventory management and order
replenishment policies, industry profitability was high (Bailey & Rabinovich 2005).
As well as being homogenous books were at a price point where consumers were prepared to
risk the possibility of a failed transaction. If Amazon demonstrated they were a reliable
supplier customers would order higher value products and this trust would be an enduring
feature of the Amazon ‘brand’.
Amazons Competitive Advantage.
After choosing books as the first product for customers to experience the convenience of
Internet shopping Amazon made two important decisions. Firstly to be among the first to
market it did not want to spend time and money building warehouses and managing
inventory. It was willing to forego margins to suppliers in exchange for not having to pay for
warehouses and inventory carrying costs (Rabinovich, Rungtusanatham & Laseter 2008).
4. 3
Secondly to survive fierce competition from other e-ventures it needed to grow rapidly by
expanding the range of products and services offered from the web site. This required
forming strategic relationships with other suppliers including retailers of similar goods and
services. This was an excellent strategy because it increased Amazons revenues at a low
marginal cost and offered customers a larger range of products and services than was possible
if they held inventory for all products they sold. The Amazon ecommerce platform was
scalable so the cost of transacting other vendor’s products was small compared to managing
inventory. Vendors were willing to pay Amazon a sales commission and the case study states
that profit on commission sales was almost as high as retail sales.
Initially vendors simply saw Amazon as another sales channel but for Amazon the value of
customer data it managed far exceeded the sales commission. This information enabled
Amazon to improve the on-line customer experience and sustained a long term relationship.
The risk in this strategy is other vendors were responsible for fulfilment and poor
responsiveness would adversely affect Amazons reputation. This was mitigated by carefully
selecting partners and vendors who shared Amazons strong customer service orientation.
Amazon was able to use the plethora of product and personal information generated from
sales to create a high barrier of entry from competition. No longer was the customer
experience limited to receiving a product but it could be imbedded in convenient
personalization features, product recommendations, one-click ordering, product reviews and
complementary product marketing. Bezos knew improving supply chain responsiveness was
the key to this strategy but if Amazon was not among the first to market, this opportunity
could be lost (Mellahi & Johnson 2000) (Poletti, Engelland & Ling 2011).
Bezos also considered it critical to obtain the ‘first mover’ advantage to attract both
customers and investment capital (Poletti, Engelland & Ling 2011) so although inventory
management and distribution networks are strategically important it was considered more
important to direct resources to processes supporting inventory postponement.
The case study notes Amazon was still able to sell products at prices lower than physical
retailers even after shipping charges however this point may be moot as Amazon suffered
heavy operational losses during this period and it was only investment capital sustaining the
business.
5. 4
Nevertheless once Amazon commenced trading it was able to develop its ecommerce
platform and design inventory management policies aligned to the inventory postponement
strategy it was developing. Had in-house inventory management been implemented earlier
they may implemented systems not aligned to the on-line shopping experience and their
strategic goals (Enders & Jelassi 2000; Rabinovich, Rungtusanatham & Laseter 2008).
Amazons Inventory Management.
The case study describes how in 1999 Amazon increased its warehouse capacity from
300,000 square feet to over five million square feet by investing in ten warehouses
strategically located in low taxing states and near transport hubs. Supply chain
responsiveness was improved by stocking popular items, keeping complementary products
together, reducing split shipments and forecasting seasonal and local demand variations.
This was both a logical and necessary step to unlock the value of information they were
gathering and ensure the long term growth of the company. Rather than rely on other vendors
inventory management practices, Amazon was able to use its own business intelligence to
improve supply chain responsiveness and reduce uncertainty. Integrating multiple suppliers
without proprietary warehouses is a difficult task especially when supply chains are not
seamlessly integrated (Enders & Jelassi 2000).
As order volumes and variety of products increased the opportunity costs of not having an
item in stock increased. Warehouses enabled Amazon to reduce both holding costs of
inventory and ordering costs. Amazon could replenish stocks of popular items in large orders
rather than placing multiple small orders as is the case with drop shipping (Bailey &
Rabinovich 2005; Rabinovich, Rungtusanatham & Laseter 2008).
Customer responsiveness was improved because popular items could be dispatched
immediately an order was received and disparate products (such as books, CD’s, toys and
consumer electronics) could be aggregated into a single order. Orders were able to be
processed faster by not dealing asynchronously with several suppliers using drop shipping.
Shorter lead times and increased responsiveness enabled Amazon to improve customer
service and cross promote other products, and because Amazon only ships an item after it is
ordered return rates were lower than industry standards further increasing the efficiency of
warehouses.
6. 5
Managing inventory did not preclude Amazon from ordering low volume or slow moving
items directly from distributors or drop shipping through its own distribution centres. The
case study states that improved inventory management helped achieve the company’s first
profit in the fourth quarter of 2001 and therefore this strategy must be considered a success.
Outsourcing Inventory Management.
The case study suggests Amazon decided to “concentrate on its main activities and outsource
inventory management in order to earn more profits” but fails to explain the source of any
resultant supply chain surplus. Supply chain surplus is the difference between the price a
customer pays for a product and total cost of all supply chain activities in getting the product
to the customer. The basic premise in outsourcing is that supply chain surplus can be
increased and shared without a significant increase in risk (Chopra & Meindl 2013).
Third-parties may be able to aggregate capacity, inventory and transport of multiple retailers
to achieve a supply chain surplus through economies of scale greater than any individual
retailer but it is important that the drivers of profit be understood before making sourcing
decisions (Chopra & Meindl 2013). Amazon had already achieved economies of scale for
products having predictable large volumes and 35 per cent of Amazons orders contained
products from different categories making drop shipping inefficient.
On the other hand there is no reason orders could not be filled using an optimal combination
of the two opposing strategies, in-stock inventory and drop shipping. Both strategies can be
used simultaneously to better manage Internet retailers inventory (Bailey & Rabinovich
2005). Outsourcing inventory management is advantageous if products are slow moving, low
volume or require specialised handling or expertise. For example Amazon chose Ingram
Micro and Cell star as distributors for technology and mobile phone products respectively.
Unlike books technology products are complex, become obsolete quickly and require
specialist skills to manage and support. For Amazons partners however these activities are
routine and can be performed efficiently. Outsourcing inventory management in this instance
is a good strategy because it enables Amazon to stock more products and services without the
cost of maintaining expertise in specialist areas.
The Internet also provided a cost effective means of integrating vendor and supplier supply
chains mitigating the risk of losing supply chain visibility and reducing coordination costs
enabling Amazon to focus on competitive advantages rather than managing inventory.
7. 6
The case for selling competitors’ products.
Economic theory suggests if prices are transparent and the same information is available to
all buyers the result will be perfect competition where market price equals marginal cost of
production. Empirical research however has found significant price dispersion and
consequently Internet retailers can differentiate themselves by offering either superior or
inferior value to potential customers (Bailey 2005).
Therefore purchasing decisions are not made solely on price but include service
characteristics such as choice, convenience and confidence that products will arrive in a
timely manner. After Amazon had established a high level of customer service there were
many advantages in selling other retailers products.
Firstly Amazons ecommerce facility was scalable and could easily manage more products
and greater choice would increase the appeal of Amazon as a desirable shopping destination.
Customers generated product reviews, ratings and product recommendations and these
features were not easily replicated by other Internet retailers. Amazon was also able to cross
promote products and services across all these customers.
Secondly as discussed commission on sales of competing retailer’s inventory was almost as
high as retail margins so Amazon was able to quickly increase product offerings without a
corresponding increase in inventory management expense. If other retailers did not meet
Amazons service level requirements the relationship could be terminated.
Finally if product volumes were large Amazon had the ability to implement an optimal
inventory management policy using a combination of in-stock and drop shipping. A possible
risk is customers could ‘leak’ to competing retailers for future purchases however if
Amazon’s service characteristics remained superior this would be unlikely, especially as a
large percentage of orders were from more than one product category.
Shopping at Amazon was more like shopping at a ‘mall’ rather than a single shop and this
point of difference combined with the value of the customer experience provides a high
barrier of entry for competing on-line retailers. According to the Amazon model all that is
needed is a web site to “greet customers and take orders” and other parties should handle the
capital intensive aspects of stocking inventory (Mellahi & Johnson 2000).
8. 7
In achieving rapid growth and increasing market penetration Amazon also acquired outright
or formed strategic alliances with other customer focussed on-line retailers in diverse market
segments. This could be seen as a defensive strategy as it was not clear which retail segments
would be the most successful and indeed many of these enterprises failed.
These strategic investments had two additional benefits. First was the ability to share
infrastructure, customer databases and integrate supply chains. Second Amazon increased its
market valuation as the value of these investments soared during the ‘dot com’ boom when
enterprises, most of which had never traded at a profit, were grossly overvalued. This in turn
allowed Amazon to raise even more investment capital expanding infrastructure, logistical
operations and entrenching its market position.
9. 8
Conclusion
Inventory management, customer service and other tangible resources can be easily imitated
by competitors and yet the Amazon brand has endured.
The case study describes events in the first eight years of Amazons history but does not
provide a deep analysis of supply chain management principles or how competitive
advantages are maintained. The ecommerce market place offers little protection from
imitators and yet Amazon was able to turn a ‘first mover’ advantage into a lasting legacy and
how this was achieved has not been explored.
The Internet has matured into a ubiquitous communications platform any business can use to
inexpensively conduct ecommerce or utilize intermediary services such as those provided by
eBay, PayPal, iTunes or Google. The widespread adoption of mobile devices such as
smartphones and tablets and the evolution of digital formats for content have further changed
the landscape since Amazon launched in 1995 however despite the best efforts of many
competitors Amazon remains at the forefront of Internet retailing.
Today the Amazon business is valued at $100 billion, employs 65,000 workers and has $48
billion in revenues and $5 billion in cash reserves. This is larger than all six of the major US
publishing conglomerates combined (Wasserman 2012).
This is a testament to the success of its inventory management strategy, the continuous
expansion of its product and service offerings and innovation in its sales channels.
10. 9
References:
Bailey, JP & Rabinovich, E 2005, 'Internet book retailing and supply chain management: an analytical
study of inventory location speculation and postponement', Transportation Research Part E:
Logistics and Transportation Review, vol. 41, no. 3, pp. 159-177.
Chopra, S & Meindl, P 2013, Supply Chain Management, Strategy, Planning and Operation, 5 edn.
Enders, A & Jelassi, T 2000, 'The converging business models of Internet and bricks-and-mortar
retailers', European Management Journal, vol. 18, no. 5, pp. 542-550.
Mellahi, K & Johnson, M 2000, 'Does it pay to be a first mover in e.commerce? The case of
Amazon.com', Management Decision, vol. 38, no. 7, pp. 445-452.
Pillai, P 2004, Amazon.com's Inventory Management in Centre for Management Research (ICMR),
India.
Poletti, M, J., Engelland, B, T. & Ling, H, G. 2011, 'AN EMPIRICAL STUDY OF DECLINING LEAD TIMES:
POTENTIAL RAMIFICATIONS ON THE PERFORMANCE OF EARLY MARKET ENTRANTS', Journal of
Marketing Theory and Practice, vol. 19, no. 1, pp. 27-38.
Rabinovich, E, Rungtusanatham, M & Laseter, TM 2008, 'Physical distribution service performance
and Internet retailer margins: The drop-shipping context', Journal of Operations Management, vol.
26, no. 6, pp. 767-780.
Wasserman, S 2012, 'The Amazon Effect', Nation, vol. 294, no. 25, pp. 13-22.
