The Amazon Arbitrage

The Amazon Arbitrage

“Grand strategy is the art of looking beyond the present battle and calculating ahead. It requires that you focus on your ultimate goal and plot to reach it.” — Robert Greene, The 33 Strategies of War


Let’s travel back in time.

Back to 279 BC. There was a Greek king whose name was Pyrrhus, and his army of 25,000 soldiers defeated the Romans in two bloody battles. In them, Pyrrhus lost thousands of soldiers and valuable military resources that couldn’t be replenished. And while he won two battles against the Romans, the greatest army the world had ever seen, Pyrrhus didn’t have enough soldiers to keep fighting.

The Romans may have lost the battle, but they were only temporarily defeated. Even though they suffered more casualties than King Pyrrhus’ army, the Romans still had a large reservoir of replacement soldiers, all of whom were eager to sharpen their swords and march into battle.

The casualties harmed King Pyrrhus more than the Romans. Aware of his disadvantage, Pyrrhus famously told a friend that another battle against the Romans would “utterly destroy him.” Damaged by the size and strength of the Roman army, Pyrrhus surrendered against the Romans. He gathered his troops and sailed back to Greece in defeat.

The lesson is this: Pyrrhus won the battles but lost the war.

His victories came at too great a cost — just like many Direct-to-Consumer (DTC) brands who sell on Amazon.


Why Brands Work with Amazon

At first glance, using Amazon as your main distribution channel makes perfect sense.

The initial investments are minimal and the bank accounts fatten right away. Better yet, brands who sell on Amazon don’t have to build their own shelf space or master complex logistics. The dirty work is taken care of. They don’t have to worry about apps, themes, hosting, engineers, and all the other technical challenges of building a website.

It’s easy to start selling on Amazon.

Sites like Forooition and My Work from Home Money have step-by-step tutorials for sellers who want to set up an Amazon store. There, they can learn how to secure a loan for initial inventory and sell goods on one of the most trafficked websites in the world. Once they’re set up, they can access Amazon’s unlimited supply of customers.¹

When it comes to shopping, Amazon is more important than Google. Amazon is the 4th biggest website in America. More than 47% of customer searches start on The Everything Store. 63 percent of Americans subscribe to Amazon Prime, which is more than the number of people who earn more than $50,000, attend church monthly, or own a telephone landline. You can’t afford to ignore Amazon.

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Where DTC Brands Go Wrong

Socrates once said: “When a random internet blogger talks about Amazon, you should listen.”

Like fire, Amazon can kill you or keep you alive. Use it wrong and you’ll burn down your treasured home. Use it well and you’ll have a roof over your head and healthy, nutritious food every night. Thousands of Amazon employees work night and day to optimize every part of the website, and when you sell on Amazon you benefit from their hard work.

Amazon’s organic traffic makes it easy to reach customers right away. It’s retail on big, Barry Bonds style steroids. For many brands, Amazon is like a drug. Once you get addicted, you can’t stop. The up-front costs are cheap and the short-term experience feels good, but the long-term implications hurt more than a knife to the stomach.

When I speak with retailers who’ve never managed a digital budget, they map what they know about retail onto digital. But Amazon isn’t a traditional retailer, for better and for worse. Retailers who work for most big companies are guided by the traditional rules of retail. They’re used to working with grocery stores and wholesalers whose margins are thinner than the prosciutto at your favorite Italian deli. Many of these brands have an army of distributors so ruthless that Genghis Khan would have been proud. Every day, brand associates go into the retail stores to restock the shelves, and if they can undermine their competitor by stealing an inch of shelf space, they do it.

Merchandising on Amazon is different. Instead of swinging their swords over shelf space, sellers fight for reviews and keyword rankings.² In just a couple hours, they can put products on “shelves” and sell those products in more countries than Carmen Sandiego.

Brands are used to working with data-scarce wholesalers and grocery stores who know little about private label products. Those who maintain product quality, respond to customer service requests, and keep up with inventory demands will likely reach more customers on Amazon than they would with traditional retail partnerships. Nevertheless, the costs of working with Amazon are as real as the benefits.


Amazon’s Private Label Push

Brands who sell on Amazon don’t receive any information about their customers.

Name. Email. Birthday. Nothing.

Brands can’t communicate with customers on Amazon and they sure as hell can’t build community on it. Worse, they’re sharing precious data with a $900 billion company that aims to suck the margin out of profitable product categories by launching private label brands.

Amazon launched 66 private label brands in 2018, and while most of these brands are still small, Amazon can build DTC skills faster than DTC brands can build efficient customer journeys and the logistics required to manage them.

Many industry insiders fear Amazon’s future private label dominance. They believe that due to Amazon’s reach, resources, and distribution advantages, they’ll inevitably dominate every category they enter. After all, they have proprietary access to valuable data, thousands of 53-foot trailers, a dedicated air hub in Ohio, and more than 100 million square feet of distribution center space across the United States.

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Amazon has the power and they know it. Amazon knows which sellers are struggling to fulfill demand, and which command a large margin for their products. The private label product opportunities are in the data. With it, Amazon can anticipate customer needs, trends, and unfulfilled desires. Rather than surveying users, they look at their shopping carts. Where others guess, Amazon knows.

Third-party sellers on Amazon Marketplace are now required to offer hassle-free returns, often without a physical return of the product. Friends in the industry who work with Vendor Central tell me that Amazon typically takes 60 days to pay sellers. Moreover, Amazon can change the price of your product without warning. Worse, if commodity suppliers raise prices on Amazon and fall down the search results, another company will undercut their prices and steal their sales.

Great for buyers. Terrible for sellers. As Bezos famously said: “Your margin is my opportunity.”

Look, I get it. Hearing these words from the wealthiest person in the world isn’t exactly comforting. To this day, if you type Relentless.com into your search bar, you’ll be redirected to the Amazon home page.

Hint, hint... ladies and gentlemen… Jeff Bezos means business.

But if I’m being honest, I think the fear of Amazon private labels are overblown. If you’re a brand manager, I have good news for you: Amazon hasn’t figured out how to replicate their success in basic private label categories, such as batteries. A 2016 study estimated that Amazon captured 94% of all battery sales with its Amazon Basics brand. Since basic batteries are a commodity, they attract buyers who seek generic alternatives because they focus on price above other variables.

“The Everything Store” continues to struggle, even as it gains market share in the overall clothing category. Amazon now controls more than 550 brands, and 68% of them are apparel-focused. But in product categories where brand matters, Amazon struggles. One study looked at 23,000 products and found that “shoppers aren’t more likely to buy Amazon brands, even when the company elevates them in search results.”

Selling on Amazon can bring long-term risks. You give up community, brand equity, customer data, and customer communication. By selling on the platform, you trade long-term sustainability for quick revenue. By doing so, you give up the compounding benefits of owning your own infrastructure and driving customers to those owned sales channels.


How is Amazon Changing?

Behind the veil of colorful branding is the messy logistics process of moving product from the manufacturing plant, to the warehouse, through the white picket fence, and onto the customer’s front door step. Brands know this, and many of them will need to partner with Amazon.

A successful partnership with Amazon begins by understanding how the company is changing.

Amazon is moving away from fulfillment and towards becoming a marketplace. That way, the company can accelerate its flywheel advantage.

Trend #1: Amazon is Moving Away from Fulfillment and Towards Marketplace

The genesis of the Amazon Marketplace product came from Jeff Bezos’ observation that sellers on the platform lacked the skills to ship directly to customers, which hurt the Amazon customer experience. With Amazon Marketplace, Amazon wanted to help anybody sell on Amazon, no matter where they were located, or what they wanted to sell — 24 hours a day, 7 days a week.

Bezos and his Seattle-based minions removed small points of friction, streamlined the on-boarding process, and became the easiest way to start selling online. Customers signed up in masse. Selection grew exponentially. Brands handed control over the customer experience to Amazon and shipped their product inventory directly to Amazon’s fulfillment centers.

Hard-to-replicate tacit knowledge, such as shipping and logistics became competitive advantages.

Trend #2: Amazon’s Flywheel Advantage

As Amazon expanded into new markets beyond books, the customer experience improved and the number of SKUs skyrocketed. In the process, Amazon earned a 12-15% commission for products sold through Amazon Marketplace and collected data points along the way. Rather than holding purchased inventory, Amazon sits in the middle between brands and customers.

As brands flocked to Amazon Marketplace, its flywheel spun faster and faster. Amazon Marketplace has three core advantages: low prices, fast delivery, and vast product assortment. Each one of Amazon’s advantages makes the others stronger. Customers associate Amazon with selection, so Amazon has become the de facto storefront for the booming world of online commerce.

Consider the seller on-boarding process. To reduce friction, Amazon eliminated the UPC code requirement, which lowered the barrier-to-entry for new, less established sellers in particular. In 2017, an estimated 65 percent of gross merchandise volume sales on Amazon were attributable to third party sellers. Today, Amazon is handing responsibility for logistics back to the brands themselves. More than 100,000 businesses make $100,000 or more per year on Amazon. Commissions from Marketplace fulfillment services totaled $6.4 billion in Q1 2017, accounting for approximately 25% of Amazon’s total revenue.

By increasing convenience, removing checkout friction, gathering purchase history, and providing value, Amazon’s flywheel spins faster and faster.

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Data and Re-Targeting

If you want to build a sustainable DTC brand, you need to own as much of your critical infrastructure as possible. You should create your own site, even if the up-front costs of creating one are steep. The long-term returns of building a site are generally worth the up-front investment, if only because creating a memorable brand experience reduces competition, raises your margins, and accelerates data collection.

Look. I get it. It’s hard to resist the allure of instant sales and a pre-made online store. But first-party data is worth its weight in gold.

First and foremost, retargeting pools are more efficient. Searching for new potential customers is expensive. But once you find one, advertising costs plummet. All things being equal, companies with more data and the means to use it effectively will improve their re-targeting capabilities. They can educate their customers and re-target them in a cost-effective manner, which drives down customer acquisition costs. Guided by customer data, DTC brands can drive customers to high-relevance articles. Instead of driving traffic to a landing page, they can lead people to content on their owned and operated sites, which can drive up Facebook relevance scores and drive down the cost of closing a sale.

In contrast, brands who sell on Amazon are likely to advertise there too. “Sponsored Products” are paid ads that appear at the top of search results, and as Amazon aggregates additional sellers and customers, its advertising business will grow faster.

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Companies who manage their own owned and operated websites are gifted with their own version of presents under the Christmas tree: customer emails, phone numbers, addresses, names, and interests. Tracking pixels are Santa and Christmas is 365 days a year. But data that isn’t acted upon is like a bad gift from your Aunt. You won’t use it. And worse, you’ll pay for it in clutter and storage costs.

The benefits of owned and operated websites accrue to brands with savvy performance marketing and data analytics teams. The best ones can analyze customer data, and use it to map out customer demographics and psychographics. They benefit from higher customer lifetime values, increased potential of a profitable exit, and complete control over the customer journey from discovery to purchase.

Business 101: You never want to fully depend on one partner.

Business 102: Amazon is a massive platform and you can’t afford to ignore it.

Nice… Congrats on your MBA.


Partnering with Amazon

Working with Amazon is a delicate balance. Treat Amazon like a bottom of the funnel sales channel, not a top of the funnel brand building platform. Own your branded search keywords, so you can capture customers with strong purchase intent and prevent them from switching to your competitors.

Armed with a website, you can control three critical aspects of their brand: (1) storytelling, (2) commerce, and (3) the checkout cart.

We’ll take each in turn.

  1. Storytelling: The best direct-to-consumer brands tell their own story. That’s why brand strategists must balance quick revenue and long-term sustainability with the compounding benefits of owning your infrastructure and driving customers to your owned sales channels. Over the long term, brands who focus on brand equity and build relationships with customers will outperform those who emphasize third party sales channels.

  2. Commerce: Catchy slogans, press releases, and colorful logos get all the media attention, but successful Direct-to-Consumer brands need to lock down the nitty gritty details as well. Premium aesthetics are just the beginning. Sales requires product, collection, and acquisition pages. The more customers visit your owned site, the cheaper your customer acquisition costs can be.

  3. The Checkout Cart: Owning your own site demands integration between shipping rates and delivery carriers. You should also agree to pre-set rates with payment processors who can manage fraud protection. That way, you won’t have to rely on one platform. Since Amazon often operates with a “guilty until proven innocent mentality,” bad actors on Amazon can get your store delisted.

Amazon is a great place to sell products, but a terrible place to build a brand. That’s why DTC brands need to build their own infrastructure.


Winning the Battle, but Losing the War

“Do not be ashamed to make a temporary withdrawal from the field if you see that your enemy is stronger than you; it is not winning or losing a single battle that matters, but how the war ends.”— Paulo Coelho, Warrior of the Light

Focus on the war, not the battle.

The relationship between DTC brands and Amazon is remarkably similar to that of King Pyrrhus and the Roman army. Don’t risk your long-term survival by selling on Amazon, even if it gives you quick revenue and low-overhead in the short-term. Doing so will increase the chances of a Pyrrhic victory, where the cost of winning in the short-term leads to long-term defeat.

The battles of business are different from the battles of antiquity. In business, people don’t die. Rather, when companies lose battles, they waste resources, lose market share, and watch their marketing dollars evaporate like a lake in the Sahara. As the water disappears, the very companies who once looked like up-and-coming unicorns begin to struggle. Their profits are squandered to big competitors who, like the Romans, have the resources to stay patient and replace their fallen soldiers.

Venture-backed DTC brands shouldn’t depend too much on Amazon. To become self-sufficient, they should build their own site, control the customer experience, and own their customer data.

Otherwise, just like King Pyrrhus, they’ll win the battle but lose the war.


  1. This article was co-authored with Nik Sharma. You can text him with questions or comments: +1 (917) 905-2340

  2. Note: If you’d like to receive future posts by email, subscribe to my Monday Musings newsletter.


Footnotes

¹ Amazon sellers participate in one of two programs: Vendor Central and Seller Central.

Amazon’s invite-only program is called Vendor Central. Brands who sign up for Vendor Central sell their products directly to Amazon. Then, Amazon re-sells the product. Brands are only responsible for billing, inventory, and the back-end of the supply chain. Amazon handles storage, shipping, pricing, boxing, returns, exchanges, and even gift wrapping.

Brands who use Vendor Central can sell unlimited products for a fixed fee. They don’t have to manage back-stock or the excess inventory that picks up dust in storage. The benefits don’t end there. Brands can access to Amazon Marketing Services, where they can run keyword-targeted ad campaigns and drive traffic to branded or product detail pages. Once a brand signs up for Vendor Central, their products are listed as “Sold by Amazon,” which boosts shopper confidence and leads to increased sales. Then, Amazon ships those products on the brand’s behalf, which gives them access to the most efficient checkout experience in the world.

Like magic, the friction disappears. Amazon is like a personal chauffeur. For brands, the experience is like driving on the highway, raising your hands of the steering wheel, taking a nap, moving towards your destination, and never running out of gas. Amazon does the hard work for you.

All brands can participate in Seller Central. On it, brands are classified as third-party sellers, and trade ease for flexibility. They don’t have to give up control of pricing, promotions, and the number of units they want to sell. While they can sell directly to Amazon’s 95 million Prime members, they have to pay traditional Amazon seller fees, and manage the logistics of storage, shipping, packaging, and returns unless they participate in the Fulfilled by Amazon (FBA) program. In it, brands can store their products in Amazon’s fulfillment centers, where Amazon packs, ships, and provides customer service on a brand’s behalf. Additionally, FBA items qualify for free shipping and Amazon Prime.

Before participating in either program, brands should consider the tradeoffs. Seller Central brands are responsible for lost inventory and taxation liabilities. All else being equal, Seller Central vendors typically receive fewer sales because their products don’t come with the “Sold by Amazon” endorsement.

To recap, using Amazon’s word class infrastructure keeps headcount and overhead low and promises immediate revenue. With Vendor Central, brands sell their products directly to Amazon, which then re-sells them to customers. On Seller Central, brands sell directly to Amazon’s customers, and Amazon takes a fee for each sale.-

² There is one caveat. Brands who sell on Seller Central can use Amazon customer data to learn more about who is buying products and where those buyers are coming from. But that data cannot be used to re-market to Amazon’s customers, which makes it less valuable.