I.IntroductionAmazon.com is one of the world's largest eCommerce retailers, or etailers for
short, of consumer goods. With sales several times that of its competitors, the
company has achieved its status as the industry leader by adopting the concept of
selling goods via the Internet's World Wide Web. The company presently enjoys
significant brand, scale and capital advantages over its rivals.
Despite the fact that Amazon is currently in debt, the company very well may
still make profit in the future because of its low discount rate and excellent market
strategy. Thus, we would like to present our investigation into Amazon.com. First,
we will respectively describe Amazon's marketing mix. Second, we will attempt to
analyze its cost and revenue structures. Moreover, we will display the Porter model
of competition, and the comparison of working capital and infrastructure requirements
of retailers and etailers. Third, we will explain the reasons why Amazon.com runs
into debt, and present an analysis of the company’s Net Present Value (NPV). Finally,
we will provide our recommended solutions for Amazon to get out of debt.

Amazon.com homepage
II. Marketing Mix1. Product linesAmazon has many products such as books, music, video & DVDs, auctions, toys
& games, consumer electronics, e-Cards, and zShop. However, the etailer is not
satisfied with the current situation and still trying to expand its product lines.
According to a company report by C.E. Unterberg Towbin, CEO Jeff Bezos recently
said that he would be disappointed if the company does not open more stores in 2000
than it did in 1999. Therefore, it is clear that the company will expand its product
lines to increase its scale. We believe that scale advantages will enable Amazon to
support many of its key investment initiatives, including its distribution infrastructure development and its product lines and services.
2. PricingAmazon's pricing goal is to offer a lower price than its competitors. With lower
prices, it can attract new customers to maximize its market share. We are convinced,
based upon our investigation, that Amazon will be able to consistently offer lower
prices in relation to the traditional retailers.
3. Distribution Channel
Although the method by which Amazon distributes its products and services to
its customers is a retailer mode, there are several differences between traditional
retailer and etailer manners of distribution. Etailers provides more shopping
convenience, local inventories, and exchange services than do traditional retailers.
When one goes shopping at holiday time, while an eCommerce site will have
shortages of hot items, just as a traditional retailer will, the consumer can
conveniently find this information at their desktop - not after a 20-minute drive to the
mall. When stock outages occur, the time lag between Amazon re-ordering a good
and it being available to consumer is likely to be several days shorter than the supply
chain of retailers.
The centralized inventory in the eCommerce world gives etailers a distinctive
advantage in terms of product availability and selection. Where a physical world
store has to make a lot of efforts to catalogue the various products for customers, an
etailer can easily customize its online store for repeat customers based on their prior
purchase habits.
In January 1999, Amazon announced plans to build a network of distribution
centers throughout the country to warehouse and ship the products it sells. This is the
most dramatic change to occur in Amazon's business model. It rapidly shifts towards
sourcing products directly from manufacturers, eliminating distributors from the
supply chain when appropriate. (ABC news, 01/1999)
In April 1999, the company clarified the magnitude of the investment required to
open these distribution facilities, and the short-term losses that would result. These
facilities will cause the company to operate with excess capacity for the rest of 1999
and probably well into 2001. The expense for these facilities falls into its sales and
marketing expense line, causing it to triple on a year-over-basis in the 2Q99,
significantly faster than revenue growth. Therefore, some have criticized these
facilities as being an indication that Amazon is no longer gravity-free, that it will have
to support infrastructure just like traditional retailers(ABC news, 12/99).
4. PromotionAside from the expense of its distribution facilities, the largest investmentrelated
expenses come from brand building. Its major promotion activity is to make
use of mass media - print and broadcast like newspaper, TV, and radio - to make
initial contact with customers. Through advertising, Amazon increases its brand
awareness. A recent study by Interbrand ranked Amazon.com as the 57th most
valuable brand in the world. A separate study by Opinion Research Corp. indicated
that 60% of US adults were aware of the Amazon brand name, the highest awareness
for any eCommerce brand name.
III. Cost StructureAmazon possesses a relatively complex cost structure that encompasses the
following major categories: advertisement, investment, products, sales, research and
development, and the distribution facilities.
Of these expenses, marketing and sales account for the greatest expenditure.
According to a company report published by C.E. Unterberg Towbin, Amazon spent
$132 million dollars in 1998 on marketing and sales. Of course, these types of
expenses include advertisement, product acquisition, smaller variable costs, and
personnel-related costs. Amazon classifies some of these personnel costs as
“investments” because it purposefully aims to hire the “right” people for its senior
executive positions. Another way in which the company spends its money in a
creative fashion: each shop is treated as its own entity, and rewarded (monetarily and
otherwise) for its performance.
The next most draining costs are related to research and development. As the
company has adopted the extremely broad vision of staying far ahead of its
competitors and offering for sale everything that its customers desire, it is easy to see
why expenditures in this arena would need to be high. According to the same report
by C.E. Unterberg Towbin, in 1998 Amazon spent an amazing $45.5 million on
research and development, and would spend a total of $139.8 million in 1999 and
$205 million in 2000 based upon estimates!
One of the reasons why the costs in the research and development category have
risen so dramatically of late is due to the building of the distribution facilities. The
near-term losses that the construction of these facilities has represented caused much
dissent among Amazon investors when discussions of the topic commenced.
However, the storm finally began to calm once it became apparent that not only would
the facilities provide a significant cost-of-procurement and cost-of-distribution
advantage over Amazon’s competitors, but also that the facilities would eventually be
needed. Amazon, in its perpetual foresight, has simply anticipated this future
necessity and it working to curb it early on in the game. A second reason for the
recent growing costs in research and development is that the etailer has been rolling
out new shops very quickly. Additionally, the infrastructure behind Amazon’s
Auctions and zShops is deceptively complex, and it represented a significant drain on
the company’s wallet as well. The estimates for the coming quarters only forecast
exponentially rising costs in the category because the eCommerce giant hopes to
present even more new shops in the coming year than in the past year. So, it is safe to
bet that Amazon will not be cutting its R&D budget any time soon.
Finally, the same report by C.E. Unterberg Towbin portrays an expenditure of
$16 million in 1998 on general and administrative costs, with an estimation of $62
million in 1999 and $93 million in 2000. Although we could not locate exact figures
for Amazon’s investment expenditures, we did find that the etailer has virtually
hundreds of interesting holdings. For example, the company has a 20% or higher
stake in the following companies, just to name a few: pets.com, drugstore.com,
HomeGrocer, Della & James, and Gear.com. Of course, being investments as they
are, these ‘costs’ will also show up in the form of revenue when we discuss Amazon’s
revenue structure. Recent news has informed us additionally of Amazon’s acquisition
of a local toy company, and an alliance with high-tech manufacturer Hewlett-Packard.
So although these costs are also rising at an alarming rate to some, we must remember
that they represent considerable additional income.
IV. Revenue StructureCompared to other major etailers, Amazon maintains a relatively high capability
of generating revenue. According to figure 1 below, Amazon reeled in $1.258 billion
in the most recent year (ending Jun-99), which is several times greater than the
revenue of other major etailers.
$0 $200 $400 $600 $800 $1,000 $1,200 $1,400
Amazon
Onsale
egghead
B&N
ValueAmerica
CDnow
Beyond
eToys
Figure 1. Comparison of major Etailers’ Annual revenues
Source: C.E.Unterberg Towbin
Amazon’s revenue is mainly derived from two sources:
1. Products groups:
A key point of Amazon’s success is the dominance of multiple product lines. It
is generally considered difficult for etailers to expand from their primary product
lines. “Books and music are low-margin business, and moving into other product
categories may be more easily said than done,” pointed out Kimberly Weisul and
Larry Dignan while discussing in January 1999 the possibilities of Amazon adding
catalogs. However, in the past months Amazon used its initial success in books to
expand and take the lead in music and videos. Moreover, the company added five
stores in 1999 and the CEO further claimed that they would open more than five in
2000. The table below shows the distribution of revenues generated from each shop
in Amazon.
Percentage of company’s revenue
SHOP
1997 1998 1999 2000 2001
Books 100% 88% 69% 57% 51%
Music 12% 15% 14% 13%
Videos & DVDs 8% 7% 7%
Auctions 1% 3% 5%
Toys & Games 3% 8% 9%
Consumer electronics 3% 6% 8%
Zshops 1% 5% 7%
Source: Amazon.com and C.E.Unterberg Towbin
2. Partnerships & Investments:
Utilizing its eCommerce knowledge base and capital, Amazon has made
investment in several emerging eCommerce categories. These investments lead to two
advantages. They:
1. Give Amazon another means of leveraging its eCommerce expertise.
2. Enable Amazon to participate in some emerging market without having to
support the entire operation.
Company Percentage of ownership
Pets.com 54%
Drugstore.com 27%
HomeGrocer 35%
Della & James 20%
Gear.com 49%
Source: C.E.Unterberg Towbin
Although Amazon generates the largest revenue among all eCommerce retailers,
the revenue figure is only a portion of that of a traditional retailer. Wal-Mart brought
in 11 times Amazon’s revenue last year and Barnes & Nobles made 2.5 times that
figure. Based on the excellent performance of Amazon and the Internet market
potential, many economists believe Amazon will easily be capable of continuing to
raise its revenue in the future. In the past two years, Amazon has been experiencing
an exponential growth of revenue and the CAGR (Compound annual growth rate) is
expected to be 68% throughout 1998 to 2002.
V. Why is Amazon in debt?Amazon has been regarded as the most successful etailer of the moment. Many
stockbrokers think of it as a platform for eCommerce. No one would disagree that
Amazon is the best revenue generator in the eCommerce arena. However, it is also
true that Amazon is now facing a huge debt. This section examines the reasons for
the company’s debt, and we will give proposed solutions in a later section.
1. Expenditure > Profit
One of the major causes of Amazon’s huge debt is its large expenditure. In order
to keep its advantageous position, Amazon has no choice but to continue to spend
astronomical amounts of money on sales & marketing, research & development, and
general & administrative costs.
“One misstep, and its love affair with investors and sources of capital could be
over.” -- Kimberly Weisul
The table below is a simple balance sheet of Amazon from the year 1998 to 2002
(expected). In 1999, the total expenses are 39% of revenue, equivalent to $566
million whilst the gross profit is 21% of revenue, equivalent to $310 million. It leads
to a negative $255 million operating income.
It is worth noticing that the ratio of expenditures is expected to decrease year by
year, from 1999’s 39% to 2002’s 20%. This essentially means that a great part of the
expenditure today is spent with a long-term prospect in mind. Along with
significantly growing revenue, in the long run these cost would become fixed costs
and account for a relevantly lower percentage of the revenue than it does today.
Percentage of revenues
Categories
1998 1999E 2000E 2001E 2002E
Sales & Marketing 22% 25% 20% 16% 12%
Research & Development 8% 10% 8% 7% 6%
General & Administrative 3% 5% 5% 4% 3%
Total expenses 32% 39% 32% 26% 20%
Income before taxes -12% -21% -12% -4% 2%
Source: C.E.Unterberg Towbin
1998 1999E 2000E 2001E 2002E
Gross Profit $134 $310 $548 $826 $1108
Total expenses $196 $566 $780 $922 $981
Operating Income -$62 -$255 -$232 -$95 $127
Source: C.E.Unterberg Towbin
2. Competitors
Although Amazon won the battle soon after entering the online CD and music
market, there are some competitors in other product lines that may be too immensely
strong to beat. For example, in March of 1999, Amazon introduced an auction
service. After a few months effort, its auction business performed slightly, indicating
how difficult it is to challenge the giants eBay and Yahoo!Auctions.
27-Sep-99 Multiplier Needed to equal eBay listings
AmazonAuctions 4.8% 15.3
eBay 73.6%
Yahoo!Auctions 21.6% 3.4
Source: Auction Web Sites and C.E.Unterberg Towbin
3. Consumer behavior
Amazon.com is widely regarded as having one of the best management teams of
any Internet company. However, there are some outside forces that are not easy to
manipulate.
. Security
As the number of Internet crimes increases, customers are becoming aware of the
possible danger involved in the process of on-line shopping. This security
problem may be not difficult to improve since security technology is innovated
quickly, but to convince the customer of this is not as easy.
. Etailers vs. retailers
Another factor that is hard to manage is customers’ purchasing habits. Most
consumers still prefer the capability of seeing a product before buying it.
Additionally, the number of people buying personal computers and that of the
Internet population will directly affect Amazon’s sales. These factors are beyond
Amazon’s control.
Another approach we can take might be to look at the market from the perspective
of the Porter model, which we present in the following section.
VI. The Porter’s model: (5 forces)The major player here is Amazon. To increase its ability to compete, Amazon
has to optimize those five forces.
For Supplier, Amazon started to build its own distribution centers in different
locations and moving the products directly from the factory rather than from other
distributors such that Amazon can lower its marginal cost.
Amazon was (fairly indisputably) the pioneer in this frontier called eCommerce.
The company started very early in the new industry. However, it must continually
remain aware of the new Entrants that become competitors to Amazon. New Entrants
did not put forward as much effort as Amazon must to develop this business. For
instance,
BN.com (Barnes & Noble) was accused of copying the Amazon’s style and
business strategy. As a result, BN.com has become Amazon’s biggest competitor. The
companies both sell similar products in a similar fashion and with similar prices.
Moreover, the aggressive competition between these two companies has put them in a
non-profit status since they struggle to offer the lowest price. Besides, other new
entrants such as
eBay, Yahoo!Auction, and beyond.com are also try to grab a piece of
this online business.
For the Consumer, Amazon.com continues to spend a lot of money on
advertisement to reach customers as well as to increase consumers’ awareness of
eCommerce in general and the brand name in particular. Despite the fact that it is
sometimes more convenient to shop on line rather than travel to a conventional store,
consumers don’t tend to change their shopping behavior in a sudden way, but rather
slowly by the influence given through an environment such as advertisement.
Thus, the Substitute of eCommerce, the traditional retailers, is still more
attractive than the etailers. For example, we as consumers more than likely would
rather go to the bookstore and browse through a book before we buy it, as opposed to
purchasing something which we have no idea about online without a preview.
Comparison of Etailers and Retailers
Source: Auction Web Sites and C.E.Unterberg Towbin
According to the chart above, we can see that the revenue of retailers is greater
than that of etailers. However, the inventory of etailers is in general much smaller
than that of retailers. The lower the levels of inventory that a company maintains, the
lower are its risks in product storage. So, it becomes an advantage for etailers to
compete with retailers based on this aspect of business. Moreover, as technology
improves, consumers should experience decreasing worry about online security and
other problems. Eventually, consumers will shift toward online shopping on some
level because of its obvious convenience. Imagine that one could order anything from
anywhere in the wold simply by viewing an online catalogue, and without buying an
airplane ticket! Therefore, it is entirely feasible that eCommerce may become more
popular than traditional retailing in the future. If that happens, Amazon will no longer
be in debt, but rather making huge revenue from the very foundation they have built
today!
VII. Opinions and ConclusionAfter our extensive research into Amazon’s marketing mix, cost and revenue
structures, net present value, and additional factors, we have come up with a four-part
solution that might possibly help the eCommerce giant to finally turn a profit.
Our first suggestion, ironically, is increased expenditure in the research and
development arena. We believe that Amazon should prepare itself for additional
telecommunications implementations such as high speed Internet, wireless Internet,
and network security. These types of implementations, though representative of
considerable R&D costs, are probably the three most significant factors that etailers
must prepare for in the near future. As users’ connections increase in speed, any
delays on the part of the etailer they are connecting to will become more and more
obvious and will be less tolerable. Also, as wireless Internet continues to gain in
popularity, some enterprising users will undoubtedly wish to connect to etailers while
on the move. Amazon can stay ahead of the pack by preparing a unique and
comfortable (yet abbreviated) interface for these users. And finally, network security
(or infosec, information assurance, etc.) is one of the moment’s buzzwords. As
consumers become more accustomed to the internet and begin to take the plunge into
the eCommerce world, they become more aware of the need for network security, and
are likely to only do business with the etailers they find to be the most secure.
Amazon will hardly go wrong by investing in the maintenance and improvement of its
own network security, and although it has the brand name to back it up now, it MUST
continue to prove the integrity of its data transmission means and methods.
Our second recommendation for Amazon is to increase its word-of-mouth
advertisement. This might seem odd for an industry leader to rely upon such a quaint
tactic as this, but we truly believe that in the world of the Internet this is a powerful
tool. We are quick to visit sites that our friends identify as being fabulous, and
Amazon might capitalize on this by rewarding its customers who can reel in new
prospects.
Our third recommendation to Amazon is to continue expanding its product lines.
Given Amazon’s vision and its unique position in the etailer industry, the cost
associated with entering new markets is significantly lower than that of its
competitors. There is no reason to let this advantage slip away unused.
And finally, Amazon must continually strive to offer low, competitive prices to
its customers. In order to draw people away from traditional on-site shopping and
toward Internet buying, we feel that prices will be the overwhelmingly decisive factor.
Amazon has already proven itself as a low-cost etailer, and has evolved (such as
building the distribution facilities) into a position where it can continue to offer these
discounts. However, it will be vitally important that the company steer clear of any
sudden price increases if it wants to maintain its customer base.
In conclusion, however, we must be fair and state that Amazon in fact is already
doing these things for the most part. And although the company has yet to turn a
profit, is it in fact favorable for them to remain in debt for the time being? We have
investigated Amazon’s relative NPV and discount rate, and discovered that the
company’s large expenditure on investments will cause a shift that will lead the
company to lower marginal costs and higher fixed costs in the future. Despite the fact
that the etailer’s profitability is currently reduced, won’t these factors indeed maintain
its dominance once its discount rate rises? So although we have introduced our
opinions about how Amazon can expect to speed up its profitability horizon, in fact it
seems that for the moment the company holds an advantageous position while
remaining in debt. No matter what, there is no doubt that Amazon has proven its
worth as a company. The feat that the etailer has accomplished by moving to be the
industry leader and being considered an actual platform for the technology is
astounding. With Amazon’s expertise, marketing, and forecasting all being taken into
consideration, there is little doubt that the company will eventually emerge from its
debt and reap the benefits of waiting patiently for its profits.