Amazon Finally Clicks

Ten years old and profitable at last, it offers a textbook lesson on how to be both focused and flexible.

Jonathan Gaw, a research manager at technology research firm IDC, says, “No one else has this kind of expertise, because no one else has invested the capital to build this kind of infrastructure.”

Amazon.com was once viewed as a leading member of the E-commerce vanguard, but most of the followers have fallen by the wayside. True, the survivors—E-bay, MSN, AOL, Yahoo, and Google—have become household names, but success remains precarious and depends on, among other things, the ability to be nimble. Amazon built its brand initially on low-priced books and waited for customers to come bargain-hunting. Today it pulls out all the stops to get people to visit, from “never-before-seen” Bruce Springsteen concert footage to a “secret message” from Madonna. If that sounds like the sort of pop-culture gimmickry one might expect from, say, AOL, there’s good reason: the E-commerce giants are out to eat one another’s lunch. When Google, for example, announced Froogle, a new service that allows users to search for a product name and be directed only to sites that sell that product, Amazon launched a new subsidiary, A9, devoted to Web searching, and even located its offices close to Google in Silicon Valley. Similarly, the boundaries between the business models of E-bay, Yahoo, and even Microsoft can be hard to discern, as all of these companies seek to protect themselves and to copy whatever seems to work.

Little wonder why Erik Brynjolfsson, a professor at MIT’s Sloan School of Management and director of its Center for eBusiness, calls Amazon “the world’s largest consumer laboratory.” Indeed, the reason Amazon survived for nine years without an annual profit is that it had a long-term vision for building its technology infrastructure, a research-and-development strategy more like a pharmaceutical company. “Our technology and content expenses were $156 million and $167 million for the nine months ending September 30, 2003, and 2002, respectively, representing 5 percent and 7 percent of net sales,” Szkutak notes. He says those expenditures will continue, but not at the expense of profitability. “Do I expect us to someday sustain year-over-year profitability? I wouldn’t be here if I didn’t,” he says.

For all its diversification, however, Amazon still derives three-quarters of its revenue from products that it inventories, sells, ships, and fulfills via its own supply chain, which includes six warehouses in the United States and four overseas. Those who have followed the brief history of E-commerce know it wasn’t supposed to be that way: Amazon’s original vision posited the company as a much more virtual entity, an electronic middleman light on capital assets. Instead, centralized distribution driven by technology—everything from inventory systems to real-time logistics analysis—has proved a potent combination.

To leverage those capabilities, a CFO needs to think in terms of inventory velocity. “Say both Amazon and a physical store are selling a digital camera for $300,” Szkutak says. “The physical store’s inventory turns are 7.5 times a year and ours are 20 times a year. The hypothetical value of the camera one year later, due to obsolescence, is, say, $210, an obsolescence loss per week of $1.70. However, since the camera is in inventory an average of 7 weeks at the physical store and only 2.6 weeks at Amazon, the obsolescence cost per unit works out to $12 for the store and $4.50 for Amazon. As a percent of sales, that’s 4 percent for the physical store and 1.5 percent for Amazon. In short, our inventory velocity translates to margin benefit.”

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