Content Guy's Note: The goal of "The Innovation Conversation" is to explore some facet of the fast-changing, technology-driven retail landscape and how it affects businesses and consumers. It is, we think, fertile territory ... and one that Tom Furphy - a former Amazon executive, the originator of Amazon Fresh, and currently CEO and Managing Director of Consumer Equity Partners (CEP), a venture capital and venture development firm in Seattle, WA, that works with many top retailers and manufacturers - is uniquely positioned to address.

This week's topic: The importance of playing competitive hardball, Amazon’s core tenets, and strengths vs. weaknesses.

And now, the Conversation continues…


KC: So, I wanted to circle back and talk to you about some MNB stories that have run since our last Innovation Conversation…

I was fascinated by the story about how Kroger has decided to avoid using Amazon Web Services for its cloud needs, figuring that it makes no sense to feather the nest of direct and increasingly threatening competition.  My reaction was this seems eminently sensible - it is the kind of hardball that I think retailers ought to play more often (like by not selling products designed to promote the brands of companies that want to steal share of stomach from a store).  Do you agree with that assessment, and if this approach is adopted by more companies (because pretty much everyone competes with Amazon), does it end up creating a problem for Amazon?  And if you do agree that hardball is warranted, does that mean that food retailers probably ought to avoid using Prime Now as their e-commerce solution?

Tom Furphy:
To me, these decisions come down to how a retailer wants to differentiate itself in the eyes of shopper. First, the retailer needs to understand their customers and determine how they can serve them as well as possible. Will it be low prices, high quality foods, great selection, great service, a valuable source of information, e-commerce, making their lives easier with auto replenishment or a combination thereof? Once this is determined, then it comes down to which capabilities can be partnered for within an ecosystem and what needs to be wholly developed and owned. The more differentiating the service component, the more it should be owned.

Web services is non-differentiating and certainly needs to be outsourced. As a retailer, there’s really no reason to allow Amazon to enjoy the revenue from hosting your data. Given other solid cloud choices such as Oracle and Microsoft, there’s no reason to even acknowledge Amazon in your tech strategy if you don’t need to. So Kroger’s move makes perfect sense. But it won’t hurt Amazon. Their cloud business is so large that losing several retailers as customers will barely be noticed.

As far partnering with Amazon otherwise, it may not be as clear. If you are certain that you don’t want to take on ecommerce fulfillment on your own, then Prime Now is a good option. Similar to Instacart or Shipt, these third party services can take care of that customer need without a significant investment. Prime Now comes with the baggage of giving Amazon more great information about your customers, but with the upside of access to more customers than you’d likely have on your own or with the others. If a large number of potential retailer customers of Amazon decide to go with competitive services, I suppose it could be problematic for Amazon in the long term.

Regardless of near term partner choices, I would advise retailers to have a path to a long term strategy, which may or may not include these fulfillment services. When ecommerce is 20% or more of store volume, I think it’s important to have a strategy that you control, even if using an ecosystem of partners.

KC: It has been interesting to see that Amazon has been lowering the prices it is charging some manufacturers to list their products on its site - eight percent on lower priced goods, vs. the 15 percent it used to charge, and the 15 percent that Walmart charges and the 10 percent that Jet charges.  Help me understand - how significant is such a move?  Is there a kind of price war breaking out that could have implications for mainstream retailers?

And what about Amazon’s decision to cover discounts on products sold by third-party merchants on its site?  Does this mean that traditional retailers are going to have to start being a lot sharper on price, and finding ways to respond to Amazon’s ability to use algorithms to rapidly respond to market conditions?

TF:
A core tenet of Amazon’s strategy is to continually lower its cost structure as it gains scale so that it can, in turn, offer lower prices to customers. These customers not only include shoppers, but also partners. For example, they have lowered their Amazon Web Services prices a couple dozen times since the launch.

On the marketplace side, they are getting scale in a couple different ways. First, they continue to offer more products on the site. This allows them to attract more sellers and shoppers, which creates volume scale. The incremental cost to add more sellers to the platform is minimal, so over time they can charge less and still increase dollar profits. Also, as they build out their fulfillment center network, they are able to ship products to customers for less cost because the products aren’t traveling as far. This drives a lower cost to serve within the FBA program, where third parties use Amazon’s logistics to ship to the customer. As this happens, Amazon’s profitability increases. They can either lower prices or generate more profit on level pricing.

This gives Amazon plenty of leeway to lower the amounts they charge merchants. It also gives them room to throw in an additional discount, which is great for the shopper. Both of these certainly make them more difficult to compete with. And I don’t see either lower fees or additional discounts stopping in the foreseeable future.

In all cases, it absolutely means that other retailers need to up their game. They need to continually look for ways to improve their capabilities while ideally lowering their cost structure. This is easier said than done, especially as their costs may increase in the short term as they take on ecommerce. But it is not an option. Amazon is stealing share in droves. Retailers that don’t build their ecosystems to offer a range of capabilities and competitive prices are in for a rough run to extinction. It won’t happen in two or three years, but it will happen in five to ten.

KC: Finally, I’d love to hear your reaction to Amazon’s decision to pull Fresh from some markets… which some people are seeing as a tacit admission of weakness or defeat, but it seems to me more like a tactical withdrawal keyed to its plans to integrate and use Whole Foods more effectively as part of its broader offering.  Thoughts?

TF:
Amazon has never been afraid to end or alter experiments that aren’t working. In this case, it is likely that certain locales just don’t have the volume and customer density to support a full-service, van-delivered, grocery ecommerce market. This doesn’t necessarily reflect on Amazon’s happiness with the program or their resolve to win in the space. Sometimes the raw variables just aren’t adequate. Instead of continuing to flush r&d money in these markets, the costs and efforts are likely better spent innovating elsewhere.

As Amazon expands the range of capabilities to serve grocery shoppers, especially with the acquisition of Whole Foods, they will certainly continue to work to figure out how to best serve customers in areas where the population density can’t support full basket delivery. In these markets, it may be a combination of pickup points, delivery on scheduled days and click & collect at store locations. All of this will be supported by shopping automation such as subscribe and save that drives a big bulk of the volume.

This move exemplifies Amazon’s acknowledgement that grocery ecommerce is hard. It certainly does not mean that they are giving up. They will continue to relentlessly innovate to serve the totality of their customers’ grocery needs. They are all in.

KC: We’ve often quoted the Jeff Bezos line in this space, about how “it isn’t an experiment if you know how it is going to turn out.” In the end, I suppose, this is an example - Amazon continues to innovate and iterate, focusing on serving customer needs, and isn’t afraid to make changes when circumstances require it. In the end, I think, this should be seen as a sign of strength, not weakness.

The Conversation will continue…