Whatever one may think of its long-term prospects, Amazon.com clearly stands in today’s front rank of online businesses. It can legitimately claim to be the first of the Web bookstores to reach a global mass market, to be “Earth’s largest bookstore,” and to have delivered significant value to shareholders, with an eighteen-month stock-price return in excess of 1,300%. These superlatives aside, Amazon continues to help define the Internet as a consumer environment, with rules, limits, and opportunities often different from those experienced in physical channels. Operating under assumptions at variance with conventional retailers, Amazon is a harbinger of successful business practices in a connected economy.
To anticipate this study’s main points, they are the following:
* Amazon uses software connected to a network to understand then meet customer needs for information goods. Prime goals are thus to increase the power of the software and the reach of the network, then to expand the scope of goods offered. One outcome of this outlook is a conscious decision to invest in reach (in the form of market share and penetration) at the cost of short-term profitability.
* Outside of this core capability, Amazon tends to connect to resources that give it scale rather Than adding internal physical mass. Amazon’s leadership team understands increasing returns economics as exemplified in the software industry, most notably by Microsoft, insofar as it seeks to promote lock-in, positive feedback loops, and other so-called network externalities.
The worldwide book publishing industry, while not approaching the size of the health care or financial services sectors, is nonetheless an $86 billion industry at retail, with $26 billion of that accounted for domestically.
The Association of American Publishers estimates that the industry, measured at wholesale in the U.S., will grow at a compound annual growth rate (CAGR) of 5% between 1996 and 2001. The industry is highly fragmented, with no single company controlling more than 10% of the retail market.1 Inventory management is a major challenge: the number of titles in print at any given time is roughly 1.5 million, or six times as many as compact discs. Amazon.com opened for business in July 1995 as an exclusively Internet-based business. It lists over 2.5 million book titles (including roughly a million out-of-prints and used titles) in its online catalogue.
To manage this sizable inventory, Amazon uses a virtual model-the company physically holds only a fraction of those titles at any given time and has close ties to wholesalers, including Ingram Book, whose presence helped drive Amazon to set up shop in Seattle.2 Amazon had over 4.5 million customers as of September 30, 1998, (up from 1.5 million 9 months earlier) in 130 countries worldwide, with 64% of book revenues representing repeat business. Net sales were $153 million with a loss of $20.9 million as of the most recent quarterly statement. The firm offered 12% of its stock to the public in May 1997 at a price of $18 per share. Roughly a year later, the stock was trading in the $90 range, a 400% return. In November 1998, it crossed the $200 mark.
The business’s long-term direction is gradually being made public. In addition to books, Amazon initially expanded into books on tape, videotapes, and sheet music. It then moved into compact disks in the summer of 1998, becoming the top Internet music merchant in its first quarter of operation. In late November, Amazon announced that it was temporarily expanding into holiday gifts, including electronics, toys, gadgets, and games. This move, while expected, came earlier than most observers predicted, providing another instance where Amazon acted proactively and forced other industry players to respond. Compared to books, such products offer higher margins and force some pessimistic analysts to revise their opinions about the stock’s long-term value.3
All of Amazon’s core products are what Hal Varian, an economist at the University of California, calls information goods, products which have distinctive characteristics and behave differently from traditional products. Information goods often need to be sampled before purchase; cost-based pricing (especially for easily duplicated online digital information) becomes to capitalize on the area’s large supply of talented computer programmers, and focused on the opportunities presented by the fact of books being information goods, by the fragmentation of both supply and demand, and by the demanding inventory needs of a book retailer being easier to meet with connections to distributors’ warehouses than with in-house stock.
It is important to note that from the outset, Amazon operated on a business model built to exploit the online environment, rather than from the standpoint of a product or service offering. This perspective directly contradicts conventional business wisdom which urges executives to set business goals and then to “enable” those goals with technology. Bezos, like FedEx’s Fred Smith and other visionaries, instead studied a set of emerging technological capabilities and wrapped a business around them.