Brands manufacturers’ traditional approach to measuring market share needs to change when considering ecommerce channels like Amazon, Walmart, and Target. In this recent article for Forbes, I explain how previous methods for measuring success is flawed, and exactly how it can be adjusted to reflect ecommerce success accurately. Shopper journeys are changing and success metrics need to change accordingly. Read the complete Forbes article here.
It’s the moment we’ve all been waiting for – Amazon earnings for COVID impacted Q2 2020.
Since the COVID-19 pandemic began, many of us are shopping on Amazon more than ever. My Amazon Echo pings all day with deliveries for my family of five. My kids open the front door several times per day just to see if any cereal or batteries or Legos have arrived. I’ve seen more Amazon delivery trucks on the streets than ever before, and you have to sell your firstborn child in Seattle to get an Amazon Fresh delivery appointment.
In Q1, we know Amazon saw such a demand spike that they had to focus entirely on essential goods and restrict everything else. But how much volume? And at what cost? Read on for three things that surprised me about Amazon’s Q2 2020 earnings release.
1. Amazon’s inventory strategy is scarily lean
Amazon earnings release reveal that revenue came in at $88.9B, +40% Y/Y (vs +26% the previous quarter), and +18% Q/Q. Categories like fashion and electronics likely saw softer sales, dampening the overall growth rate. However, some categories saw huge spikes. Throughout the end of Q1 and much of Q2, Amazon struggled operationally.
According to Brian Olsavsky, Amazon’s CFO, “Online grocery sales tripled year-over-year.”
What’s incredible is that an additional 14 points of sales growth (vs. previous quarter’s run rate) created that much disruption at Amazon. They continued to miss and delay Prime shipping promises and restrict inbound and outbound shipments.
This doesn’t seem like so much extra growth. Could your organization manage an extra 14 points of growth without too much disruption?
The level of disruption made me realize how thin they keep their inventory (typically 2-3 weeks of cover, and often less for tail assortment.) When coronavirus hit, their lean strategy backfired. Not that anyone planed for a global pandemic. However, it shines a spotlight on how lean they run.
WHAT THIS MEANS FOR MANUFACTURERS
Amazon’s lean inventory strategy, and how sensitive their network is to fluctuations in demand underscores the importance of having a hybrid selling strategy, or multiple ways to sell goods on Amazon. At the onset of the pandemic, many of our clients rushed to get a 3P account set up, dropship capabilities, etc. Better to be prepared for future demand fluctuations and have your hybrid strategy ready-to-go.
Also, Amazon’s going to run out of space (for real) in Q4. This comment from Brian O. was shocking:
“Now as we move into Q3, we’re starting to – we need to build the inventory more for Q4, and we’ve run out of space. So we’ve got our hands full on that challenge, but we’ve got a really good team that’s been working very hard probably since late February on this issue.”
Well I’m glad you have a team working on it, Amazon. Manufacturers: better get your goods in now!
2. Where did all of that profit come from? If we believe Amazon’s position, their normal corporate marketing ad spend must be *huge* during non-COVID times.
Amazon earnings release show that net income came in at $5.2B, up 107% Y/Y. Earnings per Share increased 94% Y/Y to $10.30. Even looking at Net Income as a % of Sales, they improved 76% Y/Y to 5.9%. They made more overall profit (which makes sense, because they had more sales), but also a higher profit margin. Yet, they spent over $4B on COVID-related expenses, such as protective equipment, cleaning, safety protocols, additional family care benefits, and a $500M employee thank you bonus, among other things.
I was convinced all the low-profit grocery sales and increased cost of doing business would severely negatively impact profit. Heck, the analysts expected Earnings per Share to be $1.46. However, Amazon earnings show they managed to deliver 7x those expectations! How did they do this?
Apparently, I’m not the only one with this question. Analyst Mark Mahaney of RBC asked,
“…these profit levels are super high now. Is Jeff aware of how profitable the company is becoming? Is he happy about it?”
Sigh. Finance humor.
Osalvsky says it came from a 1/3 reduction in Marketing expenditures. Amazon must have previously spent a LOT on marketing for this to drive EPS up 7x analyst projections.
WHAT THIS MEANS FOR MANUFACTURERS
I guess the great vendor profit claw-back I predicted is not coming after all. Manufacturers, you are safe…for now. You may want to bring up Amazon’s stellar profit performance in your next vendor negotiation. Do they really need that extra 50 bps of co-op improvement?
3. Amazon continues to invest, while other retailers scramble to keep pace
Amazon is continuing to build fulfillment centers. They’re listening to and learning from us using our Alexa. They’re moving forward with international expansion. Their competitive advantage is that it’s always Day One. According to Jeff Bezos in the Amazon earnings press release,
“Lastly, even in this unpredictable time, we injected significant money into the economy this quarter, investing over $9 billion in capital projects, including fulfillment, transportation, and AWS.”
No one asked Amazon anything about their foray into healthcare, and Amazon didn’t mention it. Amazon has quietly been acquiring all kinds of voice-enabled health technology companies (check out their Alexa Fund). They’ve launched a healthcare system for their employees. They’re doing their own COVID testing. They have like a million Healthcare experiments running, and likely COVID-19 is accelerating the customer need and general interest in all of these. Do you wonder why they’re keeping that under the radar for now?
WHAT THIS MEANS FOR MANUFACTURERS
Amazon will win by continuing to invest while others cannot. This is also how you, brand manufacturers and sellers, will win. Keep focused on your long-term initiatives. Stay strategic. Keep your head up. Finding ways to thrive, versus just survive, will put you ahead of your competitors as we adjust to the New Normal.
Also, the current coronavirus pandemic is crowding out any news about Amazon’s expansion activities. Keep reading, stay curious, and continue to dig. You definitely don’t want Amazon to surprise you!
About the author: Andrea K. Leigh is both an e-Commerce strategy enthusiast and expert. She works with suppliers on e-Commerce strategy and execution, and writes, speaks, and teaches on commerce-related topics. She is the VP of Strategy and Insights for Ideoclick, an e-Commerce managed services agency that empowers manufacturers to take charge: e-Commerce without compromise. A 10-year former senior exec at Amazon, she worked on the launch and management of automated pricing, the Prime program, Amazon Fresh, and even Harry Potter book launches.
Amazon free shipping isn’t actually free. Many consumers and brands are unware of just who foots the bill when it comes to “free” shipping provided by Amazon. Someone pays for the shipping – and it’s not who you think. Discover if the consumer, brand, or Amazon ultimately pay for the cost of free shipping.
“There’s scarcely tastier bait for American shoppers than free shipping,” according to a recent Atlantic article, “and it’s been transformed from an occasional incentive into something that closely resembles a consumer requirement.”
As consumers, we expect delivery. We really, really, need delivery. But pay for it? No way.
When is shipping truly free for the customer? When is it not? Who pays, and why? Is this sustainable? Let’s find out.
The History of Amazon Free Shipping
Back in the olden days, people rode their horse and buggy to the physical stores for all our needs. If the physical store didn’t have what we needed, we’d go without (a concept my kids still can’t wrap their heads around). The product price was a “box price” which is the price of the item only. Alternatively, people could order from a catalog. For the privilege of ordering a seemingly endless assortment (often from a rotary phone or fax machine), we paid a “landed price”, which is a box price plus a shipping fee.
Then along came eCommerce – where competing for sales is hard, and the delivery fees for space heaters, diapers, and big screen TVs are expensive. However, shipping costs are a major deterrent to online shopping (still the largest driver of all cart abandonments.) If customers were responsible for the actual, itemized delivery fees, they would feel guilty and lazy for paying to shop in their pajamas. They would go to the store.
Barbara Kahn, Professor of Marketing at Wharton, calls this the “pain tax”: “If the shipping price is incorporated in the price of the good and customers don’t have to think about that pain tax, they would definitely prefer it.”
To get people to shop online, retailers must make shipping free. So, who pays for it?
Does the Customer Pay?
Let’s say an item’s retail price is $20, and it costs $5 to ship. If the retailer charges $25 and announces, “free shipping”, then the customer is paying.
This approach is still common among many third-party sellers on sites like Amazon and eBay. These sites have toggle buttons to help customers filter for items with “free shipping”, and you want your products to show up. (On Amazon’s web site heatmap, for example, those filters are the hottest places on the page.)
Alternatively, retailers or sellers will charge shipping overtly, in the form of a shipping charge (i.e., Land’s End). Order minimums (i.e., Free Super Saver Shipping) are also a way of having the customer share the burden. Larger orders drive incremental revenue and profits for the retailer.
In these cases, the customer pays for the benefit of having products delivered to their homes.
Does the Retailer Pay?
Many eCommerce players got their start this way, matching competitors’ in-store, box prices, AND offering free shipping. In this case, the cost of the shipping comes out of the retailer’s profit margin. This helps the retailer buy customers, but it is not sustainable as a long-term strategy. If you operate in a margin-rich category, this works. It also works if your shipping costs can be reduced over time by economies of scale. Yet Amazon’s retail business is profitable…likely even before advertising.
However, cat trees, toilet paper, and Campbell’s soup carry high shipping costs. Contrary to popular belief, Amazon and Walmart have moved away from this. While Amazon has economies of scale, it would be difficult for them to ship most of their merchandise profitably – especially with One-Day shipping – without some help.
Doesn’t Amazon’s Prime Revenue Help?
It helps, but it’s likely not enough. It’s estimated Amazon spent $5-6B last year on digital content for Amazon Prime, or $40 per Prime customer. That leaves only $79/customer to allocate to Amazon’s shipping costs. This probably doesn’t cover the 24 orders per year that Prime customers place. Of course, the math is more complex, LTV, etc., but you get the picture…
So, you guessed it, someone else is subsidizing shipping.
The Manufacturer Pays (ding ding!)
Amazon is in the middle of Annual Vendor Negotiations with vendors. This year’s top request by Amazon? To increase funding, especially freight, to help pay for Amazon’s launch of One-Day shipping.
Manufacturers heavily subsidize the cost of both the pricing war between Amazon and Walmart AND their free shipping programs.
Manufacturers are also feeling the squeeze of Amazon and Walmart.com to keep on subsidizing.
Years ago, these (1P) manufacturers happily loaded their products onto Amazon with minimal trade funding. Amazon came to represent their primary eCommerce customer and a profitable growth channel.
However, in the past five years, manufacturers have consistently told me that Amazon’s gone from their least expensive channel to their most expensive – by a long shot. That’s because over time, sites like Amazon have shifted the burden of price matching and shipping costs to the manufacturers.
Amazon reports vendor profitability numbers back to vendors, requesting to be compensated when their item-level profits aren’t hitting targets. They receive this funding in the form of margin guarantees, freight allowances, accruals, CRaP allowances, straight payments, AVS/SVS programs, and Amazon Advertising. If Amazon can’t get subsidies for these products, the products are often deemed CRaP – in which case, you can’t advertise, you fall out of search, and Amazon may stop ordering. Why would Amazon drive sales of unprofitable products?
If you’re a typical manufacturer that does more than half of your eCommerce sales on Amazon or Walmart, they yield a tremendous power over your business.
In Amazon and Walmart’s defense, I don’t think anyone could have predicted how technology would drive such a pricing race to the bottom. Price matching in-store box prices carries a huge burden for an eCommerce retailer, who must ship products. Not being beat on price is an expensive proposition. On the flip side, not being competitive on price is a major trust buster for someone like Amazon or Walmart.
Please, please have a channel strategy
Manufacturers’ channel strategy – or lack thereof – plays an integral role. If you’re tied to an old-school promo calendar that gives each retailer their “turn”, you’ll always be on sale online.
If you think Amazon is your most expensive channel, take a hard look at your promotional strategy.
Also, pay attention to which retailer drives pricing in your category. Consider whether you want everyone to have the same assortment. Best-in-class manufacturers are differentiating. If you give everyone the same thing, expect a race to the bottom and a bunch of emails from eCommerce retailer buyers asking for help with profits.
Is this sustainable? What’s going to happen?
No, it’s not sustainable. Why do we rarely see third-party sellers eating the cost of shipping? Because they know that a business built on negative profit margins is generally not a good business.
Major retailers are still competing over eCommerce customers. However, over time, manufacturers are going to run out of money to subsidize retailer profits. When that happens, I believe we’ll eventually see eCommerce pricing adjust up to reflect the true cost to serve customers. (Sorry, customers.)
In the meantime, the customer wins
Unless it’s clear the customer is paying shipping, someone else is. Therefore, the customer wins. Yay customers!
One thing’s for sure – you’ve got to appreciate Bezos’ customer focus. In a recent shareholder letter, he said, “There are two kinds of companies: those that work to try to charge more, and those that work to charge less. We will be the second.”
We recently outlined some perspectives and tips on the AVS (Amazon Vendor Services) vendor-funded support service. Whether you are considering the value of the service or have already signed on and want to ensure you’re making the most use of those funds, this video provides information on how to avoid the six most frequent mistakes brands make when utilizing the AVS program. Also, this chart explains the possibilities for utilizing your AVS resource:
News and industry discussions are swirling around the rumor that Amazon is shaking things up with smaller suppliers and planning to cut all 1P manufacturers under $10M in annual sales. If you read the Bloomberg article or have heard of this elsewhere and you’re concerned, please don’t worry because we have you covered!
Here’s the gist of why you shouldn’t worry: First, there have been no confirmed timelines associated with this change – so it’s possible you’ll never be affected. Second, there are tremendous advantages to a being third-party seller on Amazon, and we can readily help you get set-up. If you already have a hybrid 1P/3P arrangement, we can help you optimize your seller central account and product assortment as a precaution to best mitigate risk.
First, it’s helpful to understand what’s likely driving Amazon’s motivations behind the rumored transition:
Having lots of smaller suppliers introduces risk to Amazon
For Amazon, holding and managing inventory for smaller suppliers with less predictable product movement represents a financial risk. Also, it’s difficult to properly vet, police and remove (when necessary) the smaller suppliers who may be selling counterfeit or otherwise unauthorized product. Similarly, smaller manufacturers who may not have met certain safety or testing standards can clearly become problematic for Amazon. We realize our clients don’t fall into these counterfeit or safety-risk categories, but Amazon may not.
First-party vendors are more high-maintenance for Amazon
As with any business, a company must consider how employees’ time spent generates revenue and constantly evaluate the value of each employee. Considering the time involved in onboarding and managing first-party platform vendors and items (even with scaling and automation efforts), Amazon finds that the arrangement comes at a high cost to serve compared to the realized revenue.
Amazon’s investment into one-day shipping means they must find ways to shift to more profitability elsewhere. Third-party vendors create “easier” profit for Amazon, and better selection for customers
- Without the maintenance mentioned above, Amazon still earns commission on every sale through the 3P platform – so it’s guaranteed earnings at a lower cost to serve.
- Having a large stable of 3P sellers allows Amazon to offer their customers a larger selection, without the heavy burden of directly managing them.
- With Amazon’s “hands off the wheel” price matching algorithm for 1P vendor items, the items and even entire brands may become exposed to a CRaP out situation, which presents a loss for Amazon as well as vendors. Vendors moving to 3P gain the control to price their products more sustainably – creating a win/win for vendors and Amazon.
Here are some advantages of the third-party seller central account:
A seller central account gives you the ability to set your own retail prices (avoid CRaP status), manage your own inventory and marketing. And because you manage your own data, you have access to superior reporting.
There’s a tremendous community of experienced Amazon third-party seller forums that share best practices and help others troubleshoot. You will be amazed at the plethora of resources available.
What you should do
If you don’t already have a seller central account, let us help you set one up. For reference, we have published an FBA playbook that you can request here if you don’t have it already. (Or, if you’re an existing client, reach out to your account manager.)
We can help you create and manage a pricing strategy. Be aware that in your seller account, you will have to manage sales tax remittance in all states.
If you receive communication from Amazon regarding hybrid selling, or selling as a third-party seller on Amazon, we recommend that you don’t respond immediately. Please consult first with your Ideoclick Account Manager. We will help you craft a strategy and response that serves your best interests.
You will find the seller community a very welcoming place and the third-party arrangement an incredible opportunity to continue growing your business, and we look forward to helping you through this transition!