Amazon.com
In
1994, with a handful of programmers and a few thousand dollars in workstations
and servers, Jeff Bezos set out to change the retail world when he created
Amazon.com (ticker: AMZN). Shel Kaphan, Amazon’s first programmer, assisted by
others, including Paul Barton-Davis, used a collection of tools to create Web
pages based on a database of 1 million book titles compiled from the Library of
Congress and Books in Print databases. Kaphan notes that “Amazon was dependent
on commercial and free database systems, as well as HTTP server software from
commercial and free sources. Many of the programming tools were free software”
[Collett 2002]. In July 1995, Amazon opened its Web site for sales. Using
heavily discounted book prices (20 to 30 percent below common retail prices);
Amazon advertised heavily and became the leading celebrity of the Internet and
e-commerce. Sales and Relationships Amazon made its initial mark selling books,
and many people still think of the company in terms of books. However, almost
from the start, the company has worked to expand into additional areas—striving
to become a global retailer of almost anything. Some of the main events
include: 1995 books, 1998 music and DVD/video, 1999 auctions, electronics,
toys, zShops/MarketPlace, home improvement, software, and video games [1999
annual report]. By the end of 1999, the company had forged partnerships with
several other online stores, including Ashford.com, Audible, Della.com,
drugstore.com, Gear.com, Greenlight.com, HomeGrocer.com, Kozmo.com, living.com,
NextCard.com, Pets.com, and Sothebys. Of course, most of those firms and Web
sites later died in the dot-com crash of 2000/2001. Amazon also established
partnerships with several large retailers, including Target, Toys ‘R’ Us,
Babies ‘R’ Us, and Circuit City. Effectively, Amazon became a service
organization to manage the online presence of these large retailers. However,
it also uses its distribution system to deliver the products. The Circuit City
arrangement was slightly different from the others—customers could pick up
their items directly from their local stores [Heun August 2001]. After Circuit
City went under, the relationship ended. By mid-2003, the Web sales and
fulfillment services amounted to 20 percent of Amazon’s sales. Bezos points out
that most companies realize that only a small fraction of their total sales (5
to 10 percent) will come from online systems, so it makes sense to have Amazon
run those portions [Murphy 2003]. In 2001, Amazon took over the Web site run by
its bricks-and-mortar rival Borders. In 2000, Borders lost $18.4 million on
total online sales of $27.4 million [Heun April 2001]. Also in 2001, Amazon
partnered with Expedia to offer travel services directly from the Amazon site.
However, in this case, the Amazon portion consists of little more than an
advertising link to the Expedia services [Kontzer 2001]. The deals in 2001
continued with a twist when Amazon licensed its search technology to AOL. AOL
invested $100 million in Amazon and payed an undisclosed license fee to use the
search-and-personalization service on Shop@AOL [Heun July 2001]. In 2003,
Amazon launched a subsidiary just to sell its Websales and fulfillment
technology to other firms. Bezos noted that Amazon spends about $200 million a
year on information technology (a total of $900 million to mid-2003). The
purpose of the subsidiary is to help recover some of those costs—although Bezos
believes they were critically necessary expenditures [Murphy 2003].
With so
many diverse products, and relationships, it might be tempting to keep
everything separate. However, Amazon perceives advantages from showing the
entire site to customers as a single, broad entity. Yes, customers click to the
various stores to find individual items. But, run a search and you will quickly
see that it identifies products from any division. Additionally, the company is
experimenting with cross sales. In 2002, the Project Ruby test site began
selling name-brand clothing and accessories. Customers who spent $50 or more on
apparel received a $30 gift certificate for use anywhere else on Amazon [Hayes
2002].
By 2004, 25 percent of Amazon’s sales were for
its partners. But, one of Amazon’s major relationships took a really bad turn
in 2004 when Toys ‘R’ Us sued Amazon and Amazon countersued. The complaint by
Toys ‘R’ Us alleges that it had signed a ten-year exclusivity contract with
Amazon and had so far paid Amazon $200 million for the right to be the
exclusive supplier of toys at Amazon.com. David Schwartz, senior VP and general
counsel for Toys ‘R’ Us stated that “We don’t intend to pay for exclusivity
we’re not getting” [Claburn May 2004]. Amazon’s initial response was that “We
believe we can have multiple sellers in the toy category, increase selection,
and offer products that (Toys ‘R’ Us) doesn’t have” [Claburn May 2004]. The
lawsuit counters that at least one product (a Monopoly game) appears to be for
sale by third-party suppliers as well as Toys ‘R’ Us. A month later, Amazon
countersued, alleging that Toys ‘R’ Us experienced “chronic failure” to
maintain sufficient stock to meet demand. The court documents noted that Toys
‘R’ Us had been out of stock on 20 percent of its most popular products
[Claburn June 2004]. Although the dispute sounds damaging, it is conceivable
that both parties are using the courts as a means to renegotiate the base
contract.
Small merchants accelerated a shift to
Amazon’s marketplace technology. By 2007, Amazon was simply the largest
marketplace on the Web. For example, John Wieber was selling $1 million a year
in refurbished computers through eBay. But increased competition and eBay’s
rising prices convinced him to switch to direct sales through Amazon. Similar
small merchants noted that although the fees on Amazon are hefty, they do not
have to pay a listing fee. Plus, eBay shoppers only want to buy things at
bargain-basement prices (Mangalindan 2005).
In
2010, Target ended its contract with Amazon and launched its own Web servers.
Amazon does not report sales separately for its partners such as Target, so it
is difficult to determine what impact the change might have on Amazon. However,
Amazon has many other sellers who offer similar products.
Digital Content
Amazon
has been expanding its offerings in digital content—in many ways extending
competition against Apple, but also leading the way in digital books. Although
it was not the first manufacturer, Amazon is reportedly the largest seller of
e-readers with the Kindle. Amazon does not report sales separately for the
Kindle. Amazon also noted in 2011 that ebooks for its Kindle reader have
overtaken sales of paperback books as the most popular format. The e-books had
already exceeded hard-cover books the year before [Wu 2011]. For many of these
reasons, Borders, a bricks-and-mortar competitor to Amazon went under in 2011.
Amazon is also working to expand sales of
music. The Web site has relatively standard pricing on current songs, but often
offers discounts on older albums. By 2011, Amazon was also trying to expand
into video streaming. Customers who pay $79 a year to join the Prime program
gain faster shipping, and also access to a library of digital movies and TV
shows. Unfortunately, with limited ties to the movie studios, the offerings
initially were relatively thin. However, other video streaming sites, including
Netflix and Hulu, were also struggling to develop long-term contracts with
studios. In September 2011, Amazon announced a deal with Fox to offer movies
and TV shows owned by the studio. At the same time, Netflix announced a similar
deal with the Dreamworks studio. It will take time for studios to determine
strategies on streaming video services and for consumers to make choices [Woo
and Kung 2011].
In late 2011, Amazon released its own version
of a tablet computer. The company continued to sell the Kindle e-book reader,
but the tablet focused on audio and video, using a color LCD display screen
with a touch interface. Although it lacked features available on the
market-leading Applet iPad, the Kindle table carried a price that was about
half that of the iPad and other competitors ($200). The obvious goal was to
provide a device that encourages customers to purchase more digital content
directly from Amazon [Peers 2011].
Sales Taxes
Sales
taxes have been a long-term issue with Amazon. The Annual Report notes that
several states filed formal complaints with the company in March 2003. The
basis for the individual suits is not detailed, but the basic legal position is
that any company that has a physical presence in a state (“nexus” by the terms
of a U.S. Supreme Court ruling), is subject to that state’s laws and must then
collect the required sales taxes and remit them to the state. The challenge is
that the level of presence has never been clearly defined. Amazon argues that
it has no physical presence in most states and is therefore not required to
collect taxes. The most recent challenges are based on Amazon’s “affiliate”
program. Amazon pays a small commission to people who run Web sites and
redirect traffic to the Amazon site. For instance, a site might mention a book
and then include a link to the book on the Amazon site. Several states have
passed laws claiming that these relationships constitute a “sales force” and
open up Amazon to taxation within any state where these affiliates reside. In
response, Amazon dropped the affiliate program in several states, has initiated
a legal challenge in the state of New York, and in 2011, negotiated a new deal
signed into law in California [Letzing 2011]. In the California deal, Amazon
obtained a delay in collecting taxes for at least a year, in exchange for
locating a new distribution center in the state and creating at least 10,000
full-time jobs. Amazon is also asking the U.S. Congress to create a new federal
law to deal with the sales-tax issue. However, because the state sales tax
issue is driven by the interstate commerce clause in the U.S. Constitution, a
simple law will not alter the underlying principles. However, if Congress
desired, it might create a Federal Sales tax law with some method of apportioning
the money to states. But, do not bet on any major tax laws during a
Presidential election year.
Information Technology
In the first years, Amazon intentionally kept
its Web site systems separate from its order fulfillment system. The separation
was partly due to the fact that the programmers did not have the technical
ability to connect them, and partly because the company wanted to improve
security by keeping the order systems off the Web.
By 1997, Amazon’s sales had reached $148
million for the year. The big book database was being run on Digital Alpha
servers. Applications were still custom written inhouse. By early 2000, the
company had over 100 separate database instances running on a variety of
servers—handling terabytes of data. In 2000, Amazon decided to overhaul its
entire system. The company spent $200 million on new applications, including
analysis software from E.piphany, logistics from Manugistics, and a new DBMS
from Oracle. The company also signed deals with SAS for data mining and analysis
[Collett 2002]. But, one of its biggest deals was with Excelon for
business-to-business integration systems. The system enables suppliers to
communicate in real time, even if they do not have sophisticated IT
departments. It provides a direct connection to Amazon’s ERP system either
through programming connections or through a Web browser [Konicki 2000].
About
the same time (May 2000), Amazon inked a deal with HP to supply new servers and
IT services [Goodridge and Nelson 2000]. The new systems ran the open-source
Linux operating system. Already by the third quarter of 2001, Amazon was able
to reduce its IT costs by 24 percent from the same quarter in 2000 [Collett
2002].
By 2004, the supply chain system at Amazon was
a critical factor in its success. Jeffrey Wilke, Senior VP of worldwide
operations, observed that “When we think about how we’re going to grow our
company, we focus on price, selection, and availability. All three depend
critically on the supply chain” [Bacheldor 2004]. Almost the entire system was
built from scratch, customized to Amazon’s needs. When a customer places an
order, the system immediately connects to the distribution centers, determines
the best way to ship the product, and provides the details to the customer in
under two minutes. The entire process is automatic.
Dr. Russell Allgor moved from Bayer Chemical
to Amazon and built an 800,000- equation computer model of the company’s
sprawling operation. When implemented, the goal of the model was to help
accomplish almost everything from scheduling Christmas overtime to rerouting
trucks in a snowstorm. Allgor’s preliminary work focused on one of Amazon’s
most vexing problems: How to keep inventory at a minimum, while ensuring that
when someone orders several products, they can be shipped in a single box,
preferably from the warehouse — the company had six — that is nearest the
customer [Hansell, 2001]. Dr. Allgor’s analysis is simple, but heretical to
Amazon veterans. Amazon should increase its holdings of best sellers and stop
holding slow-selling titles. It would still sell these titles but order them
after the customer does. Lyn Blake, a vice president who previously ran
Amazon’s book department and now oversees company relations with manufacturers,
disagrees with this perspective. “I worry about the customer’s perspective if
we suddenly have a lot of items that are not available for quick delivery.”
Amazon’s merchant and Marketplace systems are
powerful tools that enable smaller stores to sell their products through
Amazon’s system. Amazon continually works to improve the connections on those
systems. This system caused problems in 2001—the main issue was that the data
on the merchant Web sites was being updated only once every eight hours. The
merchant’s link to Amazon’s main database servers, and internal applications
transfer the data onto the displayed page as requested. As customers purchased
items, the inventory quantities were altered in the main servers, but the
current totals were not transferred to the display pages until several hours
later. Consequently, customers would be told that an item was in stock, even it
had sold out several hours ago. To solve the problem, Amazon installed
Excelon’s ObjectStore database in 2002. The system functions as a cache
management server, reducing the update times from eight hours down to two
minutes. Paul Kotas, engineering director for the Merchants@Group noted that
“with the growth of this business, we needed a zero-latency solution” [Whiting
2002].
In
2003, Amazon added a simple object access protocol (SOAP) gateway so that
retailers could easily build automated connections to the system. Data is
passed as XML documents and automatically converted to Amazon’s format [Babcock
2003].
One of
the most successful technologies introduced by Amazon is the affinity list.
When someone purchases an item, system makes recommendations based on similar
items purchased by other customers. The system uses basic data mining and
statistical tools to quickly run correlations and display the suggested
products. Kaphan notes that “There was always a vision to make the service as
useful as possible to each user and to take advantage of the ability of the
computer to help analyze a lot of data to show people things they were most
likely to be interested in” [Collett 2002]. The system also remembers every
purchase made by a customer. So, the Amazon programmers created the Instant
Order Update feature, that reminds customers if they have already purchased an
item in their cart. Bezo notes that “Customers lead busy lives and cannot
always remember if they’ve already purchased a particular item.” He also
observed that “When we launched Instant Order Update, we were able to measure
with statistical significance that the feature slightly reduced sales. Good for
customers? Definitely. Good for shareowners? Yes, in the long run” [2003 annual
report].
Capital
expenditures for software and Web site development are not cheap: $176 million,
$146 million, and $128 million for 2010, 2009, and 2008 respectively (2010
Annual Report). But, in comparison, in 2010, net income tax provisions were
$352 million.
New Services
Amazon requires huge data centers and
high-speed Internet connections to run its systems. Through vast economies of
scale, Amazon is able to achieve incredibly low prices for data storage and
bandwidth. Around 2005, the company decided that it could leverage those low
costs into a new business selling Internet-based services. The company offers
an online data storage service called S3. For a monthly fee of about 15 cents
per gigabyte stored plus 15 cents per gigabyte of data transferred, any person
or company can transfer and store data on Amazon servers [Markoff 2006].
Through a similar service (EC2), any company can use the company’s Web servers
to deliver digital content to customers. The company essentially serves as a
Web host, but instead of paying fixed costs, you pay 10 cents per virtual
server per hour plus bandwidth costs. Amazon’s network can handle bursts up to
1 gigabit per second. The system creates virtual servers, running the Linux
kernel, and you can run any software you want [Gralla 2006]. By 2011, the
company had several locations providing S3 and EC2 Web services. It also
offered online relational database services using either MySQL or the Oracle
DBMS. Anyone can pay to store data in the DBMS, with charges being levied per
hour, per data stored, and per data transferred. The point is that Amazon
handles all of the maintenance and other companies avoid fixed costs. Even
government agencies are adopting the benefits of storing data in these cloud
services—including those run by Amazon. For example, the U.S. Treasury
Department moved is public Web sites to the Amazon cloud. [Pratt 2011].
Perhaps the most unusual service is Mturk. The
name derives from an 18-century joke where a “mechanical” chess-playing machine
surprised European leaders and royalty by beating many expert players. The
trick was that a human was hidden under the board and moved the pieces with
magnets. Amazon’s trick is to use human power to solve prob-lems. Companies
post projects on the Mturk site and offer to pay a price for piecemeal work.
Any individual can sign up and perform a task and get paid based on the amount
of work completed. Amazon takes a 10 percent commission above the fee. For
example, the company Casting Words places audio files on the site and pays
people 42 cents to transcribe one minute of audio files into text [Markoff
2006].
The
Amazon EC2 and S3 services suffered some problems in the summer of 2011. A
configuration error during an upgrade in the East Coast facility triggered a
cascade that delayed all services in the facility. Internet services including
Foursquare and Reddit that used the facility were impacted by the problems for
almost a week [Tibken 2011]. Amazon engineers learned a lot from the problems
and the same issue is unlikely to occur again
[http://aws.amazon.com/message/65648/]. But, the outage points out the risks
involved in any centralized system. Ironically, the main problems were caused
by algorithms designed to copy data to multiple servers to reduce risks. On the
other hand, with multiple facilities, Amazon provides the ability to spread
content and risk across multiple locations.
Adam
Selipsky, vice president of product management and developer relations at
Amazon Web Services observed that “"Amazon is fundamentally a technology
company; we’ve spent more than one and a half billion dollars investing in
technology and content. We began by retailing books, but it was never in our
business plan to stay with that” [Gralla 2006].
Case
Questions
1. Who
are Amazon’s competitors?
2. Why
would customers shop at Amazon if they can find better prices elsewhere?
3. Why did Amazon create most of its own
technology from scratch?
4. If
Amazon buys products from other firms and simply ships them to customers, why
does it need so many of its own distribution centers?
5. Will
other retailers buy or lease the Web software and services from Amazon? Can
Amazon make enough money from selling these services?
6. Write a report to management that describes
the primary cause of the problems, a detailed plan to solve them, and show how
the plan solves the problems and describe any other benefits it will provide.
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