Keys to Amazon’s success: Price wars and big data

Nicholas Carr

THE WASHINGTON POST – On Friday, February 28, as the coronavirus pandemic was taking hold in Europe and the Americas, Jeff Bezos and his girlfriend, the former television anchor Lauren Sanchez, met with French President Emmanuel Macron in the Élysée Palace in Paris.

They discussed, as the Amazon Chief Executive reported in an Instagram post, “climate, sustainability, and preserving the natural world”.

The next evening the couple partied at the top of the Eiffel Tower with Diane von Furstenberg, Seth Meyers and other celebrities.

By Monday they were back in the United States (US), dining out at the posh restaurant Carbone.

A week later, everything had changed. France was under lockdown, the Carbone dining room was shuttered, and Amazon was facing its biggest challenge since the dot-com crash 20 years ago.

Hit by a wave of panic buying, the company was struggling to fill orders, often delaying shipments for days or weeks.

Its global supply chains were seizing up. Its workers were staging protests and sickouts over health and safety concerns.

In a March 21 memo, a chastened Bezos assured employees that he would devote all his time to the crisis. The globe-trotting was over.

While the pandemic poses difficult problems for Amazon, in the long run the outbreak seems likely to make the company more powerful than ever.

Not only is Amazon the world’s largest online retailer; it also operates a growing media-streaming business, a big Internet pharmacy and a burgeoning digital advertising operation. And its lucrative cloud-computing unit, Amazon Web Services, provides data processing support for many other companies’ online operations.

As social distancing practices push people to spend even more time on their phones and computers, the company stands to make more money and wield more influence.

Journalist Brian Dumaine’s new book on Amazon, Bezonomics, offers an illuminating exploration of the underpinnings of the firm’s success.

Although the book is a victim of bad timing – written before the pandemic, it already feels dated – Dumaine is a careful reporter, and his descriptions of Amazon’s operations are lucid and finely detailed.

He explained the logic behind the company’s Prime loyalty programme, which, despite incurring high costs for rapid deliveries, locks customers into Amazon’s “ecosystem” of retail and media offerings.

He describes the voice-recognition technology that gives the Alexa chatbot an eerie semblance of consciousness.

He explained how Bezos and his lieutenants use artificial-intelligence techniques, such as machine learning, to match supply with demand on a vast scale.

And he takes the reader on a tour of Amazon’s huge warehouses, where squads of robots and humans work in tight synchronisation to pack millions of cardboard boxes a day.

When Dumaine widened his perspective, to describe Amazon’s overarching business strategy, his vision gets blurry.

He attributed the firm’s rapid growth to what he calls its “flywheel” paradigm.

By keeping prices as low as possible, he explained, Amazon attracts more customers to its site.

That generates ever greater economies of scale, which in turn allow it to cut prices even further.

Dumaine presents this “virtuous cycle” as a recent breakthrough in business thinking, but it’s nothing new.

Using economies of scale to cut prices (and boost profits) is how capitalism has worked since the Industrial Revolution.

The Internet may be the most massive of mass markets, but the basic economics of business competition remain unchanged.

Amazon’s early success did stem from its pricing advantage, but the source of that advantage is more complicated than Dumaine allowed.

The company was able to undercut competitors’ prices for many years because, unlike other businesses, it didn’t have to worry about turning a profit.

Stock market investors, dazzled by the Amazon story, supplied the company with cheap capital even as it racked up big losses.

Many local mom-and-pop stores, struggling to make loan payments and meet the weekly payroll, never stood a chance.

Even large, traditional retailers couldn’t afford to match Amazon’s prices. They had expensive stores to maintain, and their investors were not so indulgent.

The advantage provided by abundant capital was magnified by a loophole that allowed Amazon to avoid charging sales taxes on purchases made by customers outside its home state, Washington.

One reason Bezos decided to establish Amazon in Seattle, Dumaine reports, was that the company would be able to offer tax-free purchases to buyers in populous, high-tax states like California and New York.

That made its low prices feel even lower. Amazon’s pricing flexibility not only gave it an edge over brick-and-mortar stores; it allowed it to crush small Internet retailers before they could threaten its business.

Dumaine told the story of Quidsi, a New Jersey start-up that launched Diapers.com in 2005. New parents flocked to the site, attracted by its promise of free overnight shipping.

That caught Bezos’s attention, and Amazon initiated a price war, selling diapers at a sharp loss. Investors began to abandon Quidsi, starving it of capital, and in 2010 the company gave in. It agreed to be acquired by Amazon.

In recent years, Amazon’s pricing advantage has eroded. As big brick-and-mortar retailers like Walmart have expanded their online offerings, they’ve been able to match Amazon’s discount, and states have passed laws requiring Amazon to collect sales taxes.

But Amazon has found another powerful source of competitive advantage: data. As Dumaine reports, thousands of independent retailers sell goods through Amazon’s site, which gives the company privileged access to information about competitors’ products, prices and sales. Amazon claims it doesn’t use that information for its own benefit, but the evidence suggests otherwise. In April, the Wall Street Journal reported that Amazon employees secretly collected data from independent sellers and used the information to develop competing products.

Amazon is an innovative, well-managed company, but it has also had the good fortune to compete on an uneven playing field that tilts in its favour.

Bezos has always been the cagiest of Internet moguls. He remains an elusive presence in the pages of Bezonomics.

He’s “a force of nature, moving at warp speed through a vast canvas,” Dumaine wrote at one point, tangling himself in cliches.

Whatever Bezos is, a force of nature he is not. He is shrewd, calculating and ruthless, and he has built his empire in his own image.