Online Retailing: Swimming Against Amazon

Includes: AMZN, GSIC
by: The Operations Room

by Martin Lariviere

Amazon (NASDAQ:AMZN) is the 800 pound gorilla of on-line retailing. They are estimated to have an 8% share of the e-commerce market. Given their span from books to apparel to frying pans, no other site really comes close. Now we have two stories about how firms are trying to compete with Jeff Bezos and company. The first concerns ShopRunner (Retailers Team Up Against Amazon, Oct 6, Wall Street Journal). As the graphic above spells out, ShopRunner is attempt to match with Amazon’s Amazon Prime service. For $79 a year, Amazon will ship every order in two days for free. Not only does this remove part of the cost comparison between buying from Amazon or at the mall, it also locks in shoppers. Why buy a book from Barnes and Noble (NYSE:BKS) on line when Amazon won’t charge for shipping?

That logic is pretty compelling. A Goldman Sachs analyst estimates that Amazon has two to three prime members in the US and about five million globally. Further, they spend a lot more than non-Prime members. Needless to say other retailers want a slice of that action. Hence, ShopRunner.

Several dozen U.S. retailers are banding together to take on Inc. by striking at one of online shoppers’ biggest concerns: shipping costs. Under a cooperative program called ShopRunner, launched on Tuesday, the retailers are mimicking Amazon by dangling a $79 loyalty program that offers unlimited two-day shipping. But in this case it’s across all of the participants’ online stores, whether it’s Babies ‘R’ Us, Pet Smart, Dick’s Sporting Goods, GNC or a host of others. One-upping Amazon, ShopRunner will offer free returns.

This is all being coordinated by a firm called GSI Commerce (NASDAQ:GSIC). GSI is largely responsible for the bookkeeping part while the individual retailers will still handle their own logistics:

Mike Golden, president of Shop Runner Inc., declined to say how much the retailers are paying to participate in the program. GSI is spending about $5 million this year to launch ShopRunner, he said. He added that retailers would share ShopRunner’s revenue from membership fees, as well as share the shipping costs. He said his market research found that ShopRunner would appeal to shoppers who buy at least eight times a year at participating retailers. …

ShopRunner’s job is to manage the logistical and bookkeeping headaches, keeping track of shipments across a range of retailers. While each retailer will be responsible for their own shipping, they have to communicate with ShopRunner about each member’s purchases, and also live up to a group standard in service.

So I see two interesting parts of this. The first is whether consumers will find this compelling. If you are already an Amazon Prime customer, why would you need this? What do any of these retailers carry (outside of house brands) that Amazon doesn’t? If you are a frequent on-line shopper but haven’t signed up for Amazon Prime yet, why will this appeal? Maybe you have some reason to dislike Amazon and are happy to support the competition. Still I am not sure whether there will be enough customers who want to shop across this set of retailers for this to make sense.

The second part of this is whether the retailers can come up with an equitable way of divvying up the costs and gains. It is worth noting that some retailers have already found ways to give discounted shipping — just make getting a break on shipping contingent on placing a big enough order. REI, for example, sometimes offer free shipping if you order more than $75 of stuff. That’s a relatively low hurdle when ordering sweaters or hiking boots. It is a relatively high hurdle if we are talking CDs or RadioShack (NYSE:RSH) knickknacks.

Put another way, this program seems most appealing to customers when they are ordering small items. But that means some of these retailers are going to be hit hard by a small frequent order. The regular GNC customer who was ordering supplements monthly to consolidate shipping may now order weekly. They might well find this program attractive even if they never patronize the other firms.

So how will ShopRunner compensate a member firm whose regular customers switch to free shipping and never order from another firm? What if they do order from another firm? GNC may be incurring a ton of additional cost for no additional revenue when their loyal customer joins ShopRunner but Sports Authority and AutoZone (NYSE:AZO) might pick up a few additional orders from the GNC loyalists. How will they dole out the membership fees or compensate GNC for their higher shipping cost? Finding a way to deal with these issues will be important for this scheme to be viable over time.

The second Amazon related article is about diapers. Yes, diapers. Or more accurately, which is a real firm and was featured on a recent BusinessWeek cover (What Amazon Fears Most: Diapers, Oct 7). Here’s the poop on and their parent company Quidsi:

Lore and Bharara did about $180 million in revenue in 2009 and expect to bring in about $300 million in 2010. Just five years old, Quidsi (the name means “what if?” in Latin) is already breaking even in a category that wasn’t supposed to work on the internet: Quickly shipping bulky, low-margin commodities. The partners don’t make money on diapers, and never planned to. Diapers are the draw that brings in loyal customers who order over and over. The money comes when a shopper throws in one of the other 25,000 SKUs, or Stock Keeping Units, that lists on its site—higher-margin items like brand-name baby shampoo, wipes, and formula. (, just introduced, adds another 25,000 SKUs. Lore and Bharara want to have well over 100,000 by the end of next year; they’re planning to get into toys, too.) According to the partners, their customers are “sticky,” ordering again and again and telling other parents about the service.

Quidsi has invested in a huge warehouse with a fair amount of automation in order to drive down the cost of handling their various items. The goal is to provide excellent service on diapers and then make money by selling other items along with the Pampers.

Here is the interesting assertion of the article:

It’s’s focus that makes it dangerous. The same focus allowed to dominate the shoe business on the Internet, a success that led to Amazon’s $1 billion-plus purchase of the company in November 2009. “An intense focus on a category enables efficiencies that even Amazon would have trouble replicating,” says Rohan. “You can optimize your business. I think specialization with scale is going to be the central theme for e-commerce for this decade.” …

Specialization works for companies like Quidsi and Zappos because they build relationships with recurring customers, and because they can get their product out quickly. Bharara and Lore, for instance, are experimenting with local city storage of most-ordered items, so that a case of diapers might appear at the door within hours. Amazon can’t move its huge selection into urban areas, but most customers are selecting from a small and predictable range. Specialization also works because you can design a website targeted to a particular audience. Start at the home page, and you’re almost done shopping.

The advantages of focused processes is one the things we push in the core OM class. What I wonder here is whether there really is that much of an advantage in handling first and foremost one category. At some point, this comes down to the complexity of picking and packing items. The narrower your selection, the easier that should be. So maybe the point is not operational advantages from a focus on diapers but having a regular flow of traffic to your site despite having a relatively small span of products because people always come back for diaper supplies.

The one operational advantage mentioned above — positioning popular items closer to urban areas — is something that Amazon can’t match across its product lines. However, it is something they could do on popular items, whether bestselling books or newborn diapers. Even if they choose not to do that, there is the question of how many categories are out there that would function like diapers. Diapers in some ways seem pretty special. Most people don’t have a whole lot of experience with the category until they all of a sudden become parents. Then there are evolving needs as the child grows. And they are consumed in high volume so cost is an issue. All of that makes a focused site that offers good prices attractive. But I am not sure there is another product that functions quite the same way.