Giants of the Internet: Amazon

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Wherever Amazon competes, it hurts incumbents by taking share and driving price deflation. Amazon has spent over $20bn on its infrastructure. Its success is forcing incumbents like Walmart to announce that it will bring forward investments of $2bn in digital infrastructure, just to catch up. Amazon’s first-mover advantage in digital sales has established barriers to entry that further cement their dominant position. Online search rankings are largely determined based on sales, which becomes a self reinforcing cycle. With e-commerce becoming a large component of overall retail sales growth, Amazon’s dominance is growing.

While Amazon presents an obvious threat to bricks and mortar retailers, it is also creating challenges for consumer goods companies. Companies such as Nestle and its global peers dominate shelf space in supermarkets, however as Amazon is not limited to stocking two or three brands in each category, smaller and emerging brands can now gain access. Furthermore, smaller suppliers can benefit from Amazon’s Dragon Boat program whereby Amazon logistics takes product direct from factories in China all the way into the customer’s home.

Amazon looks at the market in a completely different way to most retailers. A typical retailer is focused on gross profit margin, but Amazon focuses on ‘per-unit basis cost’ which accounts for shipping. Because Amazon is content with its strategy of building scale over immediate profitability, it willingly stocks items knowing it will book a loss. It has pools of profitability - such as books and electronics - while loss leaders such as fresh food are part of a broader strategy that will one day become profitable.

Amazon is not standing still. It is continuously investing to create more reasons for the consumer to shop with it. Its membership club ‘Amazon Prime’ is a unique hybrid of offline and online membership and has now penetrated one-third of US households. Amazon has over 50 million Prime members paying $99 a year with the key benefit being free delivery. However Amazon refers to a ‘flywheel ’ approach, and as more services are offered through Prime, customers’ spend increases allowing for more service offerings. This has expanded Amazon into ventures such as subscription video on demand, music, and digital storage.

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Amazon is also disrupting the way businesses procure, develop and manage their Information Technology (IT) needs. Now ten years old, Amazon Web Services (AWS) is the world’s leading ‘cloud computing’ business and powers the IT workloads of over 1 million businesses in 190 countries. AWS is now bigger than Amazon.com was at ten years old and is growing more rapidly with revenues expected to exceed US$10bn in 2016.

AWS is a ‘public cloud’ computing platform. Cloud computing may be difficult for some to conceptualise, but put simply it is any computing service that is provided over the internet. When you search for something in Google, the words you type are sent via the Internet to a handful of Google’s 4 million computers (servers) which do the work of finding the answers and sending them back to your screen. The computer executing your search request may be located in one of many locations across the globe; you’d never know, and you don’t need to!

Originally built to power Amazon’s own online retail business, AWS has revolutionised the way IT infrastructure and needs are consumed by enterprises. Traditionally a business would purchase and reside all its computer hardware and software on premises (e.g. desktop computers, network servers), requiring up-front expenditure and specialised IT staff to maintain the systems. It is also highly unlikely that an enterprise would ever fully utilise the capacity of its technology infrastructure, with utilisation rates as low as 15%. Cloud computing platforms like AWS provide all the same functionality as a traditional setup but offer a ‘pay as you go’ service which can be accessed seamlessly over the Internet. Users of AWS platform effectively drive full utilisation for every dollar of spend, a far more efficient use of capital. The resulting efficiency gains and cost savings are profound. The analysis below considers the savings under a scenario of a larger scale enterprise database/data centre using AWS vs. traditional (Fig 16).

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The core cloud computing market relevant to AWS was estimated at $25 billion in 2015 and is expected to grow to $83 billion by 2020. To put this in context, total IT spending was estimated to be $2.2 trillion in 2014, of which a third is related to enterprise IT infrastructure. While cloud computing is currently a small fraction of the massive IT spend, as AWS develops more functionality across more IT verticals, it will continue to grow its total addressable market, a market that is expected to be nearly $300 billion by 2020 according to UBS estimates (Fig 17).

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Over the last two decades Amazon has created three remarkable businesses; the retail marketplace, Prime and AWS. All three have significant runways for growth as they roll out globally. Their ingrained customer focus and infrastructure network create palpable barriers to entry.

Article contributed by Watermark Funds:  (VIEW LINK)