The little Echo Dot sitting calmly next to my bed never ceases to surprise the futurist in me. I use it for mundane daily tasks like setting alarms and not so mundane tasks like ten minute meditations and listening to the sounds of a babbling brook while easing in to a deep sleep. Its a very interesting product and I wanted to dig deeper and analyze its strategic value to Amazon and explore how transformative it could be to our daily lives. In this essay I hope to present my analysis with some facts, assumptions and hypotheses.

To understand why Alexa is such a big deal its important for us to dive deep in to Amazon’s core revenue drivers and its overall business model.

Figure 1: Amazon and its key revenue drivers

Amazon has two types of customers: Prime and non-Prime customers. Estimates suggest that there are around 80 million Prime customers in the US and the numbers are growing at a healthy pace. Prime customers are extremely valuable to Amazon because they spend twice as much as non-prime members which means Amazon is constantly trying to convert non-primers to prime. An average prime customer is likely to spend $63,000 on on Amazon over his/her lifetime (See fig.2 and 3). Now imagine 50% of US households signing up for Prime and making all of their purchases on Amazon, the numbers would be truly staggering.

A Prime customer’s average spending is nearly twice the spending of a non-prime member.

Figure 2: Prime user spending and membership growth

figure 2a: Prime users and their spending patters.

Figure 3: Average life time value of a prime customer

Considering how game changing Prime is, its only obvious for other retailers like Walmart or Target to come after them with their own competitive offerings. Walmart acquiring Jet.com and Targets rush to online retailing are all a part of this competitive response but they could barely make a dent in Prime’s expansion. It is incredibly tough for an incumbent player to compete with a transformative player like Amazon because it does things very differently compared to what the traditional retail industry is used to. In their own words —

Customer Obsession: Leaders start with the customer and work backwards. They work vigorously to earn and keep customer trust. Although leaders pay attention to competitors, they obsess over customers.

Amazon’s success in the retail market becomes very clear when it is viewed through the lens of Red ocean vs Blue ocean strategies. Amazon from day one was in the pursuit of creating efficiencies to drive down the costs for the end customer, while in parallel, creating a differentiated customer experience. It’s not very tough for a giant like Walmart to replicate an online shopping store, however it became incredibly tough for Walmart to copy Prime’s two day shipping because it just didn’t make sense to revamp its successful business model. Walmart operated on a model where the customers came to the goods whereas Amazon flipped the model on its head by delivering the goods to the customers. If you were Walmart or Target’s CEO, would you do a sudden 180 degree shift in your business model to compete with Amazon or would you continue to bank on your core strengths like value pricing and network of stores? If you pick the former, would your share holders punish you for the rise in costs they see as unnecessary?

Figure 4: Red Ocean : Blue ocean strategy : : Walmart : Amazon

By making the customers their prime focus Amazon was able to deliver on two key factors: value and convenience

Apart from offering very competitive prices online, Amazon quickly created a good mix of differentiating products and services like video, music, cloud drive, etc for the Prime users to sign up for. On the other hand, Amazon relentlessly worked on cutting the delivery times and started offering same day delivery in large cities which made it very convenient for the Prime users. This created a powerful differentiated value offering that no other retailer was able to compete with, thereby widening Amazon’s moat. Over the years, this resulted in a very differentiated, robust ecosystem that no other retailer was able to copy (see fig 5C). Alexa and Echo — the most recent products in Amazon’s ecosystem are its next big step towards differentiation and business model innovation.

This resulted in a very differentiated, robust ecosystem that no other retailer was able to copy.

Figure 5: Amazon ecosystem Evolution

One of the biggest advantages traditional brick and mortar stores have over Amazon is the presence of sales people who can help you make your purchase. Alexa bridges this gap by being a dedicated shopping assistant available to you at all times. This is yet another 180 degree flip for the retail industry which is traditionally used to customers coming to them for information about their purchases.

Alexa can be used on any compatible device: phones, tablets, computers, standalone devices, you name it! It can easily become the single channel for all purchases in a household. This removes most of the friction in the process of making an online purchase by eliminating the need for a screen from the customer’s workflow. Making an online purchase is now as easy as screaming ‘Alexa buy me some tide..’ while chopping vegetables in your kitchen. Think of all those items you forgot to buy because you are not good at keeping lists or maybe you just forgot, all that is lost revenue for Amazon. It won’t be the case anymore because users can now talk to Alexa and it directly adds it to your cart for you. The more purchases users make successfully the more Amazon’s revenues go up ( see B3 in fig 1). Preliminary data suggests that users with Alexa have increased their spending by 10% (see fig 6b).

The true value of Alexa lies in the omnipresence and user friendliness it brings to a customer’s household.Data suggests that users with Alexa have increased their spending on amazon.com by 10%.

From a strategic standpoint, Alexa is a perfect Horizon 3 product for Amazon. It defends the current core — Amazon Prime like we discussed above. It’s almost impossible for other competitors like Walmart or Target to copy Alexa because it means they will have to make very substantial advancements in Natural Language Understanding (NLU) and Automatic Speech Recognition (ASR). It can also be deployed as a critical differentiator while competing with current market leaders in other large economies; the best example being Flipkart in India.

Alexa also opens up various horizon 2 businesses via its hardware avatars like Echo and Echo dot. In addition, there are numerous possibilities to use Alexa in the fields like healthcare and enterprise— which were previously impregnable to Amazon, and this is just the beginning.

Figure 6a: Amazon and growth horizons. The Alchemy of Growth

The greatest potential for Alexa lies in Amazon’s decision to open up Alexa API to third party services and devices. As I mentioned in my previous article Alexa, Siri and the ecosystems of the future there 5M echos in the market with 6000+ Alexa skills and Amazon was able to break the dreaded ecosystem paradox — users won’t use your products till there are good apps and developers won’t build apps if there is no user base.

Figure 6b: How Alexa increases user spending

Amazon was able to create enough value for the users to start using the device while simultaneously getting the developers excited about building skills for Alexa.This is an achievement of the magnitude of the iOS app store. As a result we are now seeing the ecosystem D in the figure 7 below — Prime users surrounded by a mix of Amazon devices and services, Alexa the blue layer is beginning to wrap around this ecosystem.

Figure 7: Amazon and its Horizon 3 ecosystem

There is also an exciting hardware and devices component to this. By opening up Alexa API to other device makers who build furniture, appliances, smart homes, self driving cars, etc., Amazon has already begun planting the seeds for a thousand flower IoT bloom. Imagine a membership club of atleast 50% households in the US, EU and India making most of their purchases on Amazon. This is the scale of opportunity and transformation Alexa brings to the Amazon ecosystem the future. The revenues Amazon can make from partnering and selling such devices would be staggering; bear in mind that smart home appliances and devices would have been a big revenue stream for Best buy, Ikea, Home Depot, etc in the alternate future.

Figure 7a: The home automation market

In the not so distant future, Alexa may emerge to be the default aggregator for a wide variety of IoT devices and services in a lot of households. To complement Amazon’s core business model it would likely be cheap and widely available a la android. Owning this powerful touch point in customers lives will give Amazon huge competitive advantages like we have never seen before.

Viewed from Ben Thompson’s Aggregation theory lens, there is a high risk of of OS and Device layers becoming irrelevant since most of users life would be centered around the AI layer, especially as AI advances further. It would also be very fascinating to see how competition around this ecosystem would shape up in the long term. To limit this essay I will have conclude it with some open questions that intrigue me:

Figure 8: AI layer has the potential to make the OS layer and apps irrelevant to the user