So You Want to Compete Against Amazon?

I’ve had Amazon on my mind lately, part of which is due to my reading Brad Stone’s very interesting book, The Everything Store: Jeff Bezos and the Age of Amazon.

I’ve described in earlier blog posts how Amazon is a brutal competitor for brick and mortar merchants due to their large and growing cost advantages and a maniacal commitment (at least most of the time) to having the lowest prices anywhere. (You can read more about it here.) These same drivers also make Amazon a heavyweight competitor for e-commerce companies as well.

Much attention has been paid to the concept of “show-rooming” in the context of brick and mortar stores, where customers use their smart phones to compare the cost of a product on a physical store’s shelf against online competitors—typically Amazon. But show-rooming is also a fact of life for e-tailers due to the ease of comparing online prices. As a result, Amazon is a monster competitor for online merchants as well.

Amazon enjoys scale economies far beyond that of their online competition that they can use to support hyper-aggressive prices and fast, cheap shipping. Here is a simple illustration of their scale, using data from Internet Retailer:

Amazon is larger than the next dozen largest e-tailers—COMBINED! Its resulting scale advantages are staggering. And they aggressively re-invest the benefits of this scale into even lower prices and faster, cheaper shipping that in turn lead to growth and further scale advantages. When we consider an e-commerce investment at a16z, we always strive to carefully evaluate the risk of competition from Amazon. They’re not just a heavyweight—they’re the heavyweight champion of the world!

So how do you compete with Amazon? Here are some strategies that we’re seeing in the market from both offline and online retailers. Not all are mutually exclusive—i.e., many companies deploy multiple strategies:

Sell differentiated product:

Amazon’s sales skew very heavily towards “hard-lines”, things like media, electronics, home & garden, and toys. Most best-selling hard-line products are produced by large manufacturers who market them heavily and distribute them broadly through multiple retail channels. They are essentially commodities, identified by a standardized Universal Product Code (aka, U.P.C.). An example is a Canon digital camera; once Canon’s ads convince you that you might want a Canon camera, you know you can shop for it pretty much anywhere. And for most commodities, price is the key differentiator. Consumers know that Amazon almost always has the lowest prices, along with free and fast shipping.

Many retailers try to “hit ‘em where they ain’t” and sell in categories where Amazon is less dominant. Soft-lines is an obvious one; while Amazon is trying to build up this business, they have not achieved anywhere near the dominance that they have on the hard-line side. Online companies like NastyGal and Zappos (before their acquisition by Amazon) and offline companies like Nordstrom and Neiman Marcus have successfully pursued soft-line strategies and have managed to weather competition from Amazon relatively well. Another example is home improvement retailers, where a combination of products that “I need today” and/or bulky or heavy items are less suited to online distribution.

A related strategy is to feature products from companies that typically are not distributed or searched for on Amazon. a16z has two investments in companies that primarily sell goods from a long tail of designers that lack extensive national distribution. zulily does this in kids’ and moms’ apparel, and Fab does this in design. These designers’ unique products are typically not found through Amazon’s search engine as they lack broad awareness.

Develop your own products:

Many retailers seek to compete with Amazon by developing their own products. These products can be largely insulated from direct price comparison as they are proprietary and the producing company can elect not to have them sold by other online retailers. A number of the best performing offline chains pursue this strategy including Lululemon and Victoria’s Secret. It is also being pursued by a new breed of online retailers such as Chloe & Isabel in jewelry, Julep in cosmetics, ShoeDazzle in women’s shoes and Poppin in office goods (note: Andreessen Horowitz is an investor in Julep and ShoeDazzle). While it’s clearly much more work to design and source your own product, retailers who do are often rewarded with higher gross margins as they both cut out expensive middlemen and avoid head-to-head price competition.

Merchandise product differently:

Amazon.com at its core is a search engine for products. They are strongest where consumers know pretty much exactly what they are looking for, and the predominant way to find that on Amazon is the ubiquitous search box. Merchandising on Amazon is almost completely algorithmic—things like others searching for ‘x’ also looked at ‘y’ and ‘z’. I know of very few folks who browse Amazon in the traditional merchandising sense of the word.

One tactic a number of companies are employing to compete with Amazon is to build a great browse experience, showing consumers a targeted assortment of attractively displayed products. Offline retailers historically have done this through beautiful window displays and their in-store end caps. And a new breed of online merchants is doing this, too, although it’s often referred to as “curation”. And price is not typically top of mind during these impulse purchases.

Deploy alternative distribution strategies:

A number of online retailers are trying to put themselves directly in front of consumers before they think to consider searching for that product on Amazon. “Flash sales” companies like One Kings Lane and The Clymb send a daily email that merchandises a compelling assortment of goods at attractive prices. Other companies like Birch Box or Trunk Club are employing a subscription model that sends you a highly curated selection of product, typically on a monthly basis.

Leverage unique advantages:

Brick and mortar retailers are disadvantaged with respect to costs relative to Amazon due to higher real estate, labor and inventory costs. But a number of merchants are trying to flip this disadvantage on its head and leverage their network of local stores. Wal-Mart for a while has enabled consumers to pick up online orders at their local store on the day it was ordered. Last holiday season, they launched a test of same-day delivery for online orders from their stores in a number of cities. Both take advantage of Wal-Mart having inventory in geographically dispersed stores. And in a creative twist, they are considering crowdsourcing their local, same-day delivery to their customers, who would receive discounts on their shopping bill in exchange for their efforts. Alternatively, Williams-Sonoma has used both their store locations and their catalogs to aggressively build their online business. They have been willing to cannibalize themselves, believing rightly that someone else will do it if they don’t. Over 40% of their revenue now comes through the online channel.

It’s clear that e-commerce is highly advantaged vis-à-vis offline retail and will continue to gain share. The more interesting question to me is how e-commerce companies will compete with the heavyweight champ Amazon. Amazon will always be able to pummel other e-tailers on price and probably on shipping as their scale advantages are virtually unassailable. Companies that hope to compete with them successfully have to adopt different tactics. Similar to when Cassius Clay (now Muhammad Ali) prepared to fight the then reigning heavyweight champion Sonny Liston, they’re going to need to “float like a butterfly, sting like a bee”!