What's all the fuss about Amazon launching in Australia today?
Surely, it's just a place to order stuff online? We already have one of those with eBay.
Well, not quite. The real implications of Amazon are twofold; first its low-cost business model, and second its willingness to take losses to claim market share.
Low-cost business model – Amazon runs on tiny profit margins. For example, its North American business generated $79.8 billion in sales and just $2.3 billion in operating income (a 2.8% margin) in 2016. By contrast JB Hi-Fi Limited (ASX: JBH) reported $4.1 billion in revenue in its Australian business, and $0.26 billion in operating income, a 6.3% margin.
On this basis (not a perfect comparison), JB Hi-Fi is over twice as profitable as Amazon.
Willingness to take losses to claim market share – Ordinarily, JB Hi-Fi might appear to be the better business because it is so much more profitable. However, this overlooks the willingness of Amazon to take losses on a product to claim market share or give consumers what they want. For example, both the well-known Amazon Prime and Amazon Web Services (AWS) were unprofitable when they began, because pricing was set at a level that was appealing to the consumer.
Prime in the USA currently costs $99 a year and gives unlimited free delivery. Once customers are locked in by free delivery, they tend to order all their products from Amazon, because Amazon tries to list the widest range of goods on its site.
This gives Amazon a significant boost to its shipping volume, and allows it to get scale benefits from its warehouses as well as extract better terms from its suppliers. After a while, better terms allow the company to sell things even cheaper, which in turn attracts more business, which in turn leads to more scale benefits…. After a while, competitors can't keep up.
Also in Australia, very few companies can run huge promotions at a loss for years to build an Amazon-like scale benefit.
JB Hi-Fi Limited and Harvey Norman Holdings Limited (ASX: HVN) probably can't due to their smaller size and debt levels.
Yet Woolworths Limited (ASX: WOW) and Wesfarmers Ltd (ASX: WES) have been quick to see the risks and opportunities, and now have free delivery and click & collect on groceries. With their well-established supplier networks, warehouses, and store locations, they'll be really tough to unseat in this category. However, their margins are also higher than Amazon's, which could prove a concern if Amazon moves into groceries in the next few years.
I personally am doubtful that Amazon will destroy Australian retail or anything like that. However, the company has a culture of aggressive competition, and because of their relatively high margins, competitors have a lot to lose if they are forced to compete on price. It's a space worth watching, but maybe from the sidelines.
