EPISODE 274

Amazon Rising: Power and Seduction in the Age of Amazon

Episode Summary

It is hard to find a company more customer-centric than Amazon, not only in America but globally. The company’s “obsession” with client satisfaction drives its constant innovation, offering great deals and benefits for its Prime members, relentless price competition policy, efficiency, and sometimes threatening behavior. They see no boundaries, from healthcare to satellites; Amazon is constantly expanding, growing, and competing for a share of the market it lays its eyes on.  

Steve Shallenberger: Welcome to all of our Becoming Your Best podcast listeners wherever you might be in the world. We are so honored to have you with us today. This is your host, Steve Shallenberger and we have an amazing guest with us. He is a visiting scholar at George Washington University Institute for Public Policy and the President of Incumetrics Inc., a data and program evaluation consultancy that serves clients seeking to understand the intersection of technology, innovation, economics, and politics. And man, that’s a boatload right there. Welcome, Dr. Robin Gaster.

Dr. Robin Gaster: Thank you so much for having me.

Steve Shallenberger: Oh, yeah. 

Dr. Robin Gaster: I’m delighted to be here.

Steve Shallenberger: Well, thank you so much. And before we get started today, I would like to tell you a little bit more about Robin, that will help you appreciate our interview today and the great resource he is. From 2004 to 2014 Dr. Gaster was a lead researcher and principal writer on a 13-volume series of reports published by the National Academies of Science and Engineering on the US government’s premier innovation program for small businesses, as well as for a major report on the Manufacturing Extension Partnership. And those reports have been the gold standard for program assessments and were the basis for major congressional adjustments to those programs. And Dr. Gaster’s work has been published in Foreign Policy and the Atlantic, which is an amazing magazine. He’s edited a book on International Telecommunications and testified before Congress, and he is also the author – and this is going to be a lot of the subject of our discussion today – OF Behemoth, Amazon Rising: Power and Seduction in the Age of Amazon, which was released this month. So, wow, what a topic, right Robin?

Dr. Robin Gaster: Yes, it’s certainly a lot to talk about, that’s for sure.

Steve Shallenberger: Now, before we dive into this, our listeners I know that are interested in your background, and especially including any turning points maybe in your life that’s had a significant impact on you, and how did you end up where you are today?

Dr. Robin Gaster: A long and winding road is the answer. I grew up in England and I went to college in England, I spent a year playing poker there and driving the equivalent of an Uber. And then I went to the University of California at Berkeley and did a Ph.D. And after that, I tried being a college professor full time, decided that was not for me, so after that, I worked at a couple of big places: the International Monetary Fund, and I was a congressional fellow for the Office of Technology Assessment at the US Congress. And after I did all that I decided I had enough of large companies and started my own consulting company in 1991, and I’ve been doing that ever since with small diversions to start various businesses. I am a serial entrepreneur, though not necessarily a successful serial entrepreneur. So, along the way, I’ve been able to do I think interesting work in analysis in places for organizations that I found interesting and mostly they let me get on with it. So, that was sort of, that’s the main story. I eventually moved to Washington in 1986, the Washington area, I’ve been here ever since. It’s an interesting place to do policy and analysis, that’s for sure.

Steve Shallenberger: Oh, indeed. And you have been very busy. 

Dr. Robin Gaster: Yes, I’ve been busy. 

Steve Shallenberger: And I love this subject we’re going to talk about today. So, thanks for taking a little bit of time on your background, that’s so interesting. I was raised in the San Francisco Bay Area just north of Berkeley in Vallejo, California. 

Dr. Robin Gaster: Sure.

Steve Shallenberger: That’s an education in itself, isn’t it? 

Dr. Robin Gaster: It certainly is. It was an extreme culture shock coming from London to the Bay Area, I will say that.

Steve Shallenberger: That’s great. Okay, well, let’s just dive into Amazon because this is going to be such an interesting discussion today and I’m sure that our listeners are not usually used to listening to. So, let’s start with Amazon. Why is Amazon losing money in internet retail? And what does that mean for Amazon and its competitors? 

Dr. Robin Gaster: Yeah, that’s an interesting thing. Amazon, of course, doesn’t admit that it is losing money in internet retail. It publishes its accounts in such a way that it’s very difficult to figure it out. It took me a long time. I should say upfront that this is based on a detailed analysis of Amazon’s 10k filings and some industry data and some assumptions, which I lay out very clearly in the book. You have to kind of make some assumptions about where Amazon’s expenses should really be allocated. That said, my conclusion is that Amazon lost more than $40 billion last year in its retail operations. And it is a question you would think that owning its own platform and being as big and growing as fast as it is that Amazon must be making money hand over fist. So, I have a number of explanations.

Steve Shallenberger: Just a pause. I know I am in total shock just thinking about this idea, so I’m so interested in what you’re going to say next.

Dr. Robin Gaster: Let me say I was in shock too. I was not expecting to find this. I was just doing sort of due diligence to try and understand Amazon’s money flow. So, it came as a shock. So, why would Amazon be losing money? So, let me give you a few answers in a minute, but let me ask you a question. Have you ever managed a supply chain, one supply chain for one product? 

Steve Shallenberger: Oh, yeah. Yeah, sure. 

Dr. Robin Gaster: Yeah. So, you know how difficult it is to manage. 

Steve Shallenberger: Of course. Yeah. 

Dr. Robin Gaster: Right. Amazon is managing at least 12 million and probably 20 million supply chains, right? So, this is very, very difficult to do well, at such a scale. One of the reasons is that you have to automate a bunch of it. There’s no conceivable way that they can have enough humans to do this. But as you know, supply chains are difficult – things go wrong, people get the wrong goods, it’s hard to maintain quality. So, item one, Amazon has extended itself tremendously. It’s extended its catalog and I believe that managing its supply chain is very difficult, so that’s item one. Item two, you can imagine that Amazon on its own platform is the great white whale. It’s enormous and it is surrounded by 2 million sharks. Those are the other sellers on its platform, the independent sellers. It opened its Marketplace around the turn of the century, and since then, it’s grown very fast. And it’s a very, very successful marketplace, as I’m sure your listeners know. So, it’s attracted 2 million other sellers. So, there are people there, specializing in beach umbrellas and hockey tables, and shoes for people’s left feet only. It’s very filled with niche sellers, and I think those niche sellers know more about their particular market than Amazon does. Amazon has the data, they have the AI, they have the technology, but I’m not convinced that they know those niche markets as well as the niche sellers. That’s two things. The third thing is that over the past few years, as again you may be aware, Amazon has made a tremendous effort to bring sellers from China directly into the US. It has aggressively recruited them and it helps by providing a direct channel for shipping goods all the way here. It runs its own freight forwarding business from China, it will collect from the factory and deliver in the US. That makes it very easy, it makes it possible even. I mean before this, if you were a seller in China and you wanted to get goods to the US, you would really have no direct way. But the reality then is Amazon is effectively disintermediating itself. Those sellers are people who used to sell to Amazon or possibly still do sell to Amazon, as Amazon then resells the product. But those products can also go directly onto the Amazon platform from China, they don’t need to go through Amazon anymore. So, Amazon faces a price disadvantage to which it responds by cutting prices, but that has driven it into the red. So, there are three hypotheses of why Amazon might be losing lots of money in retail.

Steve Shallenberger: So, Robin, are you saying that on their 10k, they show they’re making money, but if you really dig down into the weeds, it’s a different picture?

Dr. Robin Gaster: It’s cleverer than that. So, they divide their revenues into five different segments. So, there’s Amazon retail, there are the fees they get from Marketplace, there are the subscriptions they get from Prime, there are the advertising revenues they get from their Marketplace vendors – which we can talk more about sometime later – and then there’s Amazon Web Services, which is the leading provider of internet infrastructure in the world. 

Steve Shallenberger: Right. Yeah, it’s a big deal. 

Dr. Robin Gaster: So, you have these five segments and they report revenues, but they don’t report costs by segment. So, they have completely different categories for costs. So, you have to find ways to cross-reference the costs to the revenues to understand whether there’s really a profit being made here or not. And this has some implications because I think you will probably have read and your listeners will have read that AWS is the primary source of profits for Amazon. It’s not true. So, if you dig through it, what you find is this – and I’m going to use 2019 numbers because those are more complete, I haven’t finished the analysis for 2020. So, in 2019, Amazon reported $14 billion in operating income. It’s a good number. AWS reported $9 billion, so AWS accounts for 60% of Amazon’s profits, right? 9 out of 14. However, Amazon retail lost 32 billion that year. So, if you take only the profitable segments of Amazon, and ignore the loss-making part for the moment, the profitable part made a total of 44 billion. So, in fact, AWS accounts for about 20% of Amazon’s true profits, excluding the losses in Amazon retail. You know, I talk to AWS folks all the time, and they think they are the most important part of Amazon, there’s absolutely no doubt about it, they are sure of it and they keep telling me, but it’s because of the profit. But in fact, they’re the tail, the dog is in retail, in Marketplace. Marketplace profits were twice as high last year as AWS.

Steve Shallenberger: Well, there’s so much to dig into on this. And one of the questions that come to mind if they’re not making it on their internet retail where are they making it at all?

Dr. Robin Gaster: Okay. Yep. So, they made about $27 million last year in their Marketplace. So, the Marketplace has these 2 million sellers, there’s some big companies there, it accounts for about 60% of the sales on the overall Amazon platform. So, the platform is about 40% of Amazon’s own retail business, and 60% leasing space to other retailers to compete. Okay, and on that 60%, Amazon takes 15% commission, it charges about 7.5% in advertising, it charges money – though it’s kind of a wash operationally – for fulfillment. So, the money coming in comes from Marketplace, advertising, Prime, and AWS. All of those generate about $10 billion or more – Marketplace is much more, Prime is much more. So, there are these multi-billion dollar businesses that generate at least 10 billion in operating income. And as against that, you have this sort of hole in the middle of the business, which is Amazon retail. And it’s sort of understandable. I mean, it was the origins of the business, it’s part of their culture to be the ‘everything store’ – and originally, the everything store meant trying to stock everything. And I think they found a model where they can maintain what they do. They’re not under any tremendous pressure, obviously, to increase profits. Wall Street seems pretty happy with them these days. And in any case, Amazon doesn’t really care about Wall Street. So, they are making changes to deal with this, but they’re slow and if they were under more pressure then they could solve this more quickly, but they haven’t had to.

Steve Shallenberger: Okay, so Robin, what are Amazon’s five defensive moats? And how do they make Amazon unbeatable?

Dr. Robin Gaster: Yeah, good question. Good question. So, when you go online, what are you looking for really? First of all… Actually, before you go online, the first thing is you have to think that you’re going to get a fair deal online in some way. 

Steve Shallenberger: Right, absolutely.

Dr. Robin Gaster: You’re not going to get ripped off. 

Steve Shallenberger: Yeah. 

Dr. Robin Gaster: And I think it was Amazon, who really figured this out early on, at the start of the millennium. They gave enough guarantees to users and they followed through with those that Amazon’s reputation quickly became very good. They are always either the most trusted or the second most trusted company in America. 

Steve Shallenberger: Yeah, indeed. 

Dr. Robin Gaster: And so, on that basis of trust, you’re looking for something. Well, there are lots of different reasons why you might buy one place rather than another. So, let’s explain why it’s going to be Amazon. First off, they have the best selection. You pretty much know that if you’re looking for something, you’re going to find it there. And if it’s not exactly from Amazon, it’s from the third parties, Amazon still guarantees that it’s going to be what you want. So, the catalog is enormous. I mean, a large Walmart carries 100,000 items; Amazon’s catalog is now rapidly approaching 500 million items. So, you can find everything. I mean, technical things that you wouldn’t even imagine finding in a store you can find on Amazon. So, they managed to build a tremendous catalog. 

Dr. Robin Gaster: Second, starting around the turn of the century again, they committed to low prices. They make every effort not to be undersold. I don’t believe that Amazon has the lowest price on every good, I just don’t believe that, I found lower prices elsewhere myself. Well, what they have is a low-enough price, unless it’s an expensive item. If you’re a Prime member – and we’re going to come to that next – if you’re a Prime member, why bother? I mean, I can go find a cable or a heater, or maybe a vacuum somewhere else for maybe 3 or 4 dollars less, but it’s not worth the effort. And it comes without all those Amazon trust guarantees. So, all Amazon has to do is to make sure that its price is competitive, and they do that. And obviously, for their own business, they do that quite often by simply pricing below cost. So, you have good prices, you have an excellent selection, then you have Prime. 

Dr. Robin Gaster: Prime was a tremendous and remarkable achievement, Prime took the notion of a Buyers’ Club and instead of saying, “Well, that’s the price to get in the door”, like Costco – you know, you get in the door, you buy your stuff, that’s great, they have very low price, terrific. Prime is not like that. Prime gets you in the door because you get good deals that are special to Prime on Prime Day and other places. But that’s just the start. Amazon is filled with ways in which it lavishes attention on its Prime members. It gives you great entertainment, you can do gaming, it gives you special access to its wardrobe functions. I mean, the list is long, there’s a whole chapter on it in the book. And it’s a long list where Amazon is constantly showing you its love for you. It really wants you to believe that being a Prime member is a great thing and it’s a commitment because you’re putting your money in upfront, $119 bucks a year, and in exchange, you get all these benefits. But the real thing you get is fast, free shipping. And that means that you have every incentive to use Amazon as often as possible because the more you ship, the better the deal is. So, Prime was a great idea. I just want to go back to Marketplace for a second because nowadays marketplaces are all over the internet and it’s no big deal. But if you go back to when Amazon started doing Marketplace around 2000, 1998, or thereabout, this was a strange idea.

Steve Shallenberger: Oh, Robin, can you just describe what Marketplace is?

Dr. Robin Gaster: Yeah. The Marketplace is if you want to sell something, you can set up a store on Amazon, you can sign in and become a seller on Amazon, it’ll take you about an hour. There’s nothing to it, minimal money upfront and you can sell to Amazon’s 120 million US Prime members just like that. 

Steve Shallenberger: Okay. 

Dr. Robin Gaster: Think about this. This is like Macy’s saying to Bloomingdale’s, “Hey, you want to take some space in my store? Come right in. We’ll compete. I don’t mind.” That would never happen, right? 

Steve Shallenberger: Yeah. Wow. Okay.

Dr. Robin Gaster: So, Amazon just opened the doors and said, “Sellers come on in. You can compete direct head-on with us and we’ll give you a fair shake.” And to a reasonable extent, that is true. There are problems. But that’s a remarkable insight that this was the way to extend the catalog far beyond anything that Amazon could do and to provide constant downward pressure on prices by having lots and lots of people competing to sell similar goods. 

Steve Shallenberger: Yeah, fascinating. 

Dr. Robin Gaster: So, Marketplace was brilliant. Prime meant that nowadays, Amazon has 120 million Prime members in the US. There are only 125 million US households, so almost everybody has Prime. In the UK, I just saw 94.8% of UK households buy from Amazon. They are ubiquitous, so if you’re a seller, where do you go? 

Steve Shallenberger: Sure. Yeah, the biggest marketplace in the world right there.

Dr. Robin Gaster: Right. And if you want to sell to American customers, you’d better be on Amazon. I know Shopify exists and we can talk about Shopify, but you have to come to Amazon. So, you can see the catalog draws in the customers, the customers draw in the sellers, the sellers extend the catalog. And the whole thing is lubricated by Amazon’s extraordinary logistics system. And I think the logistics are another brilliant insight. So, in 2000 or thereabout, Amazon’s logistics system was collapsing, they couldn’t handle the growth. It was growing like crazy and every Christmas was worse than the last one. From a management perspective, what is the obvious thing to do? It’s to outsource, right? You call UPS and you say “You do it. It’s not a core function.” Who would have thought that logistics was a core function of a small online bookstore? I mean, it’s a ridiculous idea, but in fact, that’s when Amazon decided. They decided in 2000, that they were going to own their own logistics and they spent 20 years pouring all their profits into building facilities and improving their software and building AWS, which was designed to serve their retail side. So, now, they have a logistics system that is unmatched in the US. I mean, you can’t get a package delivered by UPS overnight, to your house, for nothing effectively, right? I mean…

Steve Shallenberger: Yeah, right. 

Dr. Robin Gaster: So, the logistics part is like they spent 20 years building a wall around their business because nobody can match that now. 

Steve Shallenberger: Yeah, right. 

Dr. Robin Gaster: And even Walmart really can’t think about it, it’s too expensive, it would take too long. So, what you have then, is this relationship between sellers and customers, and Amazon that is deeply lubricated by a remarkably efficient delivery system. So, you want something here today, it’ll get here today; you might have to pay some but Amazon hopes that soon you won’t have to. Same-day delivery is their holy grail. So, you can see how these pieces all work together.

Steve Shallenberger: Yeah, absolutely amazing. That’s why they’re formidable, aren’t they? Because of those factors.

Dr. Robin Gaster: Well, they’re formidable because of that, but also because they see no boundaries. I find this fascinating. If you look at most big companies nowadays anyway, there have been conglomerates in the past, but mostly they kind of stick to their knitting. I mean, they may get into adjacent markets that are close by. So, Ford might get into rental cars or it might build buses or something like that. Amazon is not like that at all. They simply don’t see any natural boundaries. So, it’s absolutely clear, for example, that they’re getting into healthcare, but they’re also getting into satellites. This is a company whose vision is “To be the most customer-centric company on Earth” and whose leader has said a number of times, and I believe him, “Your margin is my opportunity” because Amazon doesn’t need to make a profit in the areas that it goes into. It just needs to grow.

Steve Shallenberger: Well, we probably only have time for one or two more questions. I’ve had two that have been on my mind. So, why is Amazon the world’s most innovative big company?

Dr. Robin Gaster: Oh, crikey. That’s, that’s a whole…

Steve Shallenberger: So, let’s budget our time, say three minutes on that. 

Dr. Robin Gaster: Okay. 

Steve Shallenberger: And then three minutes on a biggie I have at the end.

Dr. Robin Gaster: Okay. So, three minutes on that. The book goes into this in detail, but basically, it’s partly culture. Amazon has deliberately developed a culture that encourages innovation and demands innovation and forces innovation in certain ways. So, partly it’s that. And every large organization says that they’re an innovative disruptive entity, but in fact, Amazon’s culture really drives that. The second is the process; they have a number of ways of introducing new ideas that I think are pretty radical and seem to work really well. You can find out more about those in the book. The third is structure. What they’ve done is build innovation around thousands of small teams. Every company says they have small teams, and that it’s the teams that are able to do things. It’s not really true for most companies. Teams get to work within the structure of divisions and within whatever exists already is pretty hierarchical. Amazon has managed to find a balance between releasing the innovative capacity of teams, facilitating it, and at the same time directing it towards the needs of the larger organization. I think that balance is quite remarkable, and that’s to do with the structure and the resources that Amazon has to offer. So, it’s probably less than three minutes, but that’s it.

Steve Shallenberger: Okay, well, that’s a good one. And how do they encourage this innovation? How do they make this part of a culture-process?

Dr. Robin Gaster: Amazon is a unique company, and one way that it’s unique is that it selects for a certain kind of people, not necessarily in the warehouses, but in its white-collar workers. It is best understood as an organization like the Jesuits or the Marines. That is, most big organizations just want compliance. They want you to do what the rules kind of say, and stay within the lines and more or less follow the general herd if you like. Amazon has absolutely no interest in that. They want commitment. They want you to believe in the mission, to drink the Kool-Aid, and to see every problem as an opportunity to do something new and exciting. And so, that part of the culture is very, very powerful. It also brings its own problems because it’s obsessive in the sense that there is one overriding directive, which is to serve the customer, to be obsessed by the customer – and Amazon says that quite directly that they’re customer-obsessed. But once you set up any one directive like that, as the Prime Directive around which everything else flows, it’s very easy to justify pretty much anything as being good for the customer. And I think Amazon’s problems come because it’s now too big to ignore the fact that it is not so good for many of the people on the production side, in the warehouses, on the platform. They don’t matter fundamentally. This is an unbalanced company, but it is really pro-innovation.

Steve Shallenberger: Okay, here’s the last question, then we’ll wrap it up. So, what can we expect from Amazon in the next 10 years and beyond? What’s it going to look like? Like, in two minutes.

Dr. Robin Gaster: All right, well, it probably won’t look exactly like this. A few things seem to be obvious and a few things are speculative. Obvious things, I think it will retreat from retail. I think that is to say it will shift more and more of its goods onto the platform. It can solve the problem by eliminating a good chunk of its unprofitable products and I think it will do that over the next few years, maybe quicker than that. So, that’s item one. It will keep trying to grow the Marketplace, that’s for sure because that’s a big cash cow for them. Two, yes, definitely getting into healthcare. I see lots and lots of opportunities there and I expect Amazon to be a large player in healthcare 10 years from now in lots of different directions. 

Steve Shallenberger: Okay. 

Dr. Robin Gaster: Item three groceries. They’re getting into groceries now and I think this is just going to turn out to be a mistake. I think this is a high cost, low margin, difficult environment in which there are very well-established competitors and profit margins are minimum. There’s no place for Amazon to go there.

Steve Shallenberger: Yeah, talk about challenges and supply chains.

Dr. Robin Gaster: Yeah, exactly. So, they’re developing some kind of cool technology there, Amazon Go and all that, and no doubt they’re licensed that out, but I don’t, I can’t, I don’t know. I mean, you tell me why they would be doing this, it makes no sense to me. So, that will probably be the thing that I get wrong in this short series of predictions. Will they still be the dominant platform 10 years from now? That’s a really good question. In the US, yes. In the rest of the world? No.

Steve Shallenberger: Okay, well, now what can our listeners take from this? Any final tips you’d like to leave with our listeners? 

Dr. Robin Gaster: Well, definitely buy the book, first of all. 

Steve Shallenberger: Okay, good job.

Dr. Robin Gaster: I think it is absolutely worth your while, if you’re in business, trying to understand how Amazon does what it does. It is clearly the most remarkable company in America, with the possible exception of Tesla, but even then, I think, actually, there’s no comparison because Amazon is in so many different things. And trying to understand what it is I think can pay enormous benefits.

Steve Shallenberger: Okay, well, that’s a big deal. We’re all affected by it one way or the other. So, this has been a good overview. How can people find out about what you’re doing, Robin?

Dr. Robin Gaster: Well, they can go to my website at incumetrics.com, or they can search for the book, Behemoth, Amazon Rising. It’s available at Amazon, of course, and other bookstores as well.

Steve Shallenberger: Well, that’s great. Well, thank you so much for your time today, it’s been a delight, it’s been very interesting. And thanks for being part of our show.

Dr. Robin Gaster: Oh, you’re very welcome. It’s been a great conversation.

Steve Shallenberger: Yeah. And we wish you all the best. And to all of our listeners, you’re so amazing. We’re grateful for the chance to partner together with you and sharing ideas and becoming our best and having an influence on all of those that you associate with. So, this is Steve Shallenberger with Becoming Your Best Global Leadership, wishing you a great day.

Steve Shallenberger

Steve Shallenberger

Founder, Becoming Your Best

CEO, executive, corporate trainer, and community leader.

Robin Gaste

Robin Gaste

President, Incumetrics

Founder, expert in technologies and innovation, and author. 

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