Amazon's secret sauce

The Secret of Amazon:Lessons forMultichannel RetailersAny use of this material without specific permission of McKinsey & Company is strictly prohibited

McKinsey & Company | 1Assortment leadershipPrice leadershipAmazons "triple threat" value proposition is eroding traditionalretailers value propositionsCategory depthAvg. number of SKUs / category(5 categories)100 random itemsPrice index1 vs. Amazon.comSOURCE: William Blair pricing report, 2011; Wells Fargo SKU analysis, 2011; American Customer Satisfaction Index, 20111 Price including sales tax and shipping2 Non-food and non-club, determined by 2011 revenuesCustomer experienceExperience ratingAmerican Customer SatisfactionIndex 20113162,1257X867613% higherscores113Top 5 retailers2 1051005-13% lowerprices

McKinsey & Company | 2Other1Percent of MarginTotal = 6.2 billionProfitable diverse revenue models create lock-in and loyalty whilereinforcing Amazons core businessSOURCE: Amazon financials; McKinsey analysis; analyst reportsOperatingmargin24126329231 Includes Advertising and other non-retail revenues2 Gross operating profit is total sales less cost of sales and fulfillment (marketing, G&A, and technology costs are not subtracted); total margin from 20113 Excludes prime purchases made through marketplace vendors to avoid double-countingHow models lock-in customers▪ Amazon web services provides end-to-end e-commerce solutionsincluding hosting, web design, search technology, and data storage▪ Content strategy is centered around "cloud" powered by AWS▪ Marketplace, introduced in 2000, allows third-party vendors to sellon Amazon.com▪ Increases selection, and lowers prices through competition, morethan 2M vendors sell ~30M items on marketplace▪ Amazons A to Z guarantee improves trust among buyers▪ For an annual membership fee, Prime gives customers free two-dayshipping▪ Helps Amazon to reach different segments through targetedprograms like Amazon Moms and Amazon Students▪ Prime members spend 2.5-4.0x compared to non-prime members

McKinsey & Company | 3Amazon Prime drives loyalty and supply chain predictabilitywhile allowing Amazon more control over the customer experience8254,9195721,2186,158Gross marginStreamingcosts273Shipping andfulfillment costsCOGSMember-ship revenueIncremen-tal salesSOURCE: Analyst and expert interviews; team analysisEconomics of Amazon PrimeUSD Millions

McKinsey & Company | 40.2-0.41.5-2.0100.0Optimized inventorycontrolFactory gatePricing/directsupplier pick-up1.0-1.5Efficient outboundfulfillmentAverage MC retailercost of online salesAmazonscost of sales96.3-97.1Lower cost structure driven by world-class, high-tech supply chain…InboundOutbound1 Advanced shipping notices Pick up 90% items fromsuppliers, saving shippingcharges vs. prepaid Pick up only 35-40%items from suppliers 20 DCs within 95% of MSAs.Most orders fulfilled throughzone 0-1 shipping Favorable contracts withshippers (20%) cheaper Only 1-2 DCs for onlinenecessitate use of Zone3-5 shipping High shipping cost dueto lower volume Only 20% of items in all DCs, --reduces inventory by 3-5 days Track and trace through ASN1reduces inventory by 1-2 days▪ Most DCs not designedfor stocking products▪ Online and storesystems not integratedOther multichannelretailersSOURCE: Expert interviews; team analysis

McKinsey & Company | 532-34Top 5 retailers1… and superior working capital managementSOURCE: Bloomberg; financial statements; team analysis429015165940Top 5 retailers1Amazon.comDaysinventoryDaysreceivableDayspayableKey drivers▪ Amazon only keeps the fastestmoving items in stock in all DCs▪ Long-tail items are kept in only a fewDCs or drop-shipped▪ Advanced demand estimationtechnology leads to less inventory▪ Amazon customers are only allowedto pay by credit/debit card, ensuringfast receivable collection times▪ Companies with large cash sales(e.g., Walmart) have advantage overAmazon▪ Amazon agrees to pay manysuppliers (book publishers) onlyafter item is sold▪ Amazon takes 14 days to pay itsMarketplace sellersCash Conversion Cycle (CCC)Days, 20111 Non-food and non-club, determined by 2011 revenuesIf the top 10 retailers had Amazons CCC, they would collectively save $150B+ in working capital

McKinsey & Company | 6`Amazon spends on R&Dlike a tech company …… resulting in breakthrough efficiency andbusiness modelsTechnology spend1Percent of sales, 2011Maniacal focus on technology (~3X IT investment over top retailers)has created breakthrough efficiency and business modelsSOURCE: Financial statements, Jeff Bezos’ letters to shareholders, Team Analysis, ACSI 2010Technology examples Impact▪ Amazon invented colla-borative filtering algorithm forrecommendations▪ 35% of sales in 2006 camefrom recommendations▪ Automated/email basedcustomer service systems(90% automated vs. 44% foraverage retailer)▪ Best-in-class customersatisfaction (ACSI scoreof 86)▪ Sophisticated supplychain systems▪ Best-in-class efficiencyreduces COGS by 3-4%▪ Dynamic pricing algorithmand web crawlers▪ Intra-day price changesto maintain 5-20% price-leadership over retailers62+300%Top 5 retailers11 Non-food and non-club, determined by 2011 revenues

McKinsey & Company | 7…have made Amazon a go-to search destinationBreakthrough content andsearch innovations…▪ 7 million user-submittedreviews in 20091▪ 57% of online consumerstrust other users on retailwebsites2▪ Amazon supportskeyword, barcode,image, and voice searchfor price comparison andproduct researchWhat next? Amazons content and advanced search capabilities haveput it at the forefront of product researchSOURCE: iConsumer 201112Home improvement 11Health & Beauty 15Household products 16FurnitureElectronics 29DVDs/Videos 40Video Games 30Books 4920252020211220101 Jeff Bezos letter to shareholders 20102 Percent of consumers that trust or somewhat trust reviews by source, iConsumer 2011Where consumers start online research% of respondentsSearch engine

McKinsey & Company | 8Amazon will further strengthen its "triple threat" value proposition bycontinuing to eliminate remaining sources of friction in online shopping39611222327Easy ReturnsI dont shop onlineHuman customerservice repsNo delivery costsQuality ofproduct concernsImmediacyEnjoyment ofshoppingSOURCE: iConsumer retail survey 2011; U.S. 13+ year-old internet usersWhat if Amazon eradicatesevery single reason for yourcustomers to go to the store?Percent Example Amazon initiative to address reason…▪ Amazon is building same-daydelivery capability▪ Selling the Kindle in-store▪ Partnership with 7/11▪ Developing own store▪ Prime offers free 2-daydelivery▪ Mobile apps allow any shoppingexperience to become Amazonpurchases▪ Amazon offers free returnsfor defective productsTop reasons consumers shop in-storeAmazon isworkingtowardsremoving88% ofreasonspeople shopin store

McKinsey & Company | 9Amazon is on track to become…The king of retail … knocking big box storesoff price leadership throne with 10% lowerpricesThe next generation conveniencemultichannel retailer … without any majorretail presenceYour "anytime, anywhere digital identity"… knowing you better than you know yourselfYour “go-to” product search engine … thedefault destination for all product informationThe B2B backbone of choice … from yoursite to their doorstepYour bank account and more … from booksto personal finance, travel and beyond

McKinsey & Company | 10www.cmsoforum.mckinsey.comWWW@McK_CMSOForumwww.youtube.com/McKinseyCMSOforummarketingandsales@mckinsey.comNora AufreiterNora_Aufreiter@mckinsey.comKellyUngermanKelly_Ungerman@mckinsey.comJoshLeibowitzJosh_Leibowitz@mckinsey.com

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Amazon's secret sauce

by McKinsey Chief Marketing & Sales Officer Forum on Oct 19, 2012

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