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By now everyone knows, at least at the broadest levels, how and why Amazon has come to dominate online retail: convenient shopping, smart tech investments, and an expanding set of creative business …

By now everyone knows, at least at the broadest levels, how and why Amazon has come to dominate online retail: convenient shopping, smart tech investments, and an expanding set of creative business models. No wonder Amazon is now the world’s most valuable retail brand. In 2011, 13% of all US online retail went through Amazon, and it’s poised to capture more offline sales, too.

Inside the secret sauce that drives Amazon’s market share growth are valuable lessons for multichannel retailers if they want to capture their fair share of growth.

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  • 1. The Secret of Amazon: Lessons for Multichannel Retailers Any use of this material without specific permission of McKinsey & Company is strictly prohibited McKinsey on Marketing & Sales – Slideshare Brief October, 2012
  • 2. McKinsey & Company | 1 Assortment leadershipPrice leadership Amazon's "triple threat" value proposition is eroding traditional retailers' value propositions Category depth Avg. number of SKUs / category (5 categories) 100 random items Price index1 vs. Amazon.com SOURCE: William Blair pricing report, 2011; Wells Fargo SKU analysis, 2011; American Customer Satisfaction Index, 2011 1 Price including sales tax and shipping 2 Non-food and non-club, determined by 2011 revenues Customer experience Experience rating American Customer Satisfaction Index 2011 316 2,125 7X 86 76 13% higher scores 113Top 5 retailers2 105 100 5-13% lower prices
  • 3. McKinsey & Company | 2 Other1 Percent of Margin Total = 6.2 billion Profitable diverse revenue models create lock-in and loyalty while reinforcing Amazon's core business SOURCE: Amazon financials; McKinsey analysis; analyst reports Operating margin2 41 263 29 2 3 1 Includes Advertising and other non-retail revenues 2 Gross operating profit is total sales less cost of sales and fulfillment (marketing, G&A, and technology costs are not subtracted); total margin from 2011 3 Excludes prime purchases made through marketplace vendors to avoid double-counting How models lock-in customers ▪ Amazon web services provides end-to-end e-commerce solutions including 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 sell on Amazon.com ▪ Increases selection, and lowers prices through competition, more than 2M vendors sell ~30M items on marketplace ▪ Amazon's A to Z guarantee improves trust among buyers ▪ For an annual membership fee, Prime gives customers free two-day shipping ▪ Helps Amazon to reach different segments through targeted programs like Amazon Moms and Amazon Students ▪ Prime members spend 2.5-4.0x compared to non-prime members
  • 4. McKinsey & Company | 3 Amazon Prime drives loyalty and supply chain predictability while allowing Amazon more control over the customer experience 825 4,919 572 1,218 6,158 Gross marginStreaming costs 273 Shipping and fulfillment costs COGSMember- ship revenue Incremen- tal sales SOURCE: Analyst and expert interviews; team analysis Economics of Amazon Prime USD Millions
  • 5. McKinsey & Company | 4 0.2-0.4 1.5-2.0 100.0 Optimized inventory control Factory gate Pricing/direct supplier pick-up 1.0-1.5 Efficient outbound fulfillment Average MC retailer cost of online sales Amazon's cost of sales 96.3-97.1 Lower cost structure driven by world-class, high-tech supply chain…InboundOutbound 1 Advanced shipping notices  Pick up 90% items from suppliers, saving shipping charges vs. prepaid  Pick up only 35-40% items from suppliers  20 DCs within 95% of MSAs. Most orders fulfilled through zone 0-1 shipping  Favorable contracts with shippers (20%) cheaper  Only 1-2 DCs for online necessitate use of Zone 3-5 shipping  High shipping cost due to lower volume  Only 20% of items in all DCs, -- reduces inventory by 3-5 days  Track and trace through ASN1 reduces inventory by 1-2 days ▪ Most DCs not designed for stocking products ▪ Online and store systems not integrated Other multichannel retailers SOURCE: Expert interviews; team analysis
  • 6. McKinsey & Company | 5 32 -34 Top 5 retailers1 … and superior working capital management SOURCE: Bloomberg; financial statements; team analysis 42 90 15 16 59 40 Top 5 retailers1 Amazon.com Days inventory Days receivable Days payable Key drivers ▪ Amazon only keeps the fastest moving items in stock in all DCs ▪ Long-tail items are kept in only a few DCs or drop-shipped ▪ Advanced demand estimation technology leads to less inventory ▪ Amazon customers are only allowed to pay by credit/debit card, ensuring fast receivable collection times ▪ Companies with large cash sales (e.g., Walmart) have advantage over Amazon ▪ Amazon agrees to pay many suppliers (book publishers) only after item is sold ▪ Amazon takes 14 days to pay its Marketplace sellers Cash Conversion Cycle (CCC) Days, 2011 1 Non-food and non-club, determined by 2011 revenues If the top 10 retailers had Amazon's CCC, they would collectively save $150B+ in working capital
  • 7. McKinsey & Company | 6 ` Amazon spends on R&D like a tech company … … resulting in breakthrough efficiency and business models Technology spend1 Percent of sales, 2011 Maniacal focus on technology (~3X IT investment over top retailers) has created breakthrough efficiency and business models SOURCE: Financial statements, Jeff Bezos’ letters to shareholders, Team Analysis, ACSI 2010 Technology examples Impact ▪ Amazon invented colla- borative filtering algorithm for recommendations ▪ 35% of sales in 2006 came from recommendations ▪ Automated/email based customer service systems (90% automated vs. 44% for average retailer) ▪ Best-in-class customer satisfaction (ACSI score of 86) ▪ Sophisticated supply chain systems ▪ Best-in-class efficiency reduces COGS by 3-4% ▪ Dynamic pricing algorithm and web crawlers ▪ Intra-day price changes to maintain 5-20% price- leadership over retailers 6 2 +300% Top 5 retailers1 1 Non-food and non-club, determined by 2011 revenues
  • 8. McKinsey & Company | 7 …have made Amazon a go-to search destinationBreakthrough content and search innovations… ▪ 7 million user-submitted reviews in 20091 ▪ 57% of online consumers trust other users on retail websites2 ▪ Amazon supports keyword, barcode, image, and voice search for price comparison and product research What next? Amazon's content and advanced search capabilities have put it at the forefront of product research SOURCE: iConsumer 2011 12 Home improvement 11 Health & Beauty 15 Household products 16 Furniture Electronics 29 DVDs/Videos 40 Video Games 30 Books 49 20 25 20 20 21 12 20 10 1 Jeff Bezos' letter to shareholders 2010 2 Percent of consumers that trust or somewhat trust reviews by source, iConsumer 2011 Where consumers start online research % of respondents Search engine
  • 9. McKinsey & Company | 8 Amazon will further strengthen its "triple threat" value proposition by continuing to eliminate remaining sources of friction in online shopping 3 9 6 11 22 23 27 Easy Returns I don't shop online Human customer service reps No delivery costs Quality of product concerns Immediacy Enjoyment of shopping SOURCE: iConsumer retail survey 2011; U.S. 13+ year-old internet users What if Amazon eradicates every single reason for your customers to go to the store? Percent Example Amazon initiative to address reason… ▪ Amazon is building same-day delivery capability ▪ Selling the Kindle in-store ▪ Partnership with 7/11 ▪ Developing own store ▪ Prime offers free 2-day delivery ▪ Mobile apps allow any shopping experience to become Amazon purchases ▪ Amazon offers free returns for defective products Top reasons consumers shop in-store Amazon is working towards removing 88% of reasons people shop in store
  • 10. McKinsey & Company | 9 Amazon is on track to become… The king of retail … knocking big box stores off price leadership throne with 10% lower prices The next generation convenience multichannel retailer … without any major retail presence Your "anytime, anywhere digital identity" … knowing you better than you know yourself Your “go-to” product search engine … the default destination for all product information The B2B backbone of choice … from your site to their doorstep Your bank account and more … from books to personal finance, travel and beyond
  • 11. McKinsey & Company | 10 www.cmsoforum.mckinsey.comWWW @McK_CMSOForum www.youtube.com/McKinseyCMSOforum marketingandsales@mckinsey.com Nora Aufreiter Nora_Aufreiter@mckinsey.com Kelly Ungerman Kelly_Ungerman@mckin sey.com Josh Leibowitz Josh_Leibowitz@mckins ey.com