Beyond Aggregation: How Amazon Became a Service Powerhouse

Beyond Aggregation: How Amazon Became a Service Powerhouse

In late 2015, Amazon made a strategic mistake by closing Webstore and directing its customers to Shopify, proclaiming the Canadian company as its preferred partner. However, this move ultimately led to a transformation in Shopify's business model, shifting from a SaaS model to a commission-based one. Amazon.com Inc. introduced a new service that extends some of the offerings of its popular Prime membership program to merchants off its platform, embedding payment and fulfillment options onto third-party sites.

This shift in business composition is not surprising considering Amazon's success with its other services. One of its most notable services, Amazon Web Services (AWS), has massive fixed costs but benefits from economies of scale. The initial cost to build AWS was justified by Amazon's e-commerce business, serving as its first and best customer. This symbiotic relationship allowed developers access to enterprise-level computing resources with zero upfront investment, while Amazon gained more scale for its products.

Interestingly, the AWS model is now being applied to e-commerce, as Amazon transitions from being a retailer to a service provider. Approximately 40% of Amazon's sales on a unit basis are sold by third-party merchants, many of whom utilize Fulfilled-by-Amazon. This means their goods are stored in Amazon's fulfillment centers and covered by Prime, increasing the return to scale for Amazon's fulfillment centers and deepening its moat.

It is becoming increasingly clear that Amazon intends to replicate this model in the realm of logistics. Just as they did with AWS and e-commerce distribution, Amazon is likely to offer its logistics network to third parties. This move would further increase the returns to scale and solidify Amazon's position in the market. By building out a logistics network that competes with established players like UPS and FedEx, Amazon has the potential to rein in shipping costs and improve reliability.

While Amazon's control over demand gives it a significant advantage, it also limits its overall addressable market. This limitation may not matter in markets with network effects, where Amazon appeals to everyone and can cover every consumer. However, in the case of e-commerce, Amazon will never be the only option. Competitors are working hard to reach consumers, and every customer that visits these websites has an Amazon-driven expectation in terms of shipping. To meet these expectations, merchants are constantly trying to catch up and emulate Amazon's shipping experience. Amazon now offers a solution for these merchants: the best way to achieve an Amazon-like shipping experience is to ship via Amazon.

Although Amazon may have given away business to Shopify in the past, this does not matter if that business ends up being a commoditized complement to Amazon's true differentiation in logistics. The sheer expense required to build out a logistics network gives Amazon a nearly impregnable moat that is attractive to businesses competing to be consumer touchpoints. Moreover, the more volume Amazon processes, the more challenging it becomes for competitors like Shopify to scale their own shipping solutions. This puts Shopify's current major initiative at risk.

One significant advantage that Shopify has over Amazon is its ability to collect data. Many merchants may choose not to use Amazon's new offering due to concerns about data privacy. Shopify's offering will always be differentiated in this regard. Amazon's strength lies in its focus on infrastructure at scale. Successfully moving e-commerce beyond aggregation to a service business model would mark a significant achievement for the company.

In conclusion, Amazon's journey from an aggregator to a service powerhouse has been driven by its ability to leverage economies of scale, its control over demand, and its relentless focus on customer experience. Three actionable advice that can be drawn from this transformation are:

1. Embrace the service business model: Look for opportunities to expand your business beyond simple aggregation. Providing additional services can enhance your company's value proposition and deepen its moat.

2. Prioritize scale: Scale matters, especially for consumer-facing apps reliant on advertising revenue. Focus on increasing your user base to attract advertising dollars.

3. Say 'No' to new features: It is crucial to maintain a lean and streamlined app experience, especially as your user base grows. Resist the temptation to add unnecessary features and prioritize simplicity.

By following these pieces of advice, businesses can learn from Amazon's success and position themselves for growth in an increasingly competitive market.