Amazon Gets Third Party Started
Kevin Kelleher
08/10/05 - 07:16 AM EDT
Remember that
Seinfeld episode where George Costanza changes his luck by doing the opposite of what he'd normally do?
CEO Jeff Bezos has apparently made George's philosophy a bedrock principle of
Amazon.com's(AMZN) management, and it seems to be bringing the company some pretty good luck.
Bezos has made moves that many industry observers considered unwise -- branching away from books and into electronics, and opening up software code to any takers -- and, in doing so, has managed to make Amazon stronger.
Most recently, Bezos did something a lot of companies would consider absolutely crazy: He offered to help competitors by giving them the same technology that powers Amazon's site, the secret sauce that made the company a success.
It's still early, but indications are that the move was far from a mistake; it may have saved Amazon from slow growth and rejuvenated its profit margins.
Amazon facilitates outsider retailers through three different means. The first, and best-known to longtime Amazon customers, is its Marketplace function, which allows more than 600,000 small retailers to offer new and used goods alongside those in Amazon's own inventory.
Similarly, its Merchants@ operation will show the name of a bigger retailer such as
CompUSA or
RitzCamera.com.
More recently, Amazon has gone after even bigger fish, providing, as Bezos likes to say, "the plumbing for other people to operate their Web sites in a private-label fashion."
Amazon doesn't like to talk too openly about this new program, called Merchant.com (it didn't return repeated calls for this story seeking information about it), but it has dropped a few intriguing nuggets of information during conference calls.
And while Amazon's most recent earnings showed strong revenue and profit growth, helped in good part by Merchant.com, some analysts believe this third-party program could continue to be a driver for the company's growth.
"I think it's a long-term factor," says Scott Devitt, an analyst at Legg Mason, which has no underwriting relationship with Amazon but owns a stake in it. "Amazon hasn't made it easy to get your hands around the specifics, but it appears to be a sustainable area."
When Amazon reported first-quarter earnings, it announced a string of major retailers that had signed up for its Merchant.com program, including
Target(TGT),
Macy's,
Diane von Furstenberg,
bebe (BEBE) and
Marks & Spencer.
At that time Bezos said, "We are seeing, as you can see from the recent announcements that we have been making, very strong interest in building private-label, e-commerce Web sites for other merchants who want to have an Amazon.com-like experience for their customers.
"We are offering not only the Web site, but we are also finding the people who are interested in having fulfillment and customer-service applications, too," the CEO said.
CFO Tom Szkutak added, "As people start to build e-commerce businesses of any scale, they find that scaling those businesses and making them operate at scale is much harder than when it is being done at very small scale. And so that may be one of the structural things that you are seeing in the recent announcements."
Amazon's stock tanked after its first-quarter earnings because of weaker operating margins, but contrarians who had been listening closely would have spied a buying opportunity. In the second quarter, it was new business from Merchants@ and Merchants.com that more than anything revived Amazon's margins.
Amazon's second-quarter operating profit rose 31%, above the 24% growth in revenue. Deutsche Bank analyst Jeetil Patel calculated a 3% increase in operating profit per unit in what is seasonally a slow quarter. Deutsche Bank says it intends to receive or seek investment-banking compensation from Amazon.
Last month, Amazon announced that it had signed up
Sears'(SHLD) Canadian operations as a partner in Merchants.com, and Bezos promised that the company would be "investing heavily in Merchant.com."
Revenue from Merchant.com programs show up in the "other" category on Amazon's balance sheet -- where it is combined with other initiatives like Amazon's cobranded credit card.
Amazon won't break its revenue down further, but analysts believe third-party business such as Merchant.com is contributing to the growth in "other" revenue, which more than doubled to $50 million in the second quarter from the year-ago quarter.
Now, $50 million may not seem like a lot for a company that brought in $1.75 billion last quarter. But consider that much of the business has much lower margins than Amazon's own sales. It doesn't need to invest any research money in Merchant.com, and in some cases, it doesn't carry the fulfillment costs.
"It's essentially gross margin flow-through," says Devitt. "If there's no fulfillment, then other than the cost of processing the credit card, it's all gross profit margin."
Of course, the risk for Amazon is that its big Merchant.com partners such as Target and Macy's will learn from Amazon's hard-won know-how and strike out on their own.
But Amazon will have two advantages: First, if enough big names sign up, it will still have a cost-savings edge through sheer economies of scale. Second, its heavy investment in technology will soon leave its ex-customers far behind in innovation.
And it's also unlikely that those traditional retailers have studied at the Costanza School of Management.
