The recent launch of Epik’s eCommerce platform has prompted me to study eCommerce models very closely. Any eCommerce strategy ultimately is not complete without a thoughtful discussion about the industry Goliath, Amazon. I know that many people view Amazon as being invincible. I will disagree and submit that their economic model is not well positioned and has been made more vulnerable by search-enabled price discovery.
The Amazon Economic Model is vulnerable
Although you would not guess it from the Amazon stock price, Amazon is financially challenged.
- Amazon’s balance sheet is not as strong as one would think. While companies like Apple, Google and Microsoft have enormous warchests, Amazon’s warchest is relatively small. The company has somewhere in the neighborhood of $5 billion in liquid assets versus current liabilities of about $6.3 billion. With that type of liquidity ratio, I can’t imagine that it is a great time to be selling to Amazon.
- Amazon’s cash flow from operations is actually negative on most days of the year: Net cash flow operations for the first 3 quarters of 2010 has been negative $1.93 billion. Seasonally, Q4 is CRITICAL for Amazon. Q4 cashflow should offset the first 3 quarters but if it doesn’t, the next 3 quarters are tough! Contrast AMZN with Wal-Mart with consistently positive cash flow from operations of between $20 and $25 billion and far more seasonal consistency.
- Amazon’s margins are thin and will get thinner: Under normal trading conditions, Amazon operates with gross margins in the range of 22%. During Q3 2010, margins exploded to 31%, which appears to have come almost entirely from the supply chain. That is consistent with anecdotal evidence that suppliers and affiliates have been substantially squeezed to the breaking point and are now starting to push back.
The net of this is that I believe that the Goliath called Amazon is actually as vulnerable as ever. Their core business is not producing a meaningful amount of cash flow so either shareholders are hugely believing in the promise of new products (Kindle…), or they believe that monopolistic margins can be achieved in online sales in the future (unlikely).
A Fight to the Death?
Amazon’s core eCommerce busines is fighting a battle on at least three fronts:
- Traditional big-box retailers are getting adept at eCommerce: Wal-Mart just laid down the gauntlet for the holidays with an aggressive program for free shipping. For anyone who regularly shops online, the prospect of free shipping on top of cheap prices on known brands, is pretty compelling. As near as I can tell, Amazon’s one big advantage versus Wal-Mart is the absence of sales tax on much of what they ship. If that structural competitive advantage goes away … POOF.
- Niche retailers are moving online : Let’s face it, Google has changed everything. Price discovery is now instant because of search. Long term, why would a consumer buy a product from an online super store, if the same product is available for the same price from an online store that services and supports what they sell with knowledgeable people?
- Margin compression in the value chain: The weak dollar is a challenge for the eCommerce value chain. It is only starting to show up in wholesale pricing. It will eventually show up in retail pricing. A Producer Price Index at 4% annual increase does not yet reflect the surge in commodity prices since summer. When it does — and I believe it will soon — the company with inventory (Wal-Mart) will have a structural advantage over the guy who does not (Amazon).
Bottom line: Amazon is great, but they are vulnerable
The Amazon stock price is still priced for perfection. It assumes continued topline growth and continued margin expansion. My personal forecast is that Amazon will miss the analyst estimate for Q4 and then will have a horrible Q1 2011. The buying spree with Zappos and Quidsi therefore make sense. Could this be the Amazon Empire executing a self-preservation strategy that improves the optics of sequential growth? I think quite possibly yes. Sure, Amazon has a lovely service. The company also employs wonderful people. However, the economic conditions are creating margin pressure at a time when Amazon’s competitive advantages are eroding. And as for the Kindle as savior — fuggedaboutit — the iPad is going to crush it which is bad news for Amazon’s legacy business of selling books online. The insiders see trouble brewing and are selling like crazy.
Implications: Anyone can take on Amazon and Everyone will!
The Epik eCommerce platform allows anyone to build an eCommerce store. How can you get started?
- Product Portals: Epik has built more than 10,000 product portals in the last 10 months. They are low cost, and are a flexible platform. In addition to building and maintaining these good-looking sites, owners can add their own content through easy to use tools for enhancing each site.
- Hosted eCommerce: Sites like IceCreamMaker.com often start out as a Product Portal. Once demand is verified, they become good looking eCommerce sites that achieve higher margins through actual product sales. Epik partners with the domain owner to jointly operate the site and coaches the owner all the way through.
- Managed eCommerce: For owners who want to own a full eCommerce venture like IceCreamMaker.com or EmergencyFood.com, but want nothing to do with daily operations, we also offer a Managed solution where all aspects of business operation are managed. You own it. We run it.
And so it is with great pleasure that I declare open season on Amazon. You bring the vision. We’ll help you execute it! And Goliath — say hello to a thousand hungry, ambitious Davids. We have come to eat your lunch!