Amazon on the verge of a rare mistake

January 31, 2011 § 5 Comments

Over the weekend, super-blog Engadget revealed screenshots of an apparently new product offering from Amazon.  Based on the screens, which are no longer accessible from Amazon’s site, the ecommerce juggernaut intends to offer unlimited streaming of TV shows and movies, for FREE, to all Prime subscribers.  Prime subs currently pay $79 annually for unlimited shipping, and Amazon has reported a strong correlation between the launch of this delivery service and an uptick in sales activity.

In and of itself, Prime may be a winner, but I think Amazon is on the brink of making a large mistake if it intends to include online media benefits for no additional charge.  Here’s why:

  • It devalues the online media industry.  For the sake of argument, let’s attribute the full price of the Prime service to the media feature.  At $79, it’s already $16 below Neflix’s comparable, streaming-only service.  If it’s successful, as Amazon surely hopes, Netflix will have no choice but to meet or beat the price, and voila!  There go Netflix’s profits, and Amazon’s differentiator.  Listen for the hissing sound of margin escaping the industry, like air from a balloon, as the two race each other to the bottom.
  • It requires heavy subsidization.  Shipping is a money loser for Amazon.  Even with the Prime subscription fees, Amazon spends more on shipping than it takes in, and the stats are worsening.  According to its financial statements, Amazon took in $1.193B in shipping revenue last year, while incurring $2.579 in cost.  Relative to the prior year, shipping revenue grew only 29%, while cost grew 45%.  Yikes.  It may be a perfectly sound strategy for Amazon to increase its appeal by making shipping more affordable, but with shipping being a cost center, the subsidy for the online media business has to be funded by its core ecommerce operation.
  • It smells of the “causality trap”.  Their research may indicate otherwise, but it’s not intuitive that the way to increase memberships to its premium shipping service is to add online media benefits.  And even if their ploy were successful at growing Prime subs, it’s even less likely that the new members will buy more physical goods from Amazon (which is necessary for the subsidy to work).  I think Amazon my be falling for the causality trap, in which company planners observe a beneficial correlation (in this case, Prime subs order more frequently than non subs), assume a causal relationship, and then extrapolate that if they could only drive more of the causal behavior, that the correlation will surely hold, and they’ll make a whole lot more money.  But this is flawed logic.  Existing Prime subs value the service for its shipping benefits and are therefore more likely to be active buyers.  If new subs are lured in by media benefits, they will care less about the shipping features, relatively speaking, and can be expected to behave differently from the installed base, i.e., buy less often.

So what might explain Amazon’s strategy?  It’s media business is large, contributing over 40% of its overall revenue, but while its Electronics and General Merchandise business is growing at an increasing rate (67% last year vs. 48% the year prior),  Media has started to flatten, producing a comparably modest 16% growth over the last two years.  So Amazon is under some pressure to try something new.  It is also likely anticipating a not-too-distant future as Netflix has, where streaming and downloading online content overtakes the sale of physical media, such as DVDs and Blu-ray disks.  Both are good motivations, but I think their strategy is off base.  If they’re willing to invest in subsidies, as they seem to be, they could boost media service subscriptions with a more relevant and targeted offering to electronics buyers, particularly those buying units compatible with its online media services (e.g., free 12-month trial).  Who wouldn’t give that a try?  An offer like that would produce paying subs as they roll off the promotional period, and would help differentiate their electronics business (not to mention, leverage the huge amount of volume generated by that business already).  Similar reasoning underscored Best Buy’s purchase of CinemaNow, Walmart’s acquisition of Vudu, and Sears’ recently announced partnership with Sonic Solutions.

Amazon, if you’re planning to give online media away for free to your Prime subs, you may want to take a step back and rethink that.  Sorry if I’m disappointing all you Prime customers out there.


Is LivingSocial’s $20M day the beginning of the end?

January 20, 2011 § 2 Comments

 Yesterday, LivingSocial, the #2 social couponing site behind Groupon, made history by selling over 1.3M Amazon gift cards discounted at 50%, in just 24 hours.  Their achievement trumped their previous record (reportedly in the 14K range) many times over, and also handily beat Groupon’s record set last summer — 445K coupons for national retailer, The Gap.  Taking nothing away from its huge sales volume achievement, there’s a concern that the success these firms are seeing with national deals could forever change the DNA of social couponing sites.

Part of the original allure, from the consumer’s standpoint, was that social couponing sites re-introduced us to the local and independent merchants who didn’t otherwise have an ultra-efficient channel in which to promote their services.  The corner bakery.  The day spa in the shopping center around the corner.  The off (or off-off) Broadway theater.  They promoted local discovery.  And that was good.

But there were inherent challenges with the approach.  For one, the inventory-limiting nature of the “daily deal” may have generated competition and excitement among local businesses, all clamoring for their turn at the front of the promotional line, but it also put a cap on the deal sites’ revenue, driving them to expand as quickly as possible into new markets domestically and internationally.  The one-deal-per-day model also put a ceiling on the commission that a sales rep for these companies could earn.  Another obstacle was that local merchant offers, while often having no trouble reaching the sales volume minimums required to activate the deals, and sometimes far exceeding them, didn’t always appeal to the masses, or at least not at the particular time of the offer.  And then there’s the matter of efficiency, or lack thereof, in the local sales model, as evidenced by Groupon’s run rate revenue per employee ($1B/3,100 = $323K per EE), which is much lower than the last ecommerce company I worked for, which is lower still, than a massively scaled business like, say, Microsoft ($66B/90K = $733K per EE).  You could correctly argue that efficiency isn’t the highest priority for Groupon or LivingSocial at this moment, but if Groupon goes public, as it’s rumored to be planning, or as the category matures, putting downward pressure on margins, efficiency will certainly become a factor.

But national deals, like those with The Gap and Amazon, begin to address these weaknesses in the business model.  LivingSocial’s promo for Amazon grossed over $20M for the outlet, and obviously had mainstream appeal.  And from an efficiency standpoint, the deal site not only got to promote a single offer nationally, it earned press coverage worth millions of dollars more.

On the surface, you can see why daily deal sites would be appealing to the national retailers as well.  Perhaps most importantly, they connect them with consumers who have self-selected as eager to buy.  And much of the discount funded by retailers can be offset through up-selling and cross-selling once they have the customer in the store.  They also benefit from what the industry calls, “breakage”, which is the value of any pre-paid deal that goes unredeemed (an advantage relative to traditional coupons distributed in the weekend circulars, which are pure cost unless redeemed for profitable merchandise).

But do household names such as The Gap or Amazon or Coke or McDonald’s have any problem generating awareness or buzz for offers of the magnitude of the one presented by LivingSocial yesterday?  Wouldn’t you think that if Walmart decided to give 50% off to the first 100K (or 200K or 300K) who show up, posted the offer on their site and Facebook page, Tweeted about it, tagged their paid media, and issued a simple press release, that it would garner the attention necessary to sell out?  Of course.  And they could do this without splitting the proceeds with the deal site.

And yet, that’s not what they’re doing.  Rather, we’re starting to see the big, national brands outsource their daily deal experiments.  To be fair, Amazon, which just invested $175M into LivingSocial, obviously has an ulterior motive to see its new partner succeed.  But you’d think other national brands would be less motivated to hand over the campaign to a third-party, when they could do it effectively in house.  Yet, judging by the popularity of these offers, consumers certainly aren’t discouraging national brands from promoting this way, and sadly, from displacing the local merchants who enjoyed short-lived exclusivity.  Under these circumstances, I see things playing out in possibly a few different ways.

Scenario 1: The major daily deal sites become increasingly “nationalized”, seeking out large sponsorships from major brands, and the revenue and efficiency gains that come with them.  Local businesses are gradually squeezed out of the more prominent deal sites, and are forced into the hands of the second tier, more regionally focused promo sites, which never gain much traction.

Scenario 2: The demand for independent, local offerings remains steady, even in the face of heavily discounted national offers, and the market continues to be too large for Groupon and LivingSocial, to ignore.  They launch flanker sites to handle demand from small businesses specifically, or buy out second tier sites that, time permitting, gain enough steam to become local marketing powerhouses.

Scenario 3:  National merchants, following successful experiments with third-party sites, are convinced of the merits of social couponing and daily deals, but are also acutely aware of their unique ability to drive buzz on a national scale.  They, therefore, pull away from the third-party sites and go it alone, leaving most of the inventory available to the independent merchants, and preserving the local flavor of the original concept.

I certainly hope to see Scenario 2 or 3 take shape.  It’s far more interesting to get a daily deal sponsored by a lesser known, local company.  If I want to research discounts redeemable at the mall, I already know where to go.  Local deals drive discovery, they support local economies, they prop up small businesses, and encourage all of us to try something a little different once in a while (like when I redeemed my Groupon for a tree top zipline tour with friends in the North Georgia Mountains last fall).

After all, that’s what living social is all about.

A call for better alignment between Product Management and Strategy

January 11, 2011 § Leave a comment

I was invited by the Technology Association of Georgia (TAG) to join a panel tomorrow on issues related to Product Management and Strategy.  The event is postponed due to the snow and ice, but the weather won’t deter me from commenting on what I think is a very worthwhile and timely topic.  Changes in the business environment, and particularly within the technology field, are imposing new demands on both functions, and together, they can navigate them more successfully.  We hope to reschedule the session soon, but in the meantime, here’s a summary of my point of view on the topic …

There is a fundamental gap between business owners’ requirements and the resources actually available to deliver them.  Strategic planning processes often fail to pick up or resolve this issue, and produce plans that can be unrealistic in terms of timing and resources – business owners later gripe that their failure to deliver against plan is the fault of Product or Engineering.

To compensate, business owners argue for dedicated Product and Engineering teams, which are often prohibitively expensive, or submit aggressive ROI models to ensure they are allocated the resources they need from central planning.  But even if resource allocations are “optimal” for a certain point in time, product innovation and development are not static processes given fluctuating market needs, unforeseen competitive threats, and unpredictable supply chains.  The average PLC is shortening and is more susceptible to disruption than ever before.  Companies and industries stuck in long planning and development cycles must either defy the odds and predict the future, or develop product that may be on the path to obsolescence even before it’s released.  Recall how Microsoft’s Kin was killed 2 months after launch in favor of Windows Phone 7 devices, following a 2-year development cycle initiated with the 2008 acquisition of Sidekick maker Danger.  Given this backdrop, I see several developments:

  1. Shortened planning cycles (e.g., quarterly, from annual), or more likely, continuation of the annual planning process, augmented with lighter monthly or quarterly refreshes.
  2. More iterative strategic planning processes that better align business plans with centralized resources (which means the process needs to start in Q3, rather than the all-too-common mad dash in Q4).
  3. Continued adoption of the Agile SDLC method – competitors whose business models depend on massive code pushes will need to challenge the status quo (note how Microsoft, taken to school by Google Docs, is preparing to launch Office 365, the cloud version of its popular software franchise).
  4. Extension of Agile development approaches to strategy and decision-making, highlighted by deconstruction of complex problems into smaller, testable implementation stages to packetize risk (what academics call “option value”).
  5. Increased levels of cross-training within centralized engineering/development teams to increase flexibility and maintain alignment between supply and demand across the enterprise.
  6. A challenging of the notion that core competencies cannot be outsourced – I’ve now worked for two companies, large and small, that outsourced major development projects because the resources didn’t exist internally, the vendor quality was high, and the cost was unbeatable.  Obviously, outsourcing won’t be viable in all cases, but it’s time to challenge the old assumptions.
  7. Adaptation of key functions, such as Product Management, to support the new reality.  PMs will need to manage global vendors, continuously align shifting resources with development projects, navigate fluctuating priorities, and work with business owners to determine how to create and deliver a roadmap broken into bite-sized pieces.

Why the FCC’s Net Neutrality solution fails us

January 7, 2011 § Leave a comment

During Christmas week, the FCC passed what some would call a mild Net Neutrality policy, that essentially prevents ISPs from blocking lawful content, but that generally protects their right to implement usage-based tiers.  Web publishers continue to get access to the market, and broadband providers get to charge for it, so mission accomplished, right?  If so, why does the debate rage on, and why, in its first few days of existence, is the 112th Congress already presenting a bill that would reverse the FCC’s effects?  There are three reasons, in my view:

  1. The nature of multi-sided, partisan issues: common ground is hard to come by because both sides believe that if they give an inch, the other side will attempt to take a mile.
  2. Avoids the real issue: the recently passed policy doesn’t speak to what’s really at stake here, which is that much of our country’s innovation (and new jobs) comes from the digital sector, whose business models have become dependent on cheap distribution to consumers.  Charge publishers for their share of traffic, and their profits vaporize, making investment harder to come by.  The FCC policy maintains that ISPs can charge customers use-based tiers, but these days, customers have broadband choices, and who wants to drive customers away with new fees?
  3. Isn’t necessary: a key tenant of the new policy is that ISPs shall not block lawful content.  Surely, the righteous defenders of content liberalization have noticed that while the negotiations have continued for years, no content has been blocked or “managed” in any material way.  The existence of a vibrant competitive ISP market (including options for cable, DSL, satellite, and now wireless, in most MSAs) is an already effective deterrent, and there is no place for regulation when the free market functions effectively and efficiently.

So, Net Neutrality is far from resolved.  And until it is, we all suffer because as consumers, we don’t know how our household budgets may or may not be effected; as Web publishers, we don’t have confidence in our economic models; and as ISPs, we don’t know that we’ll get a predictable return on our capital investments (especially given the explosive growth of online video).  And don’t forget the lobbyists – actually, their profits are assured for quite some time.

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