Food Times Blog

Amazon: traditional retail under attack from the Internet of things. What to do?

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Amazing Amazon. Like a tsunami out of the blue, the so-called “internet of things” is flooding our homes and increasingly eating into the bricks-and-mortar retail market share. Not unforeseen, perhaps, but certainly underestimated. To the surprise of many, huge figures are already in play. What to do, how to deal with this new phenomenon? Jump on the bandwagon, or hold out; how, and at what cost?

Amazon is not the cause of the slump in physical and virtual shops. In many ways it is more a reflection of the changing face of retail. In the right place at the right time – and with the best technology and talent, thanks to enormous ongoing investment – this giant enjoys double-digit growth even in seemingly feeble markets. Between 2004 and 2015 Amazon’s consolidated revenue increased from 6.92 to 107.01 billion dollars, reporting a 596 million profit, or 0.56% of its revenue. It boasts 304 million customers across 190 countries, 200 million references. Its model is organised around three key elements:

1) Big Data. The golden goose, the most valuable asset of any retailer, is customers and their data. Even as far back as 1996 Amazon was investing in proprietary technology that allowed ever more accurate profiling of the customers using their marketplace (304 million users, equating to just under 10% of all internet users on the planet, estimated at 3.2 billion in 2015). In this way, while the National Institute of Statistics (ISTAT) and trade association research departments make estimates based on trends that are months behind, Amazon can analyse data in real time and update predictive models based on Self learning Artificial Intelligence, in order to make better use of investments and resources.

Furthermore, knowing the spending capacity, shopping frequency and preferences, attitudes and tastes of each customer allows this advanced algorithm to tailor make offers to such an extent that the device takes on the role of the perfect personal shopper, while offering an almost infinite variety of products.

2) Cloud. Amazon is also one of the main cloud storage providers. AWS (Amazon Web Services) rents space on its own servers to many businesses both public and private. It boasts among its clients the CIA, Netflix, and most global start-ups. AWS represents 7.9% of the group’s profits, generating a 23% operating income (a considerable figure given that marketplace services generate only 4%).

3) Prime. The Prime programme is the equivalent of a loyalty card. An annual subscription (the cost varies from $7.50 in India to $99 in the USA; in Italy €20) provides free shipping and rapid delivery times, from next day to within a few hours, on selected items.

Prime allows Amazon to increase its customer base and retention, not to mention profits, while testing privileges and services.

The downside is increased shipping costs, which the company are not always able to offload onto suppliers. Returns also generate considerable costs, even though for accounting purposes they are transferred to the following financial year.

Amazon’s marketplace would seem the most obvious choice, as the state-of-the-art channel for covering or integrating online sales, especially as nowadays its profile is unrivalled and the costs of setting up and maintaining an e-commerce channel are prohibitive. But what are the real costs of this first choice?

Firstly, entrusting a shop and its line of products to Amazon means handing over the clients and their data, which can then be used by Amazon for profiling for their own benefit.

The online marketplace generates a profit (commission, up to 25%) higher than that which it would obtain through direct sales, especially on slow-moving items, where they avoid warehousing and storage costs. Meanwhile, if a product becomes profitable enough for direct sale, it is moved to Amazon’s own distribution centres, under better conditions than the sellers can offer, who nonetheless continue to sell on the marketplace. Indeed, the same item can be purchased from various sources (some inevitably folding under the pressure) furthering the primary interest of the company in acquiring data, and, therefore, profits.

In addition, Amazon collects immediately on behalf of the third-party store or supplier, who will be paid at a later date, minus commission. In this way it finances its own development at the expense of the suppliers, with only the commission on the balance sheet.

To sum up, the third-party store or supplier finances Amazon, pays up to 25% commission as well as shipping costs, not to mention fixed costs, while also giving customers and their data away to Amazon.

Physical retail still has an ace up its sleeve; being able to generate a valuable relationship with the end client, on a personal, human, and social level. That is, as long as the retailer goes the right way about establishing, maintaining and exploiting it. Not with the usual loyalty cards and newsletter subscriptions so much as the through the sharing of values that go beyond the mere act of purchasing. Successful examples in Italy involve the integration of supply chains within a given area in harmony with their ethics, promoting local production and company location, and the rejection of palm oil.

The excellent advantages of traditional retail (as opposed to Amazon) must, however, be better shared and publicised. Not just through advertising and on websites which, whether their own or affiliates, inevitably tend to be self-referential, but also in independent media, and above all on social networks. An engaging narrative in the form of web content marketing is needed, that will inspire authentic sharing. This is all the more necessary considering that it is harder for the physical shopping experience to stand out, both because of the intrinsic limits of space and time, and the lack of knowledgable staff trained in these matters. The customer must be informed, kept up to date and listened to: because only transparent, interactive communication will guarantee the loyalty of valued customers, who may well inform themselves online, but will make their purchase in a shop.

Physical retail still has this one advantage, but it must act quickly because Amazon – which has also invested in content in the Washington Post, Amazon Prime Video and Amazon Studios – is now opening physical shops, having already tested a bookshop (first in Seattle and then in NYC) and a food store (AmazonGo). E-commerce is still worth 8% of global trade, so it is only natural that profit from physical retail is their next target.

As Amazon is pushed more and more towards the end user, it will have to focus its market in areas which has the highest number of customers with the most spending power. The fourth column will therefore be distribution centres and physical shops, whose openings will follow the logic of efficiency, based on figures and the ability to interpret them, and will, as always, have further and wider aims than may be immediately apparent. Back when Nobel Prize winner Joseph Stiglitz first expressed this power in terms of information asymmetry, he could not have imagined a better example than the handling of Big Data today.

Moreover, Amazon finances itself through the reinvestment of profits from its companies (AWS). Founder Jeff Bezos sees the redistribution of profits as nothing ,ore than a missed opportunity for growth. Profits are not redistributed, and this is rewarded by the stock market with further resources.

Investment in AmazonGo is internally funded, and tested both internally (by Amazon staff) and externally (by students on the university campuses where the new shops are trialled). Students: today’s talent, and tomorrow’s consumers. Coop’s “supermarket of the future” on the other hand has been set up with the help of third parties (Accenture and Carlo Ratti) who will, presumably, try to introduce best practise to other retailers.

Having conquered a further chunk of the traditional distribution market, Jeff Bezos collosus will establish the fifth column: shipping. ATS, Amazon Transport Services, and FBA, Fulfilment by Amazon, will handle its logistics and, through outsourcing, even that of other companies. Companies which, once again, will have to carefully evaluate the trade-off between concentrating on commercial front office activities, and working for a giant that learns and evolves by working.

What to do?

Globalisation has brought, and will continue to bring, competitors who do not follow the old rules and who have access to better resources; who not only find resources on the capital market, but are also able to look for and create them elsewhere. Big players such as Apple, Google, Amazon, Facebook etc invest enormous amounts of capital in both R&D, and in the search for new talent and ideas. In 2013 Google invested $258 million in the start-up Uber (questionable for a number of reasons), while the total investment in all Italian start-ups in the same year barely reached a few tens of millions.

Physical retail can survive only by investing in knowledge of, and attention to, the customer, and in respect and care towards the consumer. Closeness and joint participation seem to be the keys to safeguarding retail in the medium-long term.

While technology can be a useful support, especially in exchanging information, it can never take the place of genuine human interaction, which remains the one true competitive advantage of traditional retail. While this may be true, it is worth bearing in mind that Echo (Alexa) is on its way, the personal assistant that Amazon is bringing into consumers’ homes in late 2017, increasing its features with every passing day (1).

Retail in Italy differs from that in many other countries. It has not yet been taken over, partly due to the significant barriers to setting up that companies like Amazon encounter, and partly due to the extensive use of cash, which keeps many small shopkeepers going, and which, obviously, cannot be used online. Paradoxically the unusually high use of cash (compared to the rest of the world) is protecting Italy. But for how long?

The gradual reduction in the use of cash could give the country the time it needs to catch up.

Since fighting on equal terms is not possible, it is important to be realistic. Although some jobs will be rendered obsolete, others will evolve: as ever, it is people that will make the difference. Because it is people that make Amazon, Apple, Microsoft, Facebook. And it is people that must envision where the road ahead might take us.

It is the ruling class that must evolve. A ruling class that designs a pension system destined to implode is obviously not capable of making adequate mathematical calculations. A ruling class that allows shell companies in order to supply labour to large businesses (state or otherwise) without paying contributions must be replaced.

A final note. Globalisation and the web, especially e-commerce, have encouraged incidences of what might be termed legislative ‘shopping around’, from the protection of workers to tax. With the help of political figures like Jean-Claude Juncker, one-time Prime Minister of Luxembourg, major groups have seen a disproportionate increase in their competitive advantages thanks to the total lack of legislative and fiscal standardisation at a European level.

Applying a Flat Tax to e-commerce companies, calculated according to sales in each geographical area and then redistributed at a local level, would seem to be the simplest way to reduce the competitive gap between local and online retailers.

In this way it would be possible, by the use of data, to monitor the quality and quantity of the work of these companies, Amazon first and foremost, thus reducing opportunities to exploit the varying tax rates. In Great Britain this is already a reality. Starting from May 2015, Amazon must pay tax in the UK, and not in Luxembourg as was previously the case, on all sales made in the United Kingdom (still currently a member of the EU despite Brexit). This will have to do, until such time as the EU holds the interests of citizens, workers and local businesses above those of large multinationals.

Dario Dongo and Fabio Ravera

Note

(1) Echo and Industry 4.0 may seem like the future, but they are not accessible to all. The rules of the game must be decided. A grocery store cannot compete with AmazonGo. An RFID tag can cost between €0.10 – €0.50, a biometric camera system some tens of thousands of Euro. How many €4 sandwiches would a small food shop have to sell to offset the cost of a technology that will be obsolete within a year, without the backing of a technology giant?