You can love it, hate it, but you can not ignore it. Amazon has captured our hearts and wallets. I’m writing this opinion piece after witnessing the Live US House Antitrust Subcommittee grill Amazon CEO, Jeff Bezos, on the business practices of his company. Throughout the questioning, I could feel my viewpoints swaying. During one line of questioning I’d find myself supporting Amazon, and a moment later I’d be on the side of the “public”. I thought it would be interesting to dissect the three main arguments they are being accused of. Hold on to your seat, it’s going to be a bumpy ride.

Amazon issues being discussed:

Issue #1 – 3rd Party Sellers & Private Label

What is the issue? Amazon, which is both a marketplace and a seller, is privy to proprietary product information of 3rd party sellers that sell through its platform. Amazon can then shrewdly use marketplace sales data to “spy” on sellers to find which products are worth selling. Then it can produce similar products, sold under its fast-growing list of private-label brands, and push the seller out. It is using its dominant position to stifle competition.

Backstory: When Amazon first launched, its platform was designed to democratize retail. It did not produce products, but acted as an objective, logistical middleman that focuses on customer satisfaction. To further expand its product selection, it brought in 3rd party sellers. These small vendors or manufacturers could sell a variety of products alongside established brands. But when Amazon started selling its own private label products in 2007, everything changed – it shifted away from being an impartial, may-the-best-product-win distribution partner to being a direct competitor to those sellers and vendors. Amazon is promoting its own brands and is privy to proprietary product information in order to understand which products are worth producing.

Let’s see an example: what is shown when I search Amazon for “batteries”. The first product shown, marked in red, is batteries sold by AmazonBasics, one of Amazon’s white-label brands launched in 2009. Only after that, in green, do we see sponsored listings from Duracell. Prior to 2009, Amazon did not sell batteries. Why did they suddenly start to produce them? One would assume internal sales data indicated that batteries are a profitable commodity and producing them would increase their margins. Duracell likely has lost sales and now needs to pay Amazon “advertising fees” to keep their products somewhat at the top.

My Take: Lawmakers fear Amazon is a monopoly, and they’re right. But what is so wrong with a monopoly? We assume the dominant company will abuse their advantage to “corner the market” by increasing prices. This would harm consumers, which lawmakers protect. At the moment, consumers are not being hurt by Amazon’s aggressive-but-legit seller practices. Quite the contrary – consumers are getting more affordable options to purchase. Who doesn’t love saving on batteries?

Customers above all: The only entity Amazon’s practices harm is their partners. Amazon has always been customer-centric, not partner-centric. Why shouldn’t they be ruthless with partners to secure the best deal for consumers? Amazon is forcing their partners to bring their A-game, or risk being kicked out of the game. Cruel? Yes. But legitimate. Natural selection should be applied to business. Not every business partner should survive. That’s the way the world will improve.

How to solve: Lawmakers need to choose – do they prefer to protect consumers or businesses? By not intervening, they are allowing Amazon to decide to favor the consumer. Today, Amazon is a “good” monopoly, but this could change in the future. A new oversight committee should be established – whose goal is to regularly monitor the leading e-commerce merchants and their value to consumers. This committee would staff both experienced lawmakers and technology experts and would decide which marketplace is licensed to operate. How this committee evaluates the marketplaces is a challenging task, so we’ll keep that for future posts. Marketplaces would be required to regularly share information and data with this group to stay licensed.

The day Amazon stops putting the consumer ahead of everyone else is the day Amazon should become regulated. So far that has not happened (putting aside minor “violations”). Amazon understands that true value is a long-term approach mindset of customer loyalty. Would you want to live in a world without Amazon? Hell no.

Issue #2 – Predatory Pricing & Competition

Overview: Amazon is a powerful tech company with a broad range of units and revenue streams. It is being accused of using a semi-illegal tactic called predatory pricing. This is when a company deliberately reduces prices of a product or service to loss-making levels in the short-term. The aim is that existing competitors will shut down, as they will be unable to compete with the dominant store without having major losses. Once the competition is eliminated, the dominant store can then raise prices to monopoly levels in the long-term to recoup their losses while enjoying increased market share.

Let’s see an example: Diapers.com was an e-commerce store founded in 2005 by a company called Quidsi. By 2008, it became the go-to shopping destination for moms. Enough so, that it popped up on Amazon’s radar. What happened next can be made into a Hollywood hit.

In 2009, Amazon expressed interest in acquiring Quidsi, but the company’s founders declined the offer. Soon after, Amazon reduced the price of their own diapers and baby products by 30%. Within a year, Diapers.com’s revenue dropped due to consumers buying with Amazon. Furthermore, their price-war with Amazon scared their investors away. The founders understood they were in a bad position.

They entered M&A talks with Walmart and Amazon in 2010. Walmart had extended Diapers.com an offer, which they were inclined on taking. Amazon, who didn’t want to lose the M&A to Walmart, upped the stakes. In September 2010 Amazon introduced Amazon Mom. This new service offered a year’s worth of free Prime shipping and gave a 30% discount on diapers. This would lead to even more losses for Diapers.com, who were desperately hanging on. At this time, Amazon was selling their diapers below cost. Experts calculated that Amazon was to lose $100 million over three months in the diaper category alone.

The founders of Quidsi, out of fear that Amazon would lower their prices even more, agreed to sell. Within several months following the acquisition, Amazon shutdown their Mom program and raised prices back to regular levels. Several years later Amazon closed Diapers.com.

My Take: Although I believe customer-centric is the best strategy, this tactic is hard to swallow. Jeff Bezos provided no valid response to defend his aggressive actions, which makes me wonder if he lost sight of the consumer for a moment. Perhaps be thought the end justify the means to build his Amazon empire. But raising prices is strictly against his own policy. Did corporate greed get the better of him this time?

How to fix: Modernize the laws for predatory pricing. This is supported by US Department of Justice claims that acknowledges this issue and claims that the courts are out of date. One solution, which would have helped in the case of Diapers.com, is to mandate Amazon to keep their low-prices for a determined period of time, such as five years. Instead of undercutting Diapers.com for several months and losing only $100mn, they would have lost $2bn. This would likely have discouraged them from this practice, as it would be hard to recoup that loss.

Issue #3 – AWS Subsidizing E-commerce Losses

Overview: What started as a book has slowly turned into a diverse tech, content and logistics conglomerate. Amazon has holdings in hundreds of diverse companies which it founded (AWS, Prime Video, Alexa) or bought (Audible, Twitch, Whole Foods). The revenue from these companies is very little compared to Amazon.com’s e-commerce sales. Except for one – AWS. This unit makes up a large portion of Amazon’s profits. Amazon is able subsidize losses in the e-commerce sector by using cash it makes from the AWS unit. This makes it hard to compete with.

Let’s talk numbers: AWS is the market leader and first-mover in the cloud computing space. Sales have been growing steadily over the past years, contributing $35bn in 2019. There is reason to believe this trend will continue as the rest of the world adopts cloud computing.

Source: Amazon Annual Reports

We’ve established that AWS drives a lot of revenue. But is $35bn actually a lot for Amazon? In 2019, the e-commerce section brought in $245bn in sales. That means AWS contributed only 14% to the entire company sales. A relatively small piece of the pie, which makes sense

Here it gets interesting. That small 14% piece represents much more when looking at operating income (profit before taxes). The graph below shows how operating income is split up between e-commerce (US+Intl) and AWS. Since 2016, AWS is driving more than half of the operating income for Amazon. In 2019, AWS brought in a whopping $9.2bn in operating income representing 63% of the company’s income.

Source: Amazon Annual Reports

Remember that big Whole Foods purchase Amazon made for $14bn? Or the acquisition of home-security company Ring for $1-2bn? That spare cash is due, in part, to AWS income. Without the highly profitable unit in the company, Amazon wouldn’t have been able to afford many of the risky investments it has made, and will continue to make.

US Hearings: The recent hearing did not focus on this aspect of the business. It’s not the first time these consolidations occur. eBay and PayPal were for years a joint company, sharing their P/L and profitability. But one can argue both products were in similar domains and made sense as a whole. But should an e-commerce logistics company own a subsidiary which develops cloud computing technologies? Are the two tightly related? That’s a question for policy makers.

What should be done? They should be broken up. Both companies operate in two separate domains, brought together through a very elementary common ground of server scalability. In China, lawmakers forced Alibaba to split its payment company into a separate company, for this very reason. By splitting up the duo, Amazon will lose its cash cow and will be less equipped to pursue shady bullying tactics such as predatory pricing. Consumers shall continue to enjoy both products separately.

Summary

Like many of us, Amazon stole my heart in the early 2000’s and turned me into a loyal customer. It has done more to change retail than we would like to admit. Their impact and importance to society is paramount. Does that mean they are perfect? Hell no. They are secretive and aggressive in upholding their customer-centric values. If that means they need to occasionally practice shady methods with their partners, so be it. Do they need to be slapped on the wrist every now and then? Hell yes. It worked with Microsoft in the 1990’s and it can work today. But regulating and controlling is a fine line. I hope US lawmakers can find the right balance, or the world will lose a gem we will later gravely miss.

References & Further Reading

1. Amazon’s Antitrust Paradox, The Yale Law Journal, by Lina M. Khan
2. The Everything Store by Brad Stone (pg 295-299)
3. How Amazon Steers Shoppers to Its Own Products, The NY Times, by Julie Creswell
4. Jeff Bezos Testimony at US House Judiciary Subcommittee July 29th, 2020, YouTube
5. Amazon Written Responses to 2019 Subcommittee Hearing, US House
6. Amazon Changed Algorithm To Boost Its Own Products, WSJ, by Dana Mattioli
7. Predatory Pricing, Wikipedia
8. Can Amazon keep growing like a youthful startup? The Economist
9. Amazon Annual Report 2010-2019, Amazon

Thanks to my peeps for reading early drafts, offering suggestions and correcting embarrassing typos: Nitai Dean, Tracey Hayse, Bonita Dean, Zvika Mond, Peleg Aran, Daniel Silberberg, Dror Blumenthal, Arielle Barokas, Sergey Toporov, Gil Karie