Capital Ideas Blog

Why Amazon's stock is up $90 in three months

By Pradeep K. Chintagunta

From: Blog

This post originally appeared on the Kilts Center Faculty Blog.

Can customers still count on Amazon for lower prices than their neighborhood big box retailers? Two recent Wall Street Journal headlines caught my attention: “Amazon losing its pricing edge” and “Fear of ‘showrooming’ fades.”
Together, the articles suggest that not only is Amazon no longer the obvious place for the lowest price, but also that brick and mortar stores are seeing a reversal in the showrooming trend. Now, people are gathering information online and buying in-store, thanks to policies like price-matching. At the same time, Amazon’s stock price in the last 3 months has gone from $280 to $370. How can we reconcile these seemingly opposing trends?

What is important to recognize is that price is only one element of a retailer’s strategy. There are two other key elements, and on these Amazon excels—the first is assortment and the second is convenience.

Amazon is unmatched among retailers in terms of assortment. Want products you can buy at Bed, Bath & Beyond, or Best Buy, or Staples, or your local grocery store? You can get it all on Amazon. Smaller retailers who maintain Amazon storefronts add to the assortment. Amazon is a “one stop shop.”

But Amazon has only recently begun to compete well on convenience. A key aspect of convenience is location—a convenient location enables access and instant gratification. By being online-only, Amazon loses out on the location dimension—buyers have to wait for their purchases to be delivered.

In Amazon’s relentless—some say paranoid—drive to improve convenience, the retailer has struck deals with states that allows it to open warehouses in geographic areas closer to its customers. It is also striving for same-day delivery of products. Importantly, it plans to offer Sunday delivery through the US Postal Service. By doing so, it is breaking a key compromise (in the words of Stalk, Pecaut and Burnett) that one typically associates with home delivery. And if consumers can get what they need from Amazon on Sundays, the company will have demonstrated value relative to shopping at a physical store.

As Farhad Manjoo points out in his recent article in the WSJ, Amazon’s deal with the USPS not only adds value for its customers, but also is a strategically sound move for creating a relationship with a third delivery agency.

Finally, Amazon can leverage its sheer volume of business to ensure low shipping costs, which further enhances its ability to offer low-cost—or even free—shipping. To use the words of Mark Whitacre (Matt Damon) in The Informant, “Paranoid is what people who are trying to take advantage of you call you to get you to drop your guard!” By staying paranoid, if you want to put it that way, Amazon is making sure that it continues to add value where it matters most—to the customer while at the same time enhancing its standing strategically.

There is another aspect of convenience that Amazon shows relentless focus on—customer service. First-hand experience and unbiased reviews from Consumer Reports verify that the company provides outstanding customer service. First, it tries hard to avoid issues in the first place. And when they do crop up, it tries to resolve these issues as quickly and efficiently as it can. Even here, the drive is on to constantly enhance service. The new “Mayday button” on the Kindle not only solidifies it customer service credentials, but also, like the USPS deal, has strategic value. It helps Amazon differentiate its version of the Android platform from other, more garden variety ones.

Amazon’s competitors need to make sure that they continue innovating as well. Given the cutthroat nature of the business it is important not to fall into what I call the Cole Sear trap, after Haley Joel Osment’s character in The Sixth Sense, who notes, “They don’t see each other. They only see what they want to see.” Cole was, of course, talking about dead people.

Amazon’s situation is not without concerns. Owen Thomas at Business Insider estimates that of the 182 million active customers at Amazon, about 10 million are Prime customers. These customers are the biggest spenders on the site and return a profit of about $78 per customer (Prime customers pay $79 for membership, so according to these calculations the membership fee can be regarded as pure profit).

If Prime customers are also the most profitable customers, and if Amazon is able to retain most of them (say a high 95% retention rate), then the lifetime value of these customers would amount to about $800. Prime customers, i.e., the “best” ones, therefore contribute about $8 billion in company value—still a small fraction of Amazon’s $169 billion in market capitalization.

Of course, this does not take into account all the other businesses that the company has ventured into (its cloud computing service, Amazon Web Services, for example). Nevertheless, continued paranoia will help keep Amazon ahead of the pack.


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