Amazon’s Relevance-based Business Model
The retail platform giant is optimized for relevance. That’s mission-critical for web businesses.
I recently wrote about the importance of relevance for successful business models on the web. In the era of on-demand markets and platform companies, maintaining relevance with customers is a key challenge. It can’t be solved by old solutions like advertising. Instead, it requires companies to understand both, their customers and the market dynamics created by the internet. Then, they need to design their business models accordingly.
Today, I want to elaborate on this by way of example. The prime illustration (pun absolutely intended) is Amazon.
M.G. Siegler put it perfectly (emphasize mine):
How the hell is the company that used to sell books online and where I now buy toothpaste also powering the backend for most of the tech services I use every day — and making Oscar-winning films?
Well, I won’t dive into how they make Oscar winning films. But I’ll explain why it is a very smart thing to do in face of the tectonic shifts happening in the attention landscape. Knowingly or not (whenever Bezos is involved I think it’s fair to assume the former), the retailer-turned-platform developed a business that ensures ongoing relevance with customers. Amazon has created a system that turns relevance into money.
Let’s start with looking at the way Amazon’s customer-facing part of the retail platform works. For the purpose of this piece, I will handily ignore AWS (Amazon Web Services). (Note that this is only acceptable because I’m focusing on one specific mechanic of its business. To understand Amazon entirely, AWS is essential. Start here.)
Amazon loves Prime members. For a simple reason: They spend significantly more money on Amazon. According to Statista data as of September 2016, the average annual amount spent on Amazon by Prime Members: $1,200. For non members that number is at $600. Other figures on the web suggest an even bigger Prime member surplus.
Signing up to Prime, thus, is like paying $130 a year to be locked-in to Amazon’s ecosystem. Why do people self-select to do so? The superior user experience Amazon created is certainly key. But that’s not enough. In order to get people to sign-up, Amazon has created a bunch of services and benefits that come with a Prime membership. The two major components: Free Prime shipping (relevant to regular online shoppers), and a sizable content portfolio ranging from video to books to music.
The latter is what really sets Amazon’s strategy apart. There is a quote from Jeff Bezos at Code Conference 2016 that I keep coming back to. It explains the reasoning behind it in a nutshell:
From a business POV for us, we get to monetize that content in an unusual way. When we win a Golden Globe, it helps us sell more shoes in a very direct way.
But let’s dig a bit deeper. While somewhat obvious, it’s worth spelling out: There is a segment of people who don’t shop enough on Amazon to justify paying for a Prime membership to themselves. The content changes those people’s calculation. Now, s/he gets a (light) version of Netflix, Spotify (and more) as well as the free shipping. Done deal!¹
The content included in Prime, thus, is what’s relevant to the user in the first place. The byproduct, as Bezos points out, is increased shopping activity on Amazon. It is a perfectly integrated approach that starts with a promise of relevance. And the user eagerly locks himself in. As soon as s/he starts to shop more on Amazon, the real and perceived value of the Prime membership increases: the more I shop on Amazon, the more I save on shipping costs.
To be a platform means to be a two-sided market (at least). A sizable number of the commerce on Amazon is actually a transaction between the user and a third-party seller. On the merchant side, Amazon is optimized for relevance too. But it’s a simpler picture:
Things don’t have to be complicated to be effective. By virtue of having achieved the scale it has, Amazon is probably the best gateway to customers for merchants. That’s not a universal statement, but it is true in many cases and reflected by the numbers. According to Jeff Bezos, close to 50% of all units purchased on Amazon come from third-party vendors. They sell there, because Amazon is where the customers are.
Some business theory.
The platform business model has proven to be the premier business model on the internet. All the major web companies from Google to Facebook, from Netflix to Uber are designed as platforms. All those businesses are built upon their success at gathering a large user base. As a result of owning the demand-side, they can attract (and eventually control) suppliers.
While the business model itself isn’t new, the internet created the environment in which it could unfold its full potential. The sheer scale of the global online population, combined with the relative ease to reach it (compared to the physical world), has turned platform companies into the juggernauts of 21st century business.
Becoming a successful platform business requires some very different capabilities and priorities than building a company in the world of physical assets. From HBR:
The resource-based view of competition holds that firms gain advantage by controlling scarce and valuable — ideally, inimitable — assets. In a pipeline world, those include tangible assets such as mines and real estate and intangible assets like intellectual property. With platforms, the assets that are hard to copy are the community and the resources its members own and contribute, be they rooms or cars or ideas and information. In other words, the network of producers and consumers is the chief asset.
The network creates the value. To be fair, though, the demand-side is likely the more important one. Suppliers will usually go where their customers are. And, while its generally advisable to foster good relationships with suppliers — it’s critical in the early stages of building a platform — the power shifts in the platform’s favor once it scaled.
Long-term success, hence, is based on the platforms ability to build and retain a large user base. For that reason, cherished tech blogger Ben Thompson stated in his famous piece Aggregation Theory (emphasize mine):
This has fundamentally changed the plane of competition: no longer do distributors compete based upon exclusive supplier relationships, with consumers/users an afterthought. Instead, suppliers can be aggregated at scale leaving consumers/users as a first order priority. By extension, this means that the most important factor determining success is the user experience: the best distributors/aggregators/market-makers win by providing the best experience, which earns them the most consumers/users, which attracts the most suppliers, which enhances the user experience in a virtuous cycle.
Putting an emphasize on user experience is certainly smart. However, I’d like to add relevance as a critical ingredient.
But, you might say, relevance is a key component of a good user experience anyway! I agree. User experience, understood correctly, is a holistic concept. A good definition comes from Nielsen Norman Group:
“User experience” encompasses all aspects of the end-user’s interaction with the company, its services, and its products.
However, relevance begins even before any interaction occurs. People usually know what is relevant to them, often before they know where to get it. So relevance is as much about attracting users, as it is about retaining them. User experience, meanwhile, only comes into play once the user is already there.
Relevance also isn’t identical to fulfilling a need. First off, terminology matters. If I asked you to tell me what’s “relevant to you”, you’d certainly come up with different answers than if I asked for your “needs”. The same goes for platforms: Instead of just wondering what their intended customers need, they ought to think about what’s relevant to them.
More importantly, though, fulfilling a need carries the notion of a one-off instance. Platforms, however, are not about a single interaction but continuous ones. They make their money over time — either by recurring fees for subscriptions (e.g. Netflix) or by taking a cut from transactions between platform participants (e.g. Amazon). Relevance, thus, is a more appropriate concept than needs because it is understood as an ongoing process. Artists, we all know, have to stay relevant. So do platforms.
Amazon’s Prime program is the company’s answer to the question how it can become and stay relevant in their users’ lives. Relevance is a new challenge for retailers (and many other businesses). It was created by the internet because it eliminated geography as the critical factor that determined accessibility. Offline, relevance isn’t (rather: wasn’t) an issue for retailers. Customers came because the shop was there. Online, however, every shop is just as close as the next one. So, suddenly, relevance becomes a differentiator.
It takes the Prime program and Oscar-winning movies, because inventory isn’t enough to ensure relevance. At least in Amazon’s case: it want’s to serve everything to everybody. But most people don’t care about most CPG products. They might need them, but they are not relevant long-term.²
If we combine the two pictures from above into one, we can see how Amazon has optimized its (retail) business entirely for relevance to its platform’s participants.
Note that Prime content only acts as one — though critical — component in the mix. It’s a key argument for many users to become a prime member in the first place. After all, Oscar-winning movies are relevant to people. But once a person signed-up, the feedback loop between the membership and her shopping behavior contributes to Amazon’s ongoing relevance in the customer’s life. But this relevance has surprisingly little to do with the actual products you can buy there. Instead, it derives from the entire universe Amazon has build around the mere act of shopping.
The integration between all these elements is critical to create a relevance-based business model. There isn’t a one-size-fits-all solution to becoming relevant which every company could readily adopt (there are only so many Oscars every year!). But in a world where the internet is an environmental condition, companies need to find a way to become and stay relevant. It’s not surprising that Amazon — the most impressive internet company — does an excellent job at mastering it.
¹ I further assume that this type of user is less likely to be a heavy general-internet user. This makes it a particularly interesting segment for Amazon. The companies depends on scale and that means, eventually, serving everybody on earth.
² Things differ for specialized niche shops who sell a high-involvement product that people buy again and again. In case of a genre-specific vinyl shop, the inventory would be relevant to the customers!
