The Faustian Pact Between Manufacturers and Amazon

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Speaking of brands and Amazon: Alexander Graf, a leading German e-commerce expert and the CEO of shoptech startup Spryker, has published an excerpt from the English version of his book, “The E-Commerce Book: About a channel that became an industry”, at Medium:

The Faustian Pact between manufacturers and Amazon or “The Manufacturer’s dilemma”“:

Manufacturers who start selling on Amazon almost always experience a tangible uptick in turnover — which is hardly surprising given the size of Amazon’s sales overall. While the Giant is very guarded about its actual turnover figures and uses highly idiosyncratic accounting techniques to disguise the exact provenance of its sales from competitors (and, in some cases, the taxman), it is not wildly overstating the case to put Amazon’s overall share of e-commerce sales at near 50% in most Western markets.

At the beginning, though, it is easy to forget that there is no such thing as a free lunch, especially for manufacturers looking to sell to Amazon as a retailer (the Vendor Model). For manufacturers happy to supply directly to it, Amazon does everything it can to look like the perfect sales partner as defined in Business Studies textbooks, buying in respectable amounts of product — its warehouses have plenty of capacity and it sales are high — and paying the listed price without batting an eyelid. If manufacturers give it a 3% fixed rebate, it will even agree to handle all returns, which is a real plus-point for organisations which have yet to build up their own distribution structures and have no experience of customer-facing activities.

​Amazon ‘lures’ manufacturers in with the demand the company can generate. Once in, manufacturers get pushed into a system that helps Amazon and its end-users:

Amazon op­erates a zero-tolerance policy towards supply issues, and does so for a very good reason: because Amazon’s competitive advantage is, to a large extent, derived from its fulfilment structures — it is process optimisation here which gives it the reserves to be able to offer both suppliers and customers best prices — any disruption to its logistics system, however small, starts to eat into its margins. That is why sales agreements often include punitive fines for late or non-compliant deliveries: exam­ples include a 60 euro cent fee per item delivered to the wrong warehouse, a €20 fine per product not in agreed packaging, and a €500 lump-sum punishment for missing or cancelled deliveries. Breaches of agreements are recorded on the notori­ous Vendor Score Card and any supplier with poor marks in logistics can expect to be dressed down and asked to accept worse conditions during annual negotiations. (…)

​One can assume that without those punishments almost no manufacturer would and could rise to Amazon’s standards (as they are far above what is usually demanded of manufacturers).

The most important thing to understand about Amazon’s system, though, is how Amazon manages to get away from needing good margins on the actual transactions to have a sound business:

Amazon does indeed offer a good price for the products it buys in, but claws back some of this by selling additional services at a premium. Larger producers, especially, often lose track of their spend as whole teams are put together to handle the sudden jump in turnover: even premium brands such as WMF (cutlery), 3M (consumer goods), and L’Oréal (cosmetics) take part in the Special Vendor Services programme and actually pay wage costs for the Amazon staff who work on their brands (providing them with training beforehand out of their own budgets, too, of course). Amazon even takes a fee for inputting longer product texts.

​Outsourcing cost and integrating manufactures in a way that makes them optimize their processes to meet Amazon’s demands is a way of cooperation that suits Amazon, the strong party here, very well. Over time this eats into the manufacturers business while at the same time overall sales are as high as they have ever been.

That is the Faustian pact. How can one get out of that again? It needs competition at Amazon’s level of the value chain befor the manufacturer will see any meaningful change. Only other big marketplaces can change Amazon’s negotiation power. (The only other way I see is differentiated positioning by manufacturers. See below for more.)

While his description of the situtation is very astute and his insights are very valuable, I don’t see Graf’s proposals as feasable:

Larger manufactur­ers can delist their product ranges and renegotiate with Amazon, driving a harder bargain; meanwhile, smaller producers in a single segment can club together and agree on minimum conditions to bolster their negotiating positions. This would mean that companies who were previously rivals would need to build up trust between one another, but if they could rely on strength in numbers, they would be able to stand up to harsh interrogation in annual negotiations and come out with settlements with which they can all get by well enough. Another possibility is not to become a vendor, but to work with Amazon as a marketplace seller (Seller Model): this means that Amazon doesn’t get customer contact and the data that goes with it.

​Safe for the last one, none of those proposals change the increasing disparity in power which is on display here or they are simply unrealistic. (Cooperation amongst competitors can be broken off easily be the aggregator of access to the segments customers by simply offering the one most susceptible a very large part of the pie with very favorable conditions as sugar on top. (And let’s not talk about legal implications of such a cooperation.) This is precisely part of the dilemma for manufacturers. You don’t just say ‘No’ to an increase of your revenues by factor 3, 5 or 10 because it’d be better for your segment. Graf contradicts his earlier description of the situation with this proposal especially. Which just goes to show how huge the challenges are.)

There are few things manufacturers can do: One, when your product category allows for any kind of service -think Dollar Shave Club or Runtastic– start experimenting with this sooner rather than later. In the end, manufacturers need to find ways to reach customers and create value for them that go beyond selling goods.

In short: whatever a retailer can do for a manufacturer, a big marketplace aggregator like Amazon Marketplace can do as well. If it weren’t Amazon it would be eBay or Alibaba or Rakuten. Those aggregators hold the market power, as they provide the access to the customers.

Every brand, every manufacturer, who can not build out a whole system that gives them differentiated leverage will get their business marginalized by those who win on the marketplace level. The only other way out is, counterintuitively, to go ‘all in’: at the other side of the spectrum, the manufacturer/brand manages to optimize towards a pure marketplace seller model, pricing the aggregator’s power in, even counting on it, and working towards best possible product positions and branding. (Think Anker or KW-Commerce.)

Yes, this is not very promising for a lot of manufacturers. Especially, this doesn’t solve today’s pain today. And, even more profoundly, this is only realistically implementable for a subset of manufacturers. (And, I might add, this is yet another reason why 20th century brands will slowly lose relevance while new brands seize a growing market opportunity.)

But as I said, for this situation to ease not to worsen there needs to be competition on the marketplace’s level. And that is the retailer’s space, not the manufacturer’s.

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