As detailed in my recent post, Amazon has built up quite a formidable competitive advantage through Fulfillment by Amazon (FBA). Not just on the demand side, which every happy Prime subscriber is already familiar with, but also on the supply side.
In that post I concluded the following:
Fulfillment is clearly beneficial on the demand side, but has a lot of supply side advantages as well. It all comes from the ability to control the inventory. That control helps reduce shipping times, which is what consumers are most focused on, but also significantly reduces costs for the entire system.
More importantly, I believe fulfillment has first mover advantages and creates lock-in because merchants have limited ability to fund working capital. The first player to offer fulfillment effectively ups the working capital requirement on subsequent fulfillment competitors. The bar goes up and becomes that much higher.
I argued that fulfillment is a flywheel that benefits the first-mover. Merchant inventory that is held in Amazon’s fulfillment warehouses are effectively locked out of competing platforms. The large variety of inventory and parallel benefit of faster delivery due to fulfillment creates greater traffic for Amazon that further encourages merchants to place an ever greater share of their inventory with FBA. As the flywheel continues, it effectively takes the air out of competing platforms as more and more inventory is locked up with FBA.
Despite the optimistic conclusion, it is an incomplete one. And for observers that purely focus on the US / European ecommerce space, it is easy to be unaware that there is another supply chain gorilla that indirectly touches Amazon and could potentially become a threat. That company is Alibaba.
To understand why, we need to examine the structure of global supply chains.
There is No Such Thing as a US Ecommerce Market, Only a Global One
Amazon is the largest US ecommerce player – an inarguable fact. But this view is reflective only of the demand side of the equation. All marketplaces are composed of two sides – the buyer (demand) and the seller (supply). Amazon can only be considered largely a US business if we consider the demand side of the equation, because whether we like it or not, the vast majority of products on the platform come from Asia, especially China. In this day and age, unless we are talking about a geographically closed system, there is no such thing as a country-specific ecommerce market, but only global ones with the supply side overwhelmingly dependent on China.
If we take a platform view, Amazon’s business is simple enough:
Equation 1: Sellers (Product) –> Amazon (Transaction Mediator and/or FBA) –> Buyers
Amazon has a lot of influence over buyers and sellers in this equation because buyers and sellers are presumably fragmented and small relative to Amazon’s size.
If we take a supply chain view, the situation looks more like this:
Equation 2: Chinese Manufacturer –> Amazon Seller –> Amazon –> Amazon Buyers
This equation reveals that many Amazon sellers are potentially also middlemen that can get aggregated on the other end. However, this is still not particularly problematic for Amazon since Chinese manufacturers are presumably also fairly fragmented with Amazon wielding the most concentrated power in the system.
Through my industry contacts and conversations, I believe >65% of Amazon products are either sourced directly or indirectly from China.
But here is where things get interesting – most sellers likely only have direct relationships with Chinese manufacturers if they are meaningfully large in size. For example, Macy’s, Walmart, Target, etc. likely have direct relationships with Chinese suppliers because they have the resources to manage and interact with such a network. But most of these players largely do not sell through Amazon.com because they view Amazon as a competitor. 3rd party sellers on Amazon are relatively small and many likely do not have direct relationships with Chinese manufacturers.
Where do these 3rd party merchants get their Chinese products from if not directly from a Chinese manufacturer? Increasingly the answer is Aliexpress.
There are thousands of videos and articles that show how everyday entrepreneurs are turning to Aliexpress as the supplier of choice for their Amazon (and/or Ebay, Shopify, etc) business.
In reality the supply chain equation looks like this:
Equation 3: Chinese Manufacturers –> Chinese Sellers –> Alibaba / Aliexpress –> Amazon Sellers –> Amazon –> Amazon Buyers
This equation exposes one of the, potentially, weakest links in Amazon’s supply-chain-driven strategy, which I believe is largely undiscussed by US ecommerce market observers/investors.
To Beat a Platform, You (Likely) Need a Platform
Amazon is a platform. Our world is now ruled by platforms, and it should be increasingly clear that non-platform businesses are not well situated to fight a platform head-on. Traditional non-platform players like Walmart, Target, Macy’s etc are at a structural disadvantage.
However, platforms are not indestructible, especially if attacked by another platform (e.g. Google leveraging search against travel OTAs such as Priceline and food review sites like Yelp).
In the Equation 3 above, Amazon and Alibaba are both platforms. In the current set-up, only a small buffer zone of middlemen sit between Alibaba and Amazon. Those middlemen are likely to be squeezed in the coming years and could potentially one day put Alibaba and Amazon more in direct contact. More direct contact could potentially reduce the effective leverage that Amazon has over the supply-side of the business since Alibaba is a massive entity. But this current set-up would still imply that Alibaba and Amazon would be upstream-downstream partners rather than competitors with Amazon wielding far greater influence over US consumers while Alibaba holds much more power over Chinese suppliers.
However, as mentioned, platforms can be destroyed, especially if attacked by another platform. The question is whether Alibaba could one day wield their platform power over suppliers to try to overcome Amazon’s platform power over consumers or vice versa.
The current situation looks like an unstable equilibrium especially based on Alibaba’s announced plans for the next 5-10 years with respect to logistics.
Alibaba has publicly announced plans to invest $15 billion over the next 5 years to establish a leading global logistics network.
Here’s a choice quote and fairly interesting article from Forbes (my emphasis in bold):
[Alibaba’s] goal is the creation of a capability to [deliver] anywhere in China within 24-hours and anywhere in the world within 72 [hours].
Alibaba aims, according to Zhang, to “build the most efficient logistics network in China and around the world.”
Why does this matter?
Because it potentially allows Alibaba to attack the heart of what consumers love about Amazon’s Prime service – fast delivery. Amazon may have a strong hold over US consumers at the moment, but if Alibaba were to succeed in their goal to establish 72 hour delivery globally, Amazon’s core value proposition in the US could come under threat.
What Do Ecommerce Customers Care Most About?
The industry is well aware that ecommerce customers care about three things – price, convenience, and variety. In the early days, Amazon won on price vs offline retailers since they didn’t have to pay for brick mortar rent and staff. But price gaps have narrowed (and nowadays Amazon isn’t always the cheapest option). Over the last decade, Amazon has effectively reoriented customers towards convenience over price. For similar price (possibly slightly cheaper or possibly slightly more expensive), you can have it in 2 days or maybe even same day.
But at the end of the day, consumers care all about three – price, convenience, and variety. The relative importance of each depends on the relative gap between the options available. Just because consumers currently prioritize 2 day delivery does not mean that consumers no longer care about price or variety.
That is where Alibaba’s threat lies. A cursory look through Aliexpress would easily surface items that are vastly cheaper than what you would find on Amazon (as long as you are not particularly brand conscious).
How many consumers would be willing to wait 3 days (Alibaba’s goal of 72 hour global delivery) instead of 2 (Amazon’s current standard) if their toilet paper, flashlight, etc was 50% cheaper? I am willing to bet that a very meaningful proportion of Amazon’s customers would gladly make that trade-off.
Building the Global Platform
It’s clear from Jeff Bezos’ numerous interviews and letters that he always starts with the customer’s point of view. This is an interesting contrast with Alibaba’s founder, Jack Ma, who has always prioritized platform sellers.
Both are clearly aiming to build the ecommerce platform for the entire world, but have started at different ends. Jeff Bezos with consumers and Jack Ma with sellers. I am a nobody in ecommerce and can only offer my limited insight gained from months of study and speaking with industry insiders, but one thing seems clear to me – Jeff Bezos’ influence over global consumers is nowhere near as great as Jack Ma’s influence over global suppliers. Global consumers are scattered and fragmented around the globe, but Jack Ma benefits from the fact that China is the world’s factory.
Jeff Bezos is a very smart man, but so in Jack Ma.