The Future of Ecommerce: Utilitarian vs Social

When people think about ecommerce today, they likely think about ecommerce along the lines of C2C (consumer-to-consumer), B2C (business-to-consumer), or B2B (business-to-business) – in other words, classification by type of buyers and sellers.

Or perhaps people think about 1P (1st party) vs 3P (3rd party), depending on whether the ecommerce platform itself engages in the direct buying and selling of goods. Amazon is 1P and 3P while Ebay is purely 3P.

However, both of these classification methods are simply the digitized forms of long-standing offline commerce analogies. They are neither new nor native to the world of digital commerce.

Ecommerce appears to be evolving and giving rise to more native forms of commerce, which I think can be loosely classified as utilitarian vs social. 

The Current Ways of Doing Things

Although ecommerce has been around for over 20 years now, it still bears a striking resemblance to offline commerce.

Consider the way ecommerce businesses/platforms are classified today. C2C, B2C, B2B and 1P vs 3P. Both of these classification systems are applicable to both offline commerce and ecommerce.

Online C2C would be Ebay, where users are largely trying to sell used items to other users. Offline C2C would be school students trying to swap cards or goods or garage sales. The offline world never really formalized C2C because, I suspect, there isn’t much money in this part of the market. The fact that Ebay took off so much faster than Amazon in the early days is simply because the offline competition was non-existent and Ebay filled a vacuum. But in the long run, Amazon was destined to outstrip Ebay because Amazon operated in B2C, a much larger part of the market.

Online B2C would include Amazon and essentially every branded/professional ecommerce business out there where consumers buy from a business. This is also how most offline commerce is conducted – in malls, on the streets, mostly everywhere.

Likewise, online B2B is not too different from offline B2B. For the most part, going from offline to online likely meant swapping phone calls for internet clicks.

In terms of 1P vs 3P, almost all offline businesses are 1P where the buyer interacts directly with a seller that owns and controls the inventory. Online 1P is the same and includes the digital channels of all of the offline 1P businesses. This includes the branded stores for Apple, Nike, Adidas, etc.

Offline 3P would be mall operators. The essence of a 3P business/platform is effectively to be a landlord. Mall operators provide a space for businesses to sell. Online 3P platforms would include Amazon, Ebay, Alibaba, and JD, all of whom are digital landlords. 3P is clearly a more commonly viable business model online because digital real estate is theoretically infinite. There can be an infinite number of online 3P platforms. And who doesn’t want to be a landlord collecting rents without having to do the branding and selling work?

So at the end of the day, ecommerce today isn’t all that different from offline commerce. They are largely direct analogies other than swapping out of physical storefronts for digital storefronts.

The New Ways of Doing Things?

What’s interesting is that ecommerce is starting to evolve in ways that offline commerce cannot follow. And this is enabled by social media, supercharged by the fact that we always have an internet-connected device with us at all times. This new way of doing things is social ecommerce, and eventually the old way of doing things will likely be viewed as utilitarian e/commerce. 

Social ecommerce is just starting to take off in the West, but has been a game-changer in Asia, particularly China.

Here are some examples.

Social ecommerce includes live streaming on Taobao (Alibaba platform). This is effectively QVC for the digital age. But on steroids because you not only watch/hear from sellers, you also see comments from other potential buyers.

Taobao Livestreaming

Source: TechinAsia

Social ecommerce includes WeChat (Tencent messaging platform) stores with integrated messaging. Buyers can message and interact directly with potential buyers in the WeChat messaging app – keeping them updated on new products, offer coupons, and deepen the brand story.

WeChat Ministore.jpg

Source: WeChat Agency

Social ecommerce includes PinDuoDuo encouraging you to round up friends to help you bargain for discounts.

Pinduoduo Bargain.jpg

Source: WalktheChat

What social ecommerce accomplishes is that it makes buying fun, all the time. Buying has always had an element of fun in the offline world, but it required coordination. For example, people (friends and/or families) go to the mall together so that you can get advice and encouragement (or tasteful critique). But that takes coordination. Ecommerce made it very easy for us to shop, but it has not made it easy for us to coordinate to recreate that level of fun. That’s what social ecommerce promises to accomplish.

Social ecommerce also connects us with opinions that we may not otherwise have in our offline lives. Perhaps you don’t have people in your life that would have the best opinion/advice, social ecommerce broadens your scope. That is something that offline commerce can never accomplish or compete with.

The benefits do not solely accrue to consumers. In fact, the benefits are probably even greater for sellers that adapt. Take Taobao live streaming for example. There are many sellers now that will livestream directly from factories to gauge what buyers are most interested in. The buyer will then purchase inventory based on the feedback with minimal inventory risk. This is a phenomenal benefit as it reduces the working capital necessary to run the business. As I’ve discussed in my previous post, the platform/player that has the greatest influence over retailer working capital will likely dominate for a very long time.

Ecommerce’s Shifting Landscape

Social ecommerce has already arrived in Asia, and it is starting to appear in the West.

For example, Apple is rolling out Business Chat, which promises to allow users to directly message businesses creating a whole new way of marketing and selling.

Apple Business Chat.png

Source: Apple

And the gorilla (in the West) is Instagram, which recently rolled out a “Shop Now” button. This is potentially transformative because Instagram is already a very important platform for branding and advertising. Users already follow brands/influencers with an affinity for the products and designs posted. The “Shop Now” button would close the commerce loop.

WSJ Instagram Shop Now

Source: Wall Street Journal 

Of course, every ecommerce post is obliged to comment on Amazon, the de-facto king of ecommerce in the West at the moment. With the emergence of social ecommerce, Amazon’s market positioning appears to be weakening and is ever more dependent on its utility aspects. Amazon still dominates if you already know what you want but want it fast and at a reasonable price.

However, Amazon is not a particularly strong platform for discovery other than for a very narrow range of “similar items” recommendations. People love Amazon because it useful, not because it is fun. Unless Amazon adapts quickly, Amazon risks being eclipsed by social ecommerce players that are superior in discovery if the logistics gap should ever close. 

More on this in a later post. Stay tuned.


The Other Supply Chain Gorilla That May One Day Challenge Amazon

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 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.

For example:

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.

Unstable Equilibrium

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.

Why Amazon is so Hard to Compete Against

Amazon has clearly become an absolute juggernaut. There are likely only a handful of companies today that have the resource and scale to compete with Amazon directly. But most of the companies that do have the resources to compete generally don’t operate ecommerce platforms, leaving the field mostly wide open for Amazon to continue to grow unabated.

I have been trying to grapple with the question of why it has been and continues to be so hard to compete against Amazon. Yes, Amazon has incredible scale, enormous cash flows, excellent assets (e.g. Fulfillment advantages as detailed in my post, Supply Side Advantages of Fulfillment (by Amazon)), but Amazon didn’t always have these advantages. And many of the competitors that Amazon has bested had either similar or even greater advantages in the early days.

For example – scale. A decade ago, Amazon was a tiny minnow compared to the Goliaths of brick and mortar retail. Even today, Amazon is still smaller than Walmart. Scale alone is not what made it hard to compete against Amazon, though it is what makes it even harder to compete against Amazon today.

Same with cash flows. Amazon may have more cash than it knows what to do with today, but its cash flows were materially weaker a decade ago. And certainly the incumbents like Walmart would have been much better positioned from a cash flow perspective to pursue Amazon’s strategy than Amazon was.

The easy explanation would be mismanagement at peers, but that seems like an incomplete explanation to me. After all, EBay wasn’t exactly poorly managed and had an internet lineage just like Amazon. EBay even had greater reach to boot, yet is now mostly an afterthought.

All of these advantages played a part…and ultimately Amazon’s differentiated strategy and perspective on retail helped them pull away, but I believe that one of the biggest reasons why competitors failed and continue to fail against Amazon is because they are never actually competing against Amazon but rather against Amazon’s past.

At any given moment, the observable parts of any company is a summation of decisions – strategic and financial – made some time ago. For most companies, the gap between those decisions and what you see is probably not large because many companies are unfortunately run to a fairly short term time horizon. However, for a company like Amazon, the gap is massive, especially since Jeff Bezos prides himself on thinking 5-10 years out.

From the perspective of a company like Walmart or Macy’s, they likely see Amazon as a large ecommerce platform with wide selection, fast delivery, and a sticky Prime loyalty program. But what they believe they are competing against (and observe) is nothing more than Amazon’s past! And likely the version of Amazon as it was strategically decided 5-10 years ago. Consider that Amazon launched Prime in the US in 2005. Amazon’s competitors are still struggling to compete against Prime with a competitive offering today, but Prime was likely decided far in advance of 2005. Even if competitors were to catch up, they would only be catching up to the Amazon of yore. The Amazon that exists today, the Amazon for which today’s strategic decisions affect, is the true juggernaut that competitors need to beat, but they won’t even know what they are truly up against until it becomes obvious a few years from now.

I think this is the key reason why Amazon is such a formidable competitor, and it is all enabled by years of advance planning. Competitors have a hard time catching up because by the time they know what they are up against, they are already years behind. Even formidable competitors like Google and Microsoft have been blind-sided by AWS, so it’s not just retail where Amazon successfully employs such a strategy.

In order for any company to successfully compete against Amazon would likely require recognizing this asymmetric form of competition and taking a leap of faith to position competitively against the Amazon of the future as opposed to the Amazon of the past. What does the Amazon 5 years from now look like? That’s the true measure of competition.

Amazon’s Capital Market Dependence

Lately, there’s been no shortage of positive coverage on Amazon – and for good reasons. The vast majority of retail is struggling with declining same-store-sales, yet, Amazon continues to post a torrid pace of growth despite its size. In FY16, Amazon grew North America segment sales by 25%, and that growth came at the expense of the rest of the retail industry.

From a business model perspective and from a consumer perspective, Amazon appears to have built an incredible flywheel that is gathering momentum. As the rest of the retail industry is forced to retrench and cut costs (e.g. reduce stores, reduce staff, reduce inventory / SKUs…), it serves to further widen the gap in consumer experience as Amazon continues to invest. Amazon’s product assortment advantage, delivery speed advantage, data advantage all continue to grow. And the wider the gap, the more inevitable Amazon’s dominance.

It’s not hard to see why sentiment has swung so strongly in Amazon’s favor.

However, as an investor, it is almost always prudent to revisit assumptions when the market believes so overwhelmingly in a single narrative.

Amazon’s Overlooked Advantage

Recently, I had the opportunity to catch up with the CFO / Chief Strategist of an Amazon competitor (which will go unnamed). Although this company is doing quite well and holding its own within the retail space, it’s clear that a full-scale showdown with Amazon could be looming. And such a showdown will be painful.

During this conversation, the company asked me an unusual question and offered an interesting remark: How would I feel if the company significantly ramped up investments to fend off competition (i.e. Amazon)? And, perhaps the more interesting part, the CFO remarked that it is unfair that Amazon has the advantage of an investor base that does not care whether they produce any earnings at all, only that they have the ability to do so. He wished he had a similar investor base because it would allow him to compete on a more level playing field.

Those words stuck with me because it’s true. A large part of Amazon’s competitive advantage in pricing and consumer experience (driven by Amazon’s large investment programs) would be far harder if investors required Amazon to produce stronger earnings. After all, the rest of the retail industry is unable to respond precisely because they are forced to defend earnings and unable to invest aggressively to ensure that they exist in the future.

In essence, Amazon’s continued success perhaps does depend in part on capital markets cooperation.

The Dangers of Capital Market Dependence

Reliance on capital markets usually don’t lead to good places. Although it is efficient to utilize capital markets to support operations and growth, a dependence on capital markets has led to the downfall of many companies.

For example, levered companies that suddenly discover that maturing debt can no longer be rolled over.

Or roll-ups / M&A-driven companies that suddenly discover that the market is no longer going to allow them to issue high-valuation stock to purchase low-valuation targets.

Or REITs and MLPs that generally have high payout ratios and therefore require capital markets to grow.

The moment the doors to the capital markets close, companies that depend on capital markets find themselves with few friends and tough choices.

How it Could Hit Amazon

I should reiterate that all of this is purely conjectural, and I remain a fairly firm believer in Amazon’s business model, but investors shouldn’t overlook the small points of weaknesses especially when consensus is overwhelmingly bullish.

If capital markets suddenly stop giving Amazon a pass (which wouldn’t be particularly outrageous since investors did become skittish just a few years ago), Amazon would likely have to pull back on fulfillment and content, which represent two of the largest costs. And these are likely the two strongest differentiators of Amazon’s customer experience vs. traditional retailers.Amazon IS 2016

And on the cash flow side, perhaps stock-based compensation would need to be swapped for cash compensation if equity investors stop believing. In FY16, Amazon recognized $3bn of stock-based compensation, which is quite sizable compared to the $3.9bn of FCF less finance lease repayments and assets acquire under capital leases.Amazon SBC.png

Concluding Thoughts

Jeff Bezos has built an incredible business in Amazon that is gathering strength. However, Amazon’s strength (and momentum) relies at least in part on investor trust. Like a flywheel, speed will beget speed. But if investor sentiment flags even if momentarily, the flywheel’s momentum could slow considerably.

Disclosure: I have no direct beneficial interest in AMZN as of publishing date and have no intent to initiate a position within the next 48 hours.