I love shopping for new things on Amazon (AMZN). That’s partly because I love sitting in my favorite chair with my iPad Pro and perusing all the colorful pictures in the comfort of my own home. It’s also quite handy to read the comments from previous users of the product. Plus, I don’t have to enter my payment info every time. Who doesn’t groan when they want to buy something online and they are met with setting up a new account at some strange website?
But could Amazon someday take over the retail world? Judging by the sensationalist coverage in the tech and financial press that is the impression you get. I really hate those clickbait titles. Amazon is not going to destroy brick-and-mortar retail stores. Far from it. If Amazon continues on the road that they are on, they will be forced to join the brick-and-mortar retail world, not destroy it.
Here is Amazon’s situation from someone who’s quantified various network price tags. Distribution costs per unit are higher for online/catalog retailers than they are for old fashioned retailers. It’s much more expensive on a per unit basis to deliver an individual box to your front door than it is to fill a trailer with forty pallets of that same item to a store and have everyone come pick it up on their own dime. This part everyone knows.
What makes catalog/online retailers cheaper than traditional brick-and-mortar stores is that they don’t have to pay the high fixed costs for all those retail buildings, inventory, and employees. The savings of not having the retail footprint outweighs the variable higher delivery costs. Delivery costs are variable and stay low with low volume. However, this model only works in a certain sweet spot. Retail stores are like automated factory equipment. The fixed costs are high but after you cross a certain volume threshold it makes more financial sense than paying the variable costs of expensive individual delivery.
If you greatly increase the volume delivered to people’s houses, the cost of adding additional distribution centers and complexity starts to eat away at your inventory and labor savings. Catalog retailers make their money on people living in or near large cities and lose money on the people who live furthest from their distribution centers. As long as the mix of people living in far-away places stays small, all is well.
I used to help calculate the shipping rates that Cabela’s would charge their catalog and online shoppers. It was always a blended rate that assumed certain percentages of profitability based on location. We made lots of money on selling small fishing lures to Dallas and lost lots of money on big coolers destined for Tokyo. If volume in an unprofitable geographic area greatly picked up we only had two options. Raise our prices or open a new distribution center to serve that area.
The mathematical models always lead to the same outcomes as volume grows. Every corporation will reach a break-even point where the high cost of delivery to individual homes starts to outweigh the cost of a retail stores with inventory and labor. At some point, it starts to become cheaper to invest in a local retail outlet. The question is when.
The biggest danger to retail stores in your local city is not that people start to order everything online. The real danger is that Amazon will open up their own store across the street. They will become the next Walmart invading local towns. Even if Amazon wanted to do drone delivery, it would require a footprint every bit as a large as Walmart because drone’s can’t fly very far.
If Amazon were to stick with their delivery to your front door philosophy they would be at a cost disadvantage to Walmart who could then undercut them in price. Because Walmart wouldn’t have the high cost of delivery to each house. If Amazon were to charge a premium for drone delivery to mitigate this danger, most people would opt to pick up their stuff to avoid the charge. And Voila! Amazon is right back into regular retail.
Online shipments are a nice augmentation to the retailers strategy and has its place. However, it can’t every fully replace retail stores because the math just isn’t there.
Now available in iBooks —> The Tesla Bubble
Here is Amazon’s situation from someone who’s quantified various network price tags. Distribution costs per unit are higher for online/catalog retailers than they are for old fashioned retailers. It’s much more expensive on a per unit basis to deliver an individual box to your front door than it is to fill a trailer with forty pallets of that same item to a store and have everyone come pick it up on their own dime. This part everyone knows.
What makes catalog/online retailers cheaper than traditional brick-and-mortar stores is that they don’t have to pay the high fixed costs for all those retail buildings, inventory, and employees. The savings of not having the retail footprint outweighs the variable higher delivery costs. Delivery costs are variable and stay low with low volume. However, this model only works in a certain sweet spot. Retail stores are like automated factory equipment. The fixed costs are high but after you cross a certain volume threshold it makes more financial sense than paying the variable costs of expensive individual delivery.
If you greatly increase the volume delivered to people’s houses, the cost of adding additional distribution centers and complexity starts to eat away at your inventory and labor savings. Catalog retailers make their money on people living in or near large cities and lose money on the people who live furthest from their distribution centers. As long as the mix of people living in far-away places stays small, all is well.
I used to help calculate the shipping rates that Cabela’s would charge their catalog and online shoppers. It was always a blended rate that assumed certain percentages of profitability based on location. We made lots of money on selling small fishing lures to Dallas and lost lots of money on big coolers destined for Tokyo. If volume in an unprofitable geographic area greatly picked up we only had two options. Raise our prices or open a new distribution center to serve that area.
The mathematical models always lead to the same outcomes as volume grows. Every corporation will reach a break-even point where the high cost of delivery to individual homes starts to outweigh the cost of a retail stores with inventory and labor. At some point, it starts to become cheaper to invest in a local retail outlet. The question is when.
The biggest danger to retail stores in your local city is not that people start to order everything online. The real danger is that Amazon will open up their own store across the street. They will become the next Walmart invading local towns. Even if Amazon wanted to do drone delivery, it would require a footprint every bit as a large as Walmart because drone’s can’t fly very far.
If Amazon were to stick with their delivery to your front door philosophy they would be at a cost disadvantage to Walmart who could then undercut them in price. Because Walmart wouldn’t have the high cost of delivery to each house. If Amazon were to charge a premium for drone delivery to mitigate this danger, most people would opt to pick up their stuff to avoid the charge. And Voila! Amazon is right back into regular retail.
Online shipments are a nice augmentation to the retailers strategy and has its place. However, it can’t every fully replace retail stores because the math just isn’t there.
Now available in iBooks —> The Tesla Bubble
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