An Illustrated Five Step Guide
Earlier this week Reuters broke the news that the U.S. House of Representatives Judiciary Committee has called on Amazon.com founder Jeff Bezos to testify on
“Allegations that the online retailer uses data from its own third-party sellers to create competing products”
The allegations are, and have been for some time, that Amazon engages in uncompetitive practices when it comes to how they compete with third-party sellers on the Amazon Marketplace.
Amazon’s platform for buying and selling consumer goods has since 2018 has enjoyed a 50% market share of all e-commerce in the United States. Starting in 2009, Amazon entered this marketplace as a seller, competing side-by-side with third-party vendors of popular “near-commodity” goods through their “private label” AmazonBasics. Since, their offering has expanded to over 1500 items and been joined by 100 other brands also owned by Amazon, selling first-party products alongside over 2,000,000 third-party sellers on the Amazon Marketplace.
One way to dive into this topic is by way of analogy to the noted antitrust case United States v. Microsoft Corporation, where the latter was accused of abusing monopoly power. Their defence, although multi-faceted, relied on the nature of network effects, colloquially defined as “demand-side economies of scale” or:
“The effect that an additional buyer/seller of goods or services has on the value of that good or service to others”
In the Microsoft case, the “service” was their operating system Windows, and their “abuse” was to leverage their (somewhat) natural monopoly position— a consequence of the indirect network effects that arise between users and developers of/on Windows — to generate insurmountable barriers to entry.
In the Amazon case, their “service” is their marketplace and their alleged “abuse” is similar: they are accused of exploiting the advantages of their 50% market share in e-commerce to create competing products that in effect make it impossible for third-party vendors of undifferentiated products to compete.
In my humble opinion (and I am no lawyer) Amazon’s conduct is not breaking any laws. Having studied how the company govern their marketplace however, does leave me with concern for third-party vendors. As such, consider this guide a warning, if you will, to third-party sellers.
“How Amazon will force you into bankruptcy”, in five simple steps:
Amazon Copies Your Popular Third-Party Product
Being the operator of a marketplace, Amazon has a unique informational advantage. Not only do they take a cut of every transaction on their platform, they also retain the data about which products sold at which price between which buyer and which seller, by individual transactions and in aggregate. This gives them unique opportunities for “exploitation”.
Put yourself in Bezos’ shoes. In order to reliably deliver your service, which in some areas includes same-day shipping, Amazon to a large degree is beholden to its suppliers. On the Amazon Marketplace, those suppliers include third-party vendors. If something goes wrong at a third-party vendor, Amazon’s customers are dissatisfied. The negative effects of supply limitations are not limited to those suppliers, in other words, but spill over to Amazon. A remedy to this, is for Amazon to take control their supply chain. That is, they can move into producing the items which their consumers turn to and rely on.
Being Amazon, which products should you begin producing first? Well, those exhibiting inelastic and high demand seem to be a good place to start. Which would that be?
“Let’s take a look at last month’s numbers”
It’s common sense for them to utilize their privileged information to improve their competitiveness and margin. Thus far, I don’t think they are stepping on many toes.
2. Amazon Undercuts the Price of the Original
Having decided which product categories to enter based on which products are most popular in their marketplace, Amazon next sets out to price their first-party versions of such goods. How much should they cost? Again, we go to the numbers.
Here, many of us likely disagree. Amazon is the 28th largest company in the world. They can afford to sell products with sub-optimal margins for a while. So they do. And have done for decades. They inevitably price their first-party products at or below the price of third-party sellers, partly because first-party products are known to be perceived as less valuable than those by third-party brands.
“Although Amazon is a publicly held company, its investors have tolerated years of razor-thin margins, which has partly played out by way of Amazon selling products at next to no profit or even at unprofitable levels.” — James Thomson
As a third-party seller, how long can you survive with sub-optimal margins?
3. Amazon Assimilates the Original
Having understood which products to buy and how to price them based on the private information they generate in their marketplace, Amazon next sets out to increase the volume for their own version of the third-party product. “What should it look like, what should we name it, how should we market it?”
Inevitably, Amazon will name the third-party version approximately exactly the same as the most popular third-party version (for SEO purposes, if nothing else) and take similar product photos. This is not uncommon (read: Hotelling’s Law). Indeed, it is a well-known phenomenon in both supermarkets and retail for vendors who offer first-party alternatives to third-party items to assimilate the packaging, messaging, price and positioning of their offering. They do it in order to minimize switching costs for consumers. Indeed, it has been proven to be rational by the so-called “median voter theorem”. I thus find this to be the spirit of fair market competition.
In my opinion, Amazon could however refrain from highlighting their own versions of the product as somehow “the best choice” ), especially when the original has more reviews, higher average reviews and sell at the same price. But, that’s just my opinion 🤷🏻♂️.
4. Amazon Steers Buyers Away from the Original
The next step is where we get really icky. Thus far, what I’ve discussed is well known. I believe however, I am the first to write about this:
As a third-party seller, let’s say, of lunchboxes, you’ve been selling your version for years and accrued over 400 positive reviews. You’ve answered 128 questions about your product in order to ensure that customers are satisfied, and they are! 4/5 star average for your brand of “EasyLunchBoxes”. God bless America.
To generate volume, and so boost their own product’s “average rating vs popularity ratio”, Amazon clearly doesn’t mind stepping on some toes.
However, highlighting their own version of a third-party product — which is more expensive and lower rated, by fewer people —seems unnecessary. Especially, I think, for the search term of the name of the third-party version, “Amazon’s Choice for ‘easy lunchboxes’”. Yuck.
5. The Third-Party Seller Leaves Amazon
At this point, Amazon has won. As a consequence of their market share, consumers will keep buying their consumables from Amazon. As a third-party seller, you’re left with an unenviable dilemma:
Stay and try to compete with an Orwellian Big Brother; or
Leave, increasing your consumers’ switching costs and your own customer acquisition costs, effectively limiting your addressable market to < 50%;
Amazon with its Amazon Marketplace, much like Microsoft with its Windows, Apple with its iOS and Google with its Android, operate what we in research refer to as intermediary economic platforms in two-sided markets. That is, they provide services which help one group (of sellers) interact and transact with another (consumers). As a consequence, they retain information advantages which they can exploit to increase the quality of their service, at the expense of one side of their platform (producers) to the advantage of the other side (consumers). The allure of their services are simple and natural, a consequence of network effects.
Amazon’s Marketplace in the short term lowers customer acquisition costs for sellers (they have a 50% market share), and opportunity costs for buyers (they can buy everything in one place);
Amazon acts in a dual role in its market place. In their role as a platform operator, Amazon has access to unique, near complete information about which products are more successful and why. As such, they — with their 50% market share of all e-commerce in the U.S. — possess a competitive advantage which they can exploit to generate better margins for themselves. They do so by assuming a dual role as both platform operator and a seller with privileged, private information;
Market concentration enables Amazon to get away with it. If there were a viable alternative to the Amazon Marketplace in the U.S. (as there is to Uber, in Lyft), producers (sellers/drivers) could choose to not deal with the platform operator that competes with its own sellers. If/when Uber starts implementing autonomous cars in certain areas, drivers in those areas can choose to not compete with Uber and instead drive for Lyft exclusively. As it stands right now, third-party sellers on Amazon Marketplace have no viable option. There simply is no Lyft in e-commerce that can minimize customer acquisition costs in the way Amazon can ;
This final point is where Amazon differs from supermarkets and retail, which have been known to engage in similar practices. As a consequence of their enormous (somewhat) natural monopoly, Amazon is in the enviable position of having no competitors. They are unique, they know it, and they take advantage of it.
Just stop being gross about it. And pay sick leave for your fucking employees.