Friday, September 30, 2011

Long Term Digital Transformation – What Can We Learn From Amazon? - by Brian Crounse

I’ve been thinking about Amazon recently. There hasn’t exactly been a shortage of ink spilled or bits flipped by people writing about Amazon. But I’m not writing about the Kindle Fire. Or how Amazon’s 2012 Kindle-related sales may exceed $6 billion. Or about Zappos. Or the Elastic Compute Cloud. All of those topics are interesting, but that’s not what I want to talk about.

I want to talk about OEM motor vehicle aftersales.

While Amazon and this industry have their differences (e.g. Amazon doesn’t have to ship mining truck axles to the middle of Chile, but they ship to millions of customers, and have seasonality issues that make even harvest-time at an agricultural OEM look tame), they have some basic commonalities: they both exist in a time of digital transformation, they both have awesome supply chain challenges, they both sell service parts, and they both want more market share. In this post, I want to talk about digital transformation. I’ll discuss the other topics in future posts.

Digital Transformation

At Carlisle & Company, we are spending a lot of time collaborating with our clients on digital aftersales strategies. Sometimes, the skeptic in me wonders why. Though we think we understand how future behavior by emerging digital service customers (EDSCs—a horrid consulting acronym if there ever was one) will shape the market, early returns are ambiguous. While our surveys and focus groups tell us that these customers are substantial in number even today, and currently have their opinions of service options shaped by online resources like reviews, it’s still hard to see where the dollars are, or how the money we invest will reap returns.

We at Carlisle haven’t earned much money in this domain yet, despite substantial investments of thought and time, and our clients, who are busy building and enhancing owner centers, online appointment capabilities, and mobile apps, haven’t hit the ball out of the park yet either. Are we doing this because we’re smart and thinking long term, or because it’s trendy and fun? While I personally schedule my car service appointments online, and have a few parts and service-related applications on my phone, I’m not exactly a representative sample. I think way more about vehicle aftersales than normal people. I also wear those weird Vibram toe shoes around the office—I’m kind of an outlier.

But then I am reminded of Amazon. Its 1997 letter to shareholders (a letter that Jeff Bezos is obviously proud of; it’s helpfully reprinted in each year’s 10-K) emphasizes that “It’s All About the Long Term.” And it was. And is. Amazon had a net loss in 1997. And 1998. And 1999. It had a net loss of $1.4B on $2.7B in net sales (yes, a net of -51%) in 2000. By 2001 (another year with a net loss), Amazon’s market cap was 80% off its peak, driven down in part by the dot-com bubble burst, in part by these mounting losses and negative free cash flow. In 2001, it was reasonable to be nervous about Amazon’s future.

Meanwhile, in 2001, the Borders Group reported $87M in earnings on $3.3B in sales, the 6th consecutive year of steady profits.

We all know what happened since then. Amazon bet on online commerce, executed brilliantly, and won. Borders lost. They weren’t direct competitors, but they sold enough of the same stuff, so they provide a useful contrast. It’s amazing to me not just that Amazon survived, not that they “won”, but that they won big.

Here’s their sales trend since 1997. I used a log scale to highlight how steady the growth has been on a percentage basis for the past decade:

Here’s a chart of their net income by year, and a simple (no discounting) cumulative sum of their net income/loss. Amazon would argue that free cash flow is a better measure of performance, and I’d usually agree, but I went with net income because the free cash flow calculations that I could track down were incomplete and a little dodgy.

I find these curves remarkable, because of both the size of the annual and cumulative losses, and the current positive trajectory. Amazon’s cumulative income, even before any consideration of a discount rate, was negative from its founding through 2009. It’s now throwing off $1B+ a year in income, supposedly more in free cash flow, and has a market cap of over $100B (at the time of this writing). Talk about focusing on the long term. And, eventually, succeeding. Big.

So how does Amazon’s current success, which has many factors, apply to OEM vehicle aftersales businesses?

Here’s my point: Even if we can’t see the money yet with digital service customers, maybe we need to take the long view and be confident in our efforts. We know that the web, social media, and mobile devices are profoundly changing how consumers select and purchase goods and services. We believe that we need to engage in these areas, at the very least as a defensive action, as our research indicates that digital consumers tend to move away from genuine OEM parts and service. Beyond that, we believe that we can use digital media to strengthen our relationships with our customers. The hard benefit NPV of our efforts may not be apparent yet.

But, I am reminded again of Borders and Amazon. One company seemed intent on preserving its established, profitable business, with some online enhancements, all the way to Chapter 11. The other bet big on its digital strategy, executed brilliantly, and is worth $100 billion.

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