Friday, October 28, 2011

Amazon Prime – Are There Lessons for Service-Parts? - by Brian Crounse

Amazon’s stock got hammered this week, following relatively weak third quarter earnings, and it’s no longer a $100 billion company. At the time of this writing, it’s “only” worth $98B. The Harvard Business Review has some insights on why the weak earnings for Q3 may not be so problematic.

To date, I’ve talked about Amazon’s online victory, and about its problems at a warehouse in PA. In this post, I want to look at one prominent piece of Amazon’s customer retention strategy, Amazon Prime.

I got to thinking about Prime after reading this Practical Ecommerce article, which sheds some light on Prime’s successes. For those of you not familiar with Prime, here’s how it works:
  • Sign up for $79 a year (79 is a prime number. Get it?)…
  • …or it’s free if you sign up for e.g. Amazon Mom
  • Get free standard or 2 day shipping on all orders (no minimum order size)
  • Or get $3.99 overnight shipping per unit
  • Access some streaming digital media (e.g. movies) bundled for free
Prime was first launched back in 2004 or so, but seems to have really gained traction recently (the article reports that there were 2 million Prime Customers in 2009, which increased to 5 million in 2011).

The genius of Prime is that it removes nearly all friction from Amazon purchases. Once Amazon gets a customer over the hurdle to commit to the $79, there really are no more hurdles for placing orders. Customers don’t have to do the math to check whether a purchase makes sense once shipping charges are added in. They don’t have to wait to pool enough purchases together to make shipping charges acceptable (or qualify for other free shipping programs that have minimum order sizes). They don’t have to wait a week for slow-boat free shipping. They don’t have to pay much more for next-day service. Amazon easily becomes the first option for making purchases.

The consumer part of me LOVES this. The part of me that likes supporting local businesses HATES this (because I buy so much more from Amazon now). The part of me that works on customer retention strategy LOVES this. The supply chain analyst in me HATES this.

Amazon is basically willing to risk significantly lower margins (due to less shipping revenue, and higher shipping costs) in exchange for growth opportunity.

For customers paying the $79, the margin risk to Amazon is actually quite low. The chart below shows Amazon’s net profit (gross profit minus fulfillment and transport expense, plus shipping charges1) for a few different cases, assuming no change in customer behavior after joining Prime. The baseline case is the blue curve: it starts at zero and slopes up based on Amazon’s operating margins (gross margin less fulfillment and net transport costs). The green line shows estimated profits for customers that always use Super Saver Shipping. Amazon makes less money on these customers per dollar purchased, because the savings in transport costs (slow boat vs. standard) are likely lower than the lost shipping charge revenue. But the point of Super Saver Shipping is to grow sales by converting ~$15 purchases into $25+ purchases.

The purple line is for Prime customers. Note that it gets a big head start at $0 purchases. The $79 membership fee is a significant profit source for any customer that buys less than $1,000 of goods a year. That’s because Amazon is in a low margin business2. By making Prime sufficiently awesome (and having the ability to make frictionless purchases is pretty awesome), Amazon can really pump its profits from smaller customers. In fact, if you buy less than about $800 a year from Amazon, and join Prime at $79, they don’t even need you to order anything the next year. You already gave them the profit they’d get from selling you stuff.

The key thing about Super Saver Shipping is that Amazon already gives up a lot of transport cost recovery, especially for larger customers, whose average order size is very likely to be greater than $25. While the gap between the blue curve (where Amazon recovers much of the transport costs by charging the customer) and the purple Prime curve gets large for large customers, the gap between the green Super Saver Shipping curve and the Prime curve is much smaller. What this means is that Amazon isn’t really risking much with Prime. Any incremental sales volume, for almost all customers, leads to greater profit, despite higher transport costs and lost shipping charges. That’s a pretty cool strategy.

So what’s the take-home for service-parts?

It depends on the customer. Our dealers are already committed to us; they are franchises. So the part we can focus on is making purchases from us frictionless, to maintain or increase dealer purchase loyalty. How do we do this? One proven way is Retail Inventory Management (RIM). At its best, RIM makes buying from the OEM very easy. Parts arrive, as needed, with relatively little attention and labor required from the parts manager. And the best OEMs design RIM policies so that dealers can get quickly the parts not stocked by RIM, at a reasonable cost, without hoops to jump through. Kind of like the no-minimum, $3.99 1-Day shipping option for Prime.

But not all RIM implementations are perfect. They don’t always do an obviously superior job of managing parts inventory, and we don’t always make it easy enough for dealers to obtain non-stocked parts. So, many of us have room for improvement. In recent years, we’ve hosted several successful roundtable and panel sessions about RIM at our benchmark conferences. The next session for NAPB participants is our Focus Day on RIM, coming this February. This will be a great opportunity to discuss how we can make our RIM systems act as our version of Amazon Prime.

But even RIM has limited upside. Our dealers are already fairly loyal customers. The customers that aren’t so loyal are the independent repairers. What might an Amazon Prime program look like for them?

To make buying from us as easy as buying from Amazon via Prime, think of all the hurdles involved with buying parts from our dealers.
  • Repairer has to be motivated to call a dealer, rather than their usual all-brands sources
  • Repairer has to wait on hold for 15 minutes
  • Repairer has to talk with a distracted parts manager to be sure they have the right part
  • Repairer has to wait several hours for the parts to be delivered
  • Repairer has to be prepared to bicker over a return if there’s something wrong with the parts (incorrect part, damage, etc.)
I’m just dreaming, but maybe we could follow Prime’s lead and do this: For a fixed price (that could be waived under various favorable conditions), independent repairers could:
  • Access an online multi-brand, detailed catalog of genuine parts;
  • Place an order online, which is then routed to the closest participating wholesaling dealer and confirmed, with a stated same-day ETA;
  • Offer guaranteed order response times - the repairer gets a discount if the parts are late, which both the dealer and OEM eat.
Actually, I’m not completely dreaming. Some OEMs have their own commercial parts sites that have some of these features. Others are looking closely at patching into aftermarket ordering systems. OEConnection’s RepairLink with MORE is in the right ballpark, at least on paper. But the key is in the execution, so that ordering parts from our wholesaling dealers is truly frictionless.

1We’re leaving marketing, S&GA, and other non-supply chain costs out of the equation here, which means we’re assuming they are fixed costs. The parameters for fulfillment, transport costs, and shipping charges are estimates based on Amazon’s annual reports. It’s difficult to precisely estimate key items like the incremental cost of 2-day vs. Super Saver Shipping, so these curves do have some uncertainty.
2It’s non-digital retail business, at least. Its digital businesses may be another story.

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