June 23, 2017

Editor Note: I hope the below provides a brief respite from the barrage of Uber news. This is the first of a two-part series around ways companies can build new core businesses/distribution by using Amazon as a case study. By leveraging a company’s internal needs and strategically playing with the value chain, new core businesses and distribution channels can be created. Little talk on financial services today, but part 2 will apply this model to banks.

The basis of this framework comes from an insightful analysis by Ben Thompson on the rationale behind Amazon’s purchase of Whole Foods. There are some easy headlines to write, such as Amazon’s testing of retail stores and contactless payments technology, as well as Amazon’s desire to get into groceries for nearly two decades (investing in HomeGrocer.com in the 1990s, AmazonFresh has been around for 10 years)).

Ben takes a deeper dive to lay out how Amazon has built new core businesses over time. By being its “first-and-best customer” of exceptional internal distribution and logistics, they had justification to invest to scale the logistics and fulfillment operations until it was good enough to sell as “Fulfillment by Amazon” to other retailers. By being the “first-and-best customer” of its data infrastructure, it achieved scale to sell AWS to others. And now, by acquiring Whole Foods, it has a built-in customer who will justify the scaling of its grocery business, which it can then break down and sell to other grocers.

Amazon is one of the few technology-based success stories that has been successful in growing significant revenue outside of its original core business. For example, only about two-thirds of its 2016 revenue came from the traditional “Amazon-as-retailer” model. Its “Fulfillment by Amazon” business above generates about 17% of revenue, and the AWS segment contributes 9% of total revenues. (Note: the percentage of revenue may not sound like a big deal since it is skewed by Amazon’s massive scale. Example – its AWS service generated $12 billion in revenue in 2016, which was 50% more than Salesforce’s total company revenue of ~$8 billion.)

Amazon’s ability to create massive new revenue business stands in contrast to most other technology companies, who have had an incredibly difficult time building new core sources of revenue. Google still relies on advertising for around 90% of its revenues, despite all of the experimentation around other ideas such as phones (Android and Pixel), autonomous cars (Waymo), life sciences (Verily), glasses (Google Glass), carbon-neutral fuel made from seawater, etc.

As Ben points out, the acquisition of Whole Foods is different from its prior expansion into third-party fulfillment and AWS. While for those two businesses, Amazon itself was at the scale that justified continued investment into a high fixed cost model, Amazon’s grocery efforts were never critical enough to the organization to rationalize the level of spend required. That has changed with Whole Foods, as now Amazon can justify spending much more to solve the needs of Whole Foods, and can then turn around and sell that grocery expertise to other grocers.

Let’s look at Porter’s Value Chain to get a more generic framework that we can build on later. You have:

Inbound logistics > Operations > Outbound logistics > Marketing/Sales > Service

In Amazon’s core business of hard-goods retail, they own the entire value chain, and the business logic of profitable sales created the flywheel effect allowing them to pour more and more money into perfecting hard-good logistics. However, perishable goods are much harder to handle, requiring extra investment in a new process. Since Amazon lacked the Marketing/Sales link in the chain, they couldn’t create the flywheel to put enough money into fresh-food logistics.

Whole Foods is the Marketing/Sales channel that relies on all of the behind-the-scenes logistics. Since Amazon couldn’t build out the value chain itself, despite its continued efforts, it eventually acquired what it couldn’t build itself.

While most businesses see the back-end processes as just enablers to fulfill the customer-facing Marketing/Sales channels, this new look at the value chain turns each part into a valuable business. Next week, we’ll look at what banks have been doing in treating themselves as Customer #1, and what potential exists in the market for a Whole Foods-type move for banks to acquire new internal customers by taking advantage of their value chain.