Amazon: Breaking Down Four Myths

There’s no denying that Amazon has changed the face of retail, but there are many misconceptions about how the company actually operates. Many wrongly believe that Amazon makes most of its profits from e-commerce, while others incorrectly view Amazon as the long-tail poster child. Unfortunately, these fallacies are leading many retail companies into making bad strategic business decisions as they try to duplicate Amazon’s success.

The following is a breakdown of some Amazon myths along with a few takeaways:

Myth 1: Amazon makes most of its profits from e-commerce. Amazon’s most profitable and fastest-growing division is actually Amazon Web Services, its secure cloud services platform that offers database storage, content delivery, and other functionality to businesses.

According to Josh Olson, an Amazon analyst with Edward Jones Research, AWS made up “roughly one half of the overall operating profit for first quarter 2017, so it remains a significant driver of profitability.” In fact, Amazon recently reported AWS posted sales of $3.53 billion in revenue for fourth quarter 2016, but more than $300 million up from third quarter 2016.

Take Away: Amazon isn’t just a retail company — much of its revenue and operating income comes from other services including Amazon Advertising, Fulfillment By Amazon (FBA), and AWS. This means that Amazon is able to subsidize its retail strategy using these other revenue streams, something other retailers can’t imitate. Retailers need to be careful when attempting to replicate a select few of Amazon’s successes (like e-commerce) while ignoring the rest of its expansive portfolio that help make such successes possible.

Myth 2: Amazon does long-tail. For years analysts, researchers, and competitors have noticed Amazon’s apparent success in generating profit from its endless aisles of products, thus spurring many retail and e-commerce companies to adopt similar long-tail strategies.

In reality, Amazon doesn’t do long-tail at all. Instead, what it offers is a marketplace for third party merchants to sell long-tail products. Amazon, meanwhile, only focuses on directly selling and fulfilling high-demand products, leaving all the costs of curating an endless aisle of products to its independent sellers to deal with.

Take Away: Amazon is a massive company with access to large amounts of aggregated retail data and advanced machine learning algorithms. If Amazon has decided against selling long-tail products directly, other retailers with fewer big data resources at their disposal might want to rethink their own endless aisle strategies.

Myth 3: Amazon has been profitable for a long time. In fact, Amazon has only had 7 quarters of straight profits in its entire history. As recently as 2015 the Wall Street Journal reported, “with $89 billion in sales last year [2014], Amazon has grown to monolithic proportions, but that same timeframe also saw the company lose $241 million overall due to massive operating expenses.”

Amazon has been able to sustain its massive growth by reinvesting its profits. Its investors have allowed Amazon to do this with an eye to the company’s future earnings. As a former Amazon director Ben Conwell states, “Wall Street has given Bezos a ‘get out of jail free’ card to make scale and they don’t have to meet profit like the rest of retail.”

Take Away: As unfair as it is, Amazon’s approach of accepting losses year after year due to reinvestment is simply not one that other companies are able to follow. Considering that many of the factors fueling Amazon’s success are not replicable, other retailers should be careful about which of its strategies they attempt to imitate.

Myth 4: Out of state Fulfillment by Amazon (FBA) sellers aren’t responsible for sales tax.  The confusion here is around the concept of “sales tax nexus.” Usually, an online seller must collect sales tax in states where they have nexus, meaning some manner of presence such as an office, warehouse, employees, etc.

Now here’s the rub: depending on state tax laws, a seller’s FBA inventory often constitutes nexus with all of its associated sales tax liability.

But it gets worse.

Because Amazon constantly moves inventory to and from its fulfillment centers throughout the country, FBA sellers might be liable for sales tax collection in dozens of states they weren’t aware of.

The true extent of this movement can be quite significant. For example, one study found that 90% of FBA sellers reviewed have had FBA inventory pass through 14 states. Many of these movements could constitute nexus.

Take Away: Given the above, FBA sellers might find that they are actually responsible for collecting sales taxes in more states than other online sellers. This is especially true considering the fact that Amazon has cut deals with 30 states such as Utah that allow it to keep a portion of the tax revenue it collects, giving it an incentive for increasing the number of sellers with tax liabilities. Thus, any company that wants to use FBA services needs to be proactive in tracking their inventory and be aware of the tax implications in each state. Otherwise they may be open to audits and fines.

When learning from Amazon, two caveats must be kept in mind:

First, any attempt to replicate its strategies must be done with a clear picture of what Amazon actually is and how it operates. Only after retailers look at the facts around Amazon’s business model will they be able to draw practical lessons that fit their particular situations.

Second, retailers need to remember that not all lessons drawn from Amazon’s business practices will be useful or worth the time and effort. Amazon’s model is extremely unique and difficult to duplicate.

If you’re a retailer, focus your efforts on developing your own strengths, not just copying Amazon. These might include enhancing your physical stores to offer experiences and not just products, offering better curation of content and improved customer service, and deepening of niche market know-how.

Remember: there is room enough in this world for more than one river — not all streams lead to the Amazon.