Reprogramming Amazon

It’s crunch time for retail-ers, and Amazon.comInc. is no exception. At its
nine massive distribu-tion centers from Fernley, Nev., to Bar Hersfeld, Germany,
workers scurry around the clock to fill up to 1.7 million orders a day–picking
and packing merchandise, routing it onto conveyors, and shipping the boxes to
every corner of the world. Like any retail warehouse  running manpower and
machinery at full holiday throttle, it’s an impressive display–but utterly
misleading. The kind of work that will truly determine Amazon’s fate is
happening in places like the tiny, darkened meeting room at its Seattle
headquarters where, one recent afternoon, five intent faces gazed at a
projection screen.

Jeffrey A Wilke, a compact, intense senior vice-president who runs Amazon’s
worldwide operations and customer service, and an engineering team were trying
out a ‘beta’ or test version of a new software they wrote. When the buying
automation program is ready for prime time in mid-2004, Amazon’s merchandise
buyers will be able to chuck reams of spreadsheets for graphics-rich
applications that crunch data for them, so they can more quickly and accurately
forecast product demand, find the best suppliers, and more. The effort is one of
scores of technology projects under way at Amazon that ultimately may change the
entire experience of shopping online–and Amazon itself.

BEZOS Aiming for an e-commerce platform that’s as mighty as Windows

Just as most folks have come to view Amazon as a retailer that happens to
sell online, guess what? It’s morphing into something new. In ways few people
realize, Amazon is becoming more of a technology company–as much Microsoft
Corp. as Wal-Mart Stores Inc. "What gets us up in the morning and keeps us
here late at night is technology," says founder and CEO Jeffrey P Bezos.

"From where we sit, advanced technology is everything."

No, Amazon isn’t selling its own shrink-wrapped software or leaving the
retail business behind. But developing technology is becoming at least as
important as selling Harry Potter books or The Strokes CDs. Indeed, some
analysts say it’s possible that in a few years so many other retailers will be
using Amazon’s tech expertise to sell on its site that they could account for
more than half the products sold on Amazon.com. Says Bezos: "Amazon
Services could be our most important business."

Already, Amazon’s technological efforts have helped it reduce costs and
boost sales so much that revenues are expected to surge 32% this year, to $5.2
billion. As a result, by the time the glittering ball descends in Times Square
on new year’s eve, Amazon may well reach a milestone some never thought it
could: its first full-year profit (chart). No wonder its stock has rocketed 152%
this year, to $49.34 a share.

But all that is just the start. Building on a raft of tech initiatives, from
an ever-richer website to new search technology, Bezos aims to reprogram the
company into something even more potent. The notion is to create a
technology-driven nexus for e-commerce that’s as pervasive and powerful as
Microsoft’s Windows operating software is in computing. That’s right: Bezos
hopes to create a Windows for e-commerce.

Self-reinforcing Cycle

Far-fetched? Not necessarily. After all, the Amazon.com website is already
essentially a giant application that people simply use over the Web rather than
in their personal computers. And bit by bit, just as its Washington neighbor did
two decades ago, Amazon is building what techies from Silicon Valley to Redmond
call a platform: a stack of software on which thousands or millions of others
can build businesses that in turn will bolster the platform in a
self-reinforcing cycle.

Since last year, Amazon has been steadily turning innovations it developed
for its own retail site into services available online. Using these so-called
Amazon Web Services, reached via a browser, merchants who want to sell more can
use its patented one-click purchasing system, for instance, or tap quickly into
sales data for particular products. Even independent programmers are getting
interested: In just 18 months, up to 35,000 programmers have downloaded software
that enables them to pick and choose Amazon services and, much as they do with
Windows, write new applications based on them.

Such developments recall the same creative spark that launched the PC
industry and, more recently, put the Linux operating system on the map. One
program makes it easy to list products for sale on Amazon. Another lets
merchants instantly check prices at Amazon via a wireless Web device when they’re
looking at stock to buy. It’s a volunteer army that costs Amazon almost
nothing. "I see them not just as a place to sell things but as a provider
of technology," says programmer Paul Bausch, author of Amazon Hacks: 100
Industrial-Strength Tips & Tools, a new book on how to use the technology
behind Amazon’s site.

Amazon doesn’t make money directly from the Web services. Merchants and
developers can get free access to the services and can use them to sell from any
outpost on the Web. Still, many of the merchants who use applications spawned by
Web services end up selling their wares to the 37 million customers assembled at
Amazon.com. When that happens, Amazon takes a commission of about 15%, and these
revenues have much higher margins than Amazon’s own retail business. Already,
22% of Amazon’s unit sales are by other merchants–and the Web services push
hasn’t had a significant impact yet.

Busting Out

While Amazon isn’t exiting retailing; its tech initiatives could, to some
extent, set it free. By beefing up its technology and distributing it more
freely, Amazon could bust out of the conceptual prison of stores and the virtual
confines of a single website. Says e-commerce consultant and author John Hagel
III: "It’s really breaking apart the whole store metaphor." Into
what? Already, Amazon has applied its own technology to forge an identity as an
online mall–a piece of business that generates gross margins about double its
25% retail margins. Plugging into its massive e-commerce system, thousands of
retailers from mom-and-pop shops to Lands’ End Inc. and Circuit City Stores
Inc. sell through its site. Amazon even runs the websites and distribution for
the likes of Target Corp. and Toys ‘R’ Us Inc., which are featured on
Amazon.com.

If Bezos’ new plans work, Amazon could become not just a website but a
service that would allow anyone, anywhere, to find whatever they want to buy–and
to sell whatever they want almost as easily. For Amazon, that means its finances
could look considerably better than traditional retailers’. Already it turns
over inventory 19 times a year, nearly double Costco Wholesale Corp.’s 11 and
almost triple Wal-Mart’s seven. Yet unlike most retailers, it hasn’t had to
trade asset efficiency for profits. Its 25% gross margin is nearly double Costco’s
and three points higher than Wal-Mart’s.

How much Amazon can expand the narrow margins of retail remains to be seen.
But if even the conservative forecasts of analysts are correct, Amazon has a lot
of upside in coming years. Shawn Milne of SoundView Technology Group Inc. sees
sales continuing to rise no less than 15% a year through 2008, to $11.3 billion,
with operating margins steadily marching up from 7% this year to 11.6% in five
years. That’s hardly the territory of Microsoft, with its 35.5% margins, but
it’s more than double Wal-Mart’s 5.3%. "You’re going to see the
company look a lot different from a retailer in terms of financial
metrics," says Milne. "Opening up the technology to other sellers is
what has gotten the Street interested."

Impossible Dream?

Bezos’ vision won’t be easy to fulfill. Trying to be a world-class retailer,
a leading software developer, and a service provider simultaneously strikes some
observers as a nearly impossible endeavor. Even some Amazon partners report
shortcomings in merchandising and technical support. Others worry about Amazon’s
inherent conflict in playing both retailer and mall owner. "They’re
biting off a lot," says Forrester Research Inc. analyst Carrie A Johnson.
"That’s their biggest risk."

BELIEVER Bookseller Wilson calls Amazon Web Services key to his business

Amazon is hardly alone in its ambitions, either. EBay Inc., the Web’s
largest marketplace, is building its own e-commerce platform. Already, it boasts
several million sellers, at least 37 million active buyers, and more than $20
billion in gross sales–quadruple Amazon’s and is far more profitable because
eBay doesn’t handle goods. Increasingly, merchants of all stripes view the two
companies as key channels to online customers. And eBay isn’t the only
contender. Search upstart Google Inc. and even Microsoft, each with its own Web
services initiatives, also aim to be hubs for connecting both shoppers and
merchants.

Still, Bezos’ bet on technology has paid off so far. Consider what has
happened in its much-criticized distribution centers, which Amazon spent $300
million to build. Back in 2000, they were eating up at least 15% of sales,
partly because processes to pick and pack different items such as books, toys,
and CD players weren’t very efficient. Chutes holding pending orders got
backed up when products didn’t arrive on time. Rampant mistakes required
expensive manual fixes. Software was primitive, too: Workers had to enter data
into the system using arcane Unix software commands.

Now, by most accounts, the warehouses hum more like Dell Inc.’s
build-to-order factories. With a menu-driven software console, workers can
anticipate where bottlenecks are likely to occur and move people around to avoid
them. Another program rolled out this year sets priorities, based on current
customer demand, for which products should be placed at the front of supply
lines, further speeding the flow.

The result: Amazon’s distribution centers can handle triple the volume of
four years ago and cost half as much to operate relative to revenue, just 7% of
sales. Wilke believes further software improvements can boost productivity by up
to 10% a year.

All that has kicked off the virtuous cycle that’s now propelling Amazon
toward more consistent profits. Lower costs have enabled it to offer more
product discounts and free shipping on most orders over $25. Those moves are
credited with recharging sales–and with operating costs up only 5% this year,
the benefits have dropped right to the bottom line.

Even so, Bezos isn’t resting easy. While Amazon’s spending on technology
likely will remain fairly steady next year at about $216 million, thanks to
declining tech prices, chief technology officer Al Vermeulen says he will hire
hundreds more software engineers and computer scientists in the next year.
"Jeff is a very big driver of the technology," says Amazon director
Tom Alberg, managing director of Seattle-based Madrona Venture Group.

For one, Bezos believes there’s still plenty of room for improvement on the
website itself. To that end, he hired last year what likely is a first for
corporate America: a chief algorithms officer, Udi Manber. His mission: to
develop better versions of algorithms, the complex mathematical recipes that get
software to do its magic. In particular, he’s creating improved algorithms for
Amazon’s newest tech push: search. On October 23, Amazon launched Search
Inside the Book, a feature that allows visitors to find any word or phrase on 35
million pages in 120,000 books, and let them read entire pages around those
keywords. In the week following, average sales growth for those books was nine
percentage points higher than for books not in that database.

Manber has bigger plans yet. He now heads Amazon’s first Silicon Valley
outpost, a subsidiary called A9 that’s charged with coming up with
cutting-edge search technology. It’s not just a defensive shot at search
phenom Google, which is testing a shopping search engine it calls Froogle.
"We need to help people get everything they need, not just a Web
page," says Manber. And whatever he and his team come up with–he’s mum
now–it won’t be confined to Amazon.com. A9 plans to offer search services it
creates to other e-commerce sites as well.

Technologies like that, in which Amazon is reaching out beyond its own site,
offer the most intriguing new opportunities–and challenges. Consider Amazon’s
Merchant.com business, which takes over the entire e-commerce operations of
other retailers. By all appearances, it’s a success. In Toys ‘R’ Us’
most recent quarter, in which results were dismal, the one bright spot was a 15%
jump in sales at Toyrus.com, run by Amazon. Other retailers seem happy, too.
"Amazon is the most sophisticated technology provider and service partner
on the Internet," says Target vice-chairman Gerald L Storch.

‘An Ecosystem’

That’s why Web Services, unfettered by logistical challenges or business
model conflicts, may offer the most expansive potential of all Amazon’s tech
initiatives. Nowhere is the potential more apparent than among the small
merchants and independent programmers who are flocking to Amazon Web Services.
"It’s like an ecosystem," says Bezos. "People are doing things
that surprise us."

People like Cleveland Wilson, a former tech recruiter who started selling
books on Amazon in early 2002. Until this year, he didn’t even think it would
be enough to pay his rent in Berkeley, Calif. But he discovered a program called
ScoutPal that uses Amazon Web services to let booksellers type or scan in a book’s
ISBN number to a laptop or wireless Web device and instantly see what it’s
selling for on Amazon. So when he visits thrift stores and garage sales, he can
buy books he knows will be profitable to resell. For example, he paid $8 for
Suicide and Attempted Suicide: Methods and Consequences and sold it for $275.
From $100,000 in sales this year, he expects to do $250,000 next year because he
has cut the time it takes to buy and sell books by two-thirds. "Without
Amazon Web services, I wouldn’t be in this business," he says.

Amazon, the next Microsoft? Not so fast. For all the promise, building a
broad platform is about as tough as a goal gets in the tech business–as nearly
every competitor to Microsoft can attest. And unlike most tech companies, Amazon
also has to contend not just with bits and bytes but also with the bricks and
mortar of warehouses and the fickle fingers of Web shoppers.

But for now, at
least, Amazon’s pursuit of cutting-edge technology has given it time to figure
out what comes next.

By Robert D Hof in Seattle in BusinessWeek. Copyright 2003 by The McGraw-Hill Companies, Inc

Turning to Tech

Amazon.com
is turning up the heat on its technology
initiatives–some of which are already paying off.

Search
On Oct.23,Amazon introduced Search Inside the Book, allowing browsers to
find any word or phrase in 120,000 books. In the following week, average
sales growth for those books was nine percentage points higher than for
books not on that list.

Web
Services Last year, Amazon began offering its underlying technology,
from its huge product database to its online shopping cart, as individual
services available over the Web to independent programmers.So far, up to
35,000 programmers have signed up, creating dozens of new applications to
help small merchants sell  more on Amazon.com and elsewhere on the Net.

E-commerce
Outsourcing After several years running e-commerce operations for the
likes of Target and Toys ‘R’ Us, Amazon gave that business a boost in
June by breaking out a new services subsidiary. Gross margins for its
outsourcing biz are nearly double
its 25% retail margins.

Web-site
Features Thanks partly to individualized pitches on clearance
merchandise, Amazon turns over inventory 19 times a year versus seven for
Wal-Mart. Prominent self-service buttons helped cut customer-service
contacts per order 50% since 1999.

Distribution
Software By using increasingly sophisticated software tools to improve
back-end operations and reduce mistakes, Amazon has slashed distribution
costs from 15% of revenues in 1999 to 7% today.