Another approach to the chicken and egg problem - Part 4
How did Amazon become a marketplace?
In the previous sections we outlined why each of the three parties - customers, sellers, and Amazon - is participating in the marketplace ecosystem. In this part we will dive deeper on the first to third party transition to explain how Amazon transitioned to a marketplace.
Amazon’s transition took twenty years from initial experiments to today’s state where about 60% of total sales come from third parties. Amazon made sure to offer a lot of value to both supply and demand to make the decision to participate in the marketplace easier for buyers and sellers. Jeff Bezos gives some more color on the strategy in the same 2018 stakeholder letter:
"We helped independent sellers compete against our first-party business by investing in and offering them the very best selling tools we could imagine and build. There are many such tools, including tools that help sellers manage inventory, process payments, track shipments, create reports, and sell across borders – and we’re inventing more every year. But of great importance are Fulfillment by Amazon and the Prime membership program. In combination, these two programs meaningfully improved the customer experience of buying from independent sellers. With the success of these two programs now so well established, it’s difficult for most people to fully appreciate today just how radical those two offerings were at the time we launched them. We invested in both of these programs at significant financial risk and after much internal debate. We had to continue investing significantly over time as we experimented with different ideas and iterations. We could not foresee with certainty what those programs would eventually look like, let alone whether they would succeed, but they were pushed forward with intuition and heart, and nourished with optimism.”
Phase 1 - Amazon develops initial supply: Even before the first marketplace experiments, Amazon started laying the foundations of a successful marketplace based on their first party business. Amazon developed the supply side through a first party model, starting with books and expanding to other categories while also launching the first international websites. With this initial supply, Amazon built a customer base which in turn gave sellers an incentive to list their products on the platform.
Phase 2 - Marketplace launch: In late 1999, Amazon launched the first marketplace version known as zShops. In the following years Amazon kept experimenting and iterating on the idea of a third party model.
Phase 3 - Marketplace scale: Amazon invented a scalable model - invested in seller recruiting, provided a lot of tools and value, and allowed sellers to directly compete with the Amazon Retail business.
What were the key strategies to drive this scale?
1. Create a standardized customer experience: We might be taking the Amazon approach for granted but there were several alternatives. Many marketplaces started as listing sites where a buyer was redirected to a seller’s website to complete a purchase. Amazon decided to follow a strategy that standardized the customer experience independent of the product or the seller, creating an experience where buyers could complete purchases without worrying about any risk interacting with an unknown third party. Customers submit their payment information once and then all following transactions can be completed with a few clicks. Needless to say, this leads to increased conversion rates. A notable innovation was the A-to-Z guarantee program, which protects Amazon customers when they purchase items sold and fulfilled by a third-party seller, covering both the timely delivery and the item condition. Customers can file a claim and Amazon will refund them usually ”no questions asked”.
2. Launch a set of value added services: To better support sellers and improve the marketplace experience, Amazon launched several value added services.
NYU Stern professor Sonia Marciano has introduced the idea of focusing on the piece of the supply chain with the greatest discrepancy. Amazon quickly realized that the greatest variance in the customer experience was the fulfillment. To mitigate, Amazon launched the biggest game changer in their marketplace play, the Fulfillment By Amazon (FBA) program. FBA allows sellers to send their inventory in Amazon Fulfillment Centers. Amazon stores seller inventory and owns the fulfillment when the seller receives an order. Amazon “will pick, pack, ship, and provide customer service”. With FBA, Amazon increased control of the fulfillment experience, reducing out of stock (as the product is already in an Amazon warehouse), and ensuring on time delivery. At the same time, Amazon increased utilization of their fulfillment network which justified higher investments and growth.
Amazon provided incentives for using the program as it awarded the Prime badge to third party products fulfilled through the Amazon Fulfillment Network, instantly making third party products more compelling and increasing conversion. This made FBA more compelling, driving high seller adoption, and the combination was another tailwind in the marketplace flywheel.
Another added value service is the Amazon Lending, a program that provides loans for sellers to expand their business on Amazon. The concept is simple and brilliant; sellers have a hard time getting a loan as banks don’t understand their business or have limited visibility on their performance. Guess who both understands the marketplace business model and knows how well a seller is doing. Amazon lends money to sellers to grow their business. Sellers can get working capital to buy more inventory, expand a product line, or invest in advertising or promotions. Now guess who is a beneficiary of all these actions (in addition to the seller). Amazon again. Amazon is better equipped than any bank to lend sellers because of their unique position.
Amazon has visibility on seller performance and benchmarks to assess it. Amazon develops their models based on data points for millions of sellers on the platform and can effectively predict which sellers have the potential to grow.
Amazon is directly receiving money from customers and pays sellers their cut. As a result, sellers can’t just decide not to pay Amazon as it already holds their money. In addition to any selling fees, Amazon also keeps any amount due for the loan repayment and pays sellers the remaining amount.
Another addition to the seller services is Amazon Advertising. Competition on Amazon is fierce, so sometimes product discovery needs some extra boost. Amazon is offering sellers a program to advertise their products and increase their sales. The big success of the program is mainly attributed to the proximity to funnel completion. To better understand this let’s compare the use of several ad options for a coffee seller.
Using Google, the seller can advertise on relevant searches for terms like “coffee”. The ad appears in the “sponsored results” area above other results. If a customer clicks on the ad, they get redirected on the seller’s website, where they need to provide their personal, shipping, and payment details in order to checkout.
Using Amazon, the seller can advertise on relevant Amazon searches for terms like “coffee”. The ad in the form of an Amazon product, appears in the “sponsored results” area above other results. If a customer clicks on the ad, they get redirected on the Amazon product page with an one-click add to cart option. Amazon already has all checkout details which makes the buying process frictionless.
Which of the two you think has the highest conversion? Amazon benefits from their position closer to the funner completion, and has managed to very quickly scale an advertising business on top of it’s ecommerce platform. Amazon advertising grew by 41% YoY, reaching total revenue of $4.78B in Q4 2019.
Last but not least, Amazon offers a comprehensive set of tools for running a business, including seller tools for managing inventory and pricing, product recommendations, and reporting.
3. Allow Sellers to compete with Amazon: Amazon has treated sellers as first class citizens of the marketplace platform, viewing Amazon Retail as one more marketplace seller. Undoubtedly, Amazon Retail is not just any seller as it’s contribution to sales and revenue is huge, but Amazon realized very early that to be successful it should allow other sellers to compete. Not surprisingly, the team took a very customer centric view where it would recommend to customers the best offer (see specific ways in the first part) independent of who the seller was. Amazon gave sellers access to their customer base, including the very valuable Prime members. Initially this was accomplished though the FBA launch, and more recently Amazon launched a Seller Fulfilled Prime option, allowing select third party sellers that displayed high performance fulfillment standards to be awarded the prime badge.
This was a bold move that created a lot of tension between teams. Every product category now had an Amazon Retail team competing for the same sale with sellers, represented by the marketplace team. At times there were heated discussions on how to resolve conflict but the principle of customer obsession guided the company to a great outcome.
Read the next parts and subscribe to get new posts in your inbox:
Part 3: Why do third party sellers use the Amazon marketplace?
Part 4: How did Amazon become a marketplace? (this article)