Summary: Amazon's stock continues to beat the bull market. Its success is based on a four level transformation to a ‘two-sided' strategy. What are the lessons for would-be platform players in all parts of the Telecoms, Media, Technology sector? (November 2009, Executive Briefing Service, Dealing with Disruption Stream, Foundation 2.0)
Amazon is a company Telco 2.0 studies closely. Their achievements in terms of logistics, cloud computing, open APIs, and two-sided business models provide great examples of business model innovation.
In this note, we review Amazon Marketplace and Amazon Web Services as successful examples of transition from one-sided to two-sided business models.
The chart below shows Amazon's performance against Vodafone, one of the better performing Telecoms stocks since 2005
Amazon and Vodafone Stocks and the S&P 500, and Amazon's ‘Two-Sided' Activities 2005-2009
Since mid-2007, Vodafone's stock value has broadly followed the S&P500. In contrast, Amazon's stock has seen a massive increase in the last three years in particular despite the crunch-crash in 2008.
Of course, stock graphs are immensely volatile, driven by both internal and external factors, and ultimately few trends are permanent. However there can be little doubt that Amazon has built a very strong business, and key to their success has been a transition from a one-sided "retailer" model, to a ‘two-sided' business model. Amazon's Marketplace service produces 5% of revenues and 30% of profits according to the Harvard Business Review.
Amazon's success is based on a fundamental economic insight; two-sided businesses are common whenever there is a role for a trading hub, a business which helps bridge the gaps of asymmetric information and facilitate trade by creating liquidity. In this role, they tend to exhibit increasing returns to scale - the more people use a stock exchange, the better the prices are likely to be - and therefore tend to become both big, and lasting.
Paul Krugman won the Nobel Prize for Economics by applying the logic of increasing returns to scale to economic geography; in a famous example, he concluded that the Erie Canal was responsible for the emergence of New York as the metropolis of the eastern US. Although the canal was only briefly used before the railways rendered it obsolete, it meant that New York was the only port with a direct connection to the Great Lakes and therefore the Midwest - and therefore, that the railway would go to New York.
Transient changes can therefore have very lasting effects on the map of the economy. Similar processes are visible in the development of stock exchanges, container ports, and Internet exchange points. Amazon CTO Werner Vogels describes the business as a "flywheel", driven by two factors - selection, and low prices.
Amazon's "Flywheel" for Platform / ‘Two-Sided' Business Models
Source: Werner Vogel's Amazon presentation to the Telco 2.0 Executive Brainstorm, 2009
In this note, we describe Amazon's transition from a pure retailer to a ‘two-sided' business model through four ‘levels'. Part of the Amazon's success is that they continue to improve at each ‘level' rather than remaining fixed in competence achieved at a certain point in time.
Amazon is best known to everyone, except for very hardcore cloud developers, as a bookshop. The story of how it created an industry-beating logistics system to fulfil orders is beyond the scope of this note, but it's worth noting that there's a circular, reciprocal relationship between two-sidedness and scale - one of those "flywheels". Being the biggest bookshop on the Internet obviously made them a much more interesting proposition for upstream partners, and gave them bargaining strength with the existing wholesale industry.
A Screenshot of Amazon's Early Home Page, c 1994
Source: Infonova Presentation to EMEA Telco 2.0 Brainstorm, Nov 2009
The key element here was Vogels' notion of "selection" - the ability to find the products you wanted among a bigger and easier to navigate range of products. Economies of scale in Amazon's distribution and its operational technology meant that the marginal cost of stocking another title was drastically lower than it was for the competition. Holding more titles meant that readers are more likely to find what they are looking for. It also means that there was more scope for fancy recommendation mechanisms, to help readers find and buy other relevant products.
This was Amazon's 1.0 period - the keys to its success were scale and investment in logistics, a simple but effective operational excellence strategy. That goes for digital logistics as well.
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