Imagine someone fell asleep in 1998, knowing Amazon (NASDAQ:AMZN) as nothing more than an online book seller. How could you possibly explain what it is today?
It’s an Everything-Store/Original-Content/Fulfillment-Center/Delivery-Network/Cloud-Computing juggernaut. It’s also increasingly taking a bite out of Google’s dominance in advertising. While hard numbers are difficult to come by, estimates indicate that advertising on Amazon’s platform doubled to $10 billion last year.
That has lots of investors excited.
But I’m worried the company might be making a deal with the devil — forgoing the most important part of what makes it great in exchange for a quick buck.
A mission to get behind
Let’s start by going back to our Rip Van Winkle who fell asleep in ’98. The best way to explain Amazon’s past two decades is to point toward its mission statement: “To be earth’s most customer-centric company.”
The e-commerce juggernaut built out a mammoth network of fulfillment centers to guarantee next-day delivery. It offers Prime at super-low costs because it can — and customers love it.
Amazon founder and CEO Jeff Bezos has said a lot of smart things over the past 20 years, but perhaps the most famous is this: “Your margin is my opportunity.”
What does this mean? It means if Bezos sees a company selling $10 worth of notebooks and pocketing $0.50 in profit, he intends — backed by Amazon’s scale — to sell those notebooks at $9.51 for $0.01 in profit. For Amazon (which gains market share) and its customers (who pay less), it’s a win-win.
Everyone has their price
All of this is to say: Amazon has done a tremendous job of showing that a customer-centric approach is a winning approach.
That’s why I’m alarmed by what’s happening with Amazon’s ad strategy. If you’re unfamiliar, Amazon displays its ads when you type something into its search bar. For instance, when I type in “diapers” to reup our supply for our newborn, this is what I see.
If I’m not paying much attention, I might miss the fact that the entire first row — for Pampers — is an advertisement. Pampers isn’t at the top because it’s the “best” or most popular product. It’s at the top because Pampers paid to have its items placed there.
Technically, these are referred to as “Sponsored Products”. It says that fairly clearly on the left-hand side. But the only tell-tale sign of what this means to everyday folks is the tiny “Advertisement” displayed in the lower right hand corner. Can you even see it?
As you might expect, given the popularity of Amazon for online shopping, those ads are proving lucrative. But they also go against everything Amazon stands for.
Writing about the trend, entrepenuer and blogger Zach Kanter had this to say in a lengthy essay:
The problem with Sponsored Products is that sponsored listings are not actually good for customers — they are good for sellers; more specifically, they are good for sellers who are good at advertising, and bad for everyone else…The ability to buy the top slot in search results favors products with the highest gross margin — hence the highest bidder — not the products that would best satisfy customers.
While such a move is clearly lucrative, it is decidedly un-Amazon.
How this could unravel
Kanter goes on to write that the company’s algorithm for displaying results is far more important than we might think. “This isn’t ‘just’ search results; search results are the entire driver of Amazon’s retail engine.” Unlimited shelf space is what makes Amazon great, but the ability to organize all those options and make the best choice is crucial. That’s what the search algorithm does.
Obviously, this isn’t going to put a dent in Amazon’s business anytime soon. Amazon’s retail business isn’t even the biggest driver of profits – Amazon Web Services (AWS) is.
But if we take a look at how Amazon became so dominant in so many fields, we can quickly see how prioritizing advertisers at the expense of customers could permanently limit the company’s ability to continue innovating in new industries.
Ben Thompson — who runs the subscription newsletter Stratechery – has a unique way of viewing Amazon’s growth. Thompson argues the build-out of an Everything Store — or the site we use to buy stuff on Amazon — is only half the story.
The other half has to do with all the solutions Amazon built for the Everything Store to work. Amazon could afford to take a gamble on fulfillment centers because it had a built-in customer — the Everything Store. No one else would build all of that without a guaranteed customer. That’s also why Amazon could gamble on AWS: If the outside world didn’t want/need it, AWS could still help the company run internal processes.
As long as the Everything Store is growing, Amazon can continue to tinker with internal tools to make the Everything Store run more smoothly. As soon as Amazon perfects those tools, it can open them up for anyone to use. That’s what it did with both fulfillment (Fulfillment by Amazon) and AWS.
Those two solutions can now largely support themselves. But if Amazon wants to continue tinkering, the Everything Store needs to continue growing. If, however, someone comes along and offers up a search algorithm that favors customers over advertisers, Amazon could slowly start to bleed away business from the Everything Store.
It’s certainly nowhere near a crisis point right now. But, as Kanter argues, “two years ago, it was hard to think of even theoretical ways that Amazon could have been caught; today, there is an opening – a real one, of meaningful size.” Walmart, Kanter goes on to say, could be the first to try and exploit that opening.
How to approach the situation
The situation is not dire at Amazon. The company is still one of the most powerful forces in retail — and cloud-computing — today,.
However, as Kanter argues, there are cracks showing. Investors should keep a keen eye on the growth of advertising dollars, and compare that growth of sales from The Everything Store. If you’re reading company releases, this means comparing the growth rate of the “Other” category — which is primarily advertising — with the growth of north American and International Retail — which is essentially the Everything Store.
No company is perfect, and I don’t expect that of Amazon. However — with Amazon currently occupying close to 20% of my real-life holdings — I don’t want to find myself — or any readers — looking back ten years from now wondering how Amazon lost its mojo. If that were to happen, this would be the first yellow flag on the radar.
This article originally appeared in the Motley Fool.
John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool’s board of directors. Brian Stoffel owns shares of Alphabet (A shares), Alphabet (C shares), and Amazon. The Motley Fool owns shares of and recommends Alphabet (A shares), Alphabet (C shares), and Amazon. The Motley Fool has a disclosure policy.