How are the unit economics of selling on Amazon and why is a US regulator suing Amazon for the same?
I assume that you, the reader, would not be extremely familiar with how e-commerce works and the language and coverage in this article is written keeping this in mind.
Have you wondered how much money a brand makes or Amazon/Flipkart makes when you purchase their product online? What are some of their expenses like?
When you go to the checkout page of any e-commerce website, you would notice a shipping fee added over an above the price of the product. However, this is hardly the case now, where you rarely find this incremental shipping fee added now, exceptions notwithstanding.
So many of you may be wondering, how does the seller who has sold these products make money?
To understand that, you must understand the basic of selling on Amazon and other e-commerce platform works.
Broadly speaking, if you are a seller on Amazon, these are some of your costs and the ones marked in bold are the charges that you have to pay to the platform
Cost of goods sold (COGS)
Referral Fee/Commission that you pay to Amazon/E-com platform to be able to list your product on the site and use their features
Shipping Fee to Amazon/E-com platform (assuming you dont use a third party for this service)
Platform marketing and ad fees (some called it “CAC” or customer acquistion fees”)
Other marketing fees
G&A and overheads such as warehousing, softwares, salaries etc
There are many other small fees that exist but that can be skipped for now.
For reference, you can check all the fees Amazon charges by category in this page.
How the unit economics of your company looks like will be based on a few broad factors:
What category or segment are you in
For how long are you operating your business on that platform i.e. - maturity of your business
How aggresive you want to be in terms of gaining market share
How do rankings on Amazon work? Broadly speaking, it depends on how much your product sells, how it is perceived by customers (ratings etc) and how well it matches with the words that you enter in the search bar (which is why SEO is so important). There are also “sponsored ads” that appear on top and you have to bid against competition to get a slot in that row. This is where Amazon really makes money and there is a reason why Amazon earns more than $30billion dollar from ads alone.
Here are some sample PnLs just for represenation:
This snapshot will also tell you how the key variables move as per the category. This is of course, very generic in nature - outliers will always exist such as an iPhone or a LV bag being a high gross margin product.
What are some of the dynamics in the key variables seen above?
Categories with high gross margins also have the highest spend on ads. This is especially true when there is intense competition for getting eyeballs and views from shoppers. That is why personal care, with gross margins of even 75%+, is usually the place where you the most volume of ads not just on e-commerce but traditional media as well
Categories like fashion have a reasonable gross margin but take a massive hit due to returns/exchanges, damages and dead-stock which lead to high platform charges and liquidation hits and hence give lower room for ads. For every Rs 1000 worth of gross sales that you make, I believe, at least Rs 100 is lost on the cost of returns/replacement alone.
Categories like food (staples) are low gross margin and have a high cost of fulfillment. That is why both Amazon/Flipkart and quick commerce apps want you to place bulkier orders while ordering groceries. Food (FMCG) has a higher gross margin than Food (staples) and hence gives you a little more room for ads.
Categories like phones and electronics are hyper competitive and hence have super low gross margins for brands and sellers. Marketplaces like Amazon/Flipkart usually make money in this category mainly via brand collaborations and sponsorships but lose a lot on the discounts that they partly fund alongside the brand. Ordering phones online sometimes becomes to cheap and subsidized that a large chunk of your “big billion day” sales actually comes from smartphone retailers. This is also the area where e-commerce sites lose the most money in general. Why do they still keep on going like this then? Its all about the optics of market share and GMV. With e-commerce sites now eyeing profitability more than ever, things are slowly changing here as well and they are doing whatever it takes to reduce the loss per order be it reducing self-funded discounts, adding more misc fees etc.
Why is the US Federal Trade Commission (FTC) suin Amazon?
Now that you have gained a primer on the unit economics of selling online, you may have come across dozens of articles on how regulators in the US and Europe keep slapping massive fines on the big tech giants for abuse of monopoly and many other charges. Amazon, gets hit by a lot of such antitrust cases including a $850 million fine slapped by regulators in Europe. To quote an article from Reuters:
“Amazon (AMZN.O) on Tuesday reached a settlement with the European Union in three antitrust probes after the U.S. online retailer addressed the EU's concerns over its use of sellers' data, saving it from a fine of up to 10% of its global turnover.
In the first case, Amazon faced charges of using its size, power and data to push its own products to gain an unfair advantage over rival merchants that also use its platform.
The company has agreed not to use sellers' data for its own competing retail business and its private label products.
The second case was about the equal treatment of sellers when ranking their offers for the "buy box" on its website that generates the bulk of its sales.
Amazon has agreed to set up a second prominently displayed buy box for a rival product if it differs substantially in price and delivery from the product in the first box.
In the third case, Amazon agreed that sellers under Amazon's Prime feature can choose their own logistics and delivery services, other than those approved and chosen by Amazon.”
Another major case that is going on now is the US Federal Trade Commission (FTC) suing Amazon."
“The Federal Trade Commission thinks the Everything Store is an illegal monopoly, and it’s suing the company to stop it — which could mean breaking up the company.
In its lawsuit filed on September 26, the antitrust agency, joined by 17 states, accuses Amazon of interlocking anti-competitive actions that, it says, have inflated prices for consumers, harmed third-party sellers in Amazon’s marketplace, and made it nearly impossible for other e-commerce platforms and retailers to compete. The complaint includes 20 charges, including monopoly maintenance of the online superstore market and the online marketplace services market, unfair methods of competition, and violations of various state antitrust laws.”
“Around 60% of items purchased on Amazon are sold by third-party sellers, company executives have said. The FTC says Amazon's fees are so high that sellers effectively keep only half of what they make on the platform.”
This is a big deal and if the FTC has its way, Amazon’s clout will definitely take a hit.
In general, the common tone in many of these cases is that:
Amazon bullies sellers and extracts the maximum possible money from them
Amazon promotes its own products (or related products) over the products sold by third party sellers. It also uses data from third party sellers to build their own private brands
Amazon forces customers to opt in for Prime and forces sellers to use its in house services
As always, I don’t think this is a black and white case of good vs evil.
The regulators are justifies in their concerns because what they accuse Amazon of, in my limited opinion and experience across e-commerce companies, has an element of truth to it. Amazon’s culture is so intensely customer-focussed be it offering the customers the lowest prices (say vs other platforms) or siding on the side of the customer in any dispute that sellers on Amazon pay through their nose for the same. If Amazon suddenly hikes their charges for selling on their platform, its usually a one way communication with sellers having no choice but to comply with it. Its also true that
At the same time, Amazon has the right to defend itself because at the end of the day, it is a business to sustain and has to do what it takes, be it increase the share of its private labels or earn more revenue through other ways. They argue that:
"If the FTC gets its way," Amazon General Counsel David Zapolsky wrote in a post, "the result would be fewer products to choose from, higher prices, slower deliveries for consumers, and reduced options for small businesses—the opposite of what antitrust law is designed to do.
The interpretation of this case really is on which side of the coin you are on. If you ask for my verdict, I’d side with the FTC/regulators very mildly in this case and its not just for Amazon but also other big tech giants. While I am a proponent of capitalism and innovation to an extent, I strongly believe that corporate ambition and hubris needs to have its own checks and balances. That is why sensitive areas like financial services are so heavily regulated.
What’s your take on this?