Our society distributes itself into barbarians, philistines and populace; and America is just ourselves with the barbarians quite left out, and the populace nearly.”

Matthew Arnold

Isn’t it remarkable that pending retail IPOs from businesses such as Officeworks could have their multiples “downgraded” on the basis of a new competitor?

This is real barbarians at the gate stuff, that this new competitor known as “Amazon” could cause such consternation – almost completely ignoring the skill and the landscape of Australian retail; and a profound understanding of the belly of the beast itself.

A little more reality on Amazon might assist.

They are a data business, first and foremost, of which approximately 70 per cent of their current $146 billion revenue comes from selling retail products. Their core business model succeeds very well historically in the United States where they are dominant, in fact second only to Walmart in retail turnover and catching up with 50 per cent of the US being Amazon prime members, and enjoying 44 per cent of all US online sales.

Formidable – yes, and in fact if you or I bought shares in Amazon 20 years ago at $18.00 our value per share is now $1,000, so innovation, acquisition and data investment is clearly paying off. Amazon is developing an even larger search engine than Google in the US.

As the Financial Times reports, however, over the last several years a striking pattern has emerged at Amazon: its sales in the US are soaring, doubling in the past three years. But its international sales have not kept up. To boost sales in its international markets, Amazon is working on replicating one of the key strategies responsible for its US growth: Amazon Prime. The service was launched 11 years ago in the US with free two-day shipping for subscribers.

Amazon is very intent on growing the Prime membership in large part to lock in customers, to habituate that customer to making Amazon their first e-commerce destination. Once you subscribe, the frequency of orders goes up significantly. So the battle is less fought on the virtual shop floor as it is in Channel TV viewing, and this is where one of Amazon’s challenges emerges.

The challenge for Amazon is to sign up more Prime users internationally. Outside of the US, the company’s biggest markets are Germany, the UK and Japan, all of which have Prime. These three countries account for four-fifths of Amazon’s global sales. Prime is also available in six other European countries, although its offering differs slightly in each. So in other words the beachhead that is Amazon being Prime currently has 80 per cent of its international sales (outside the US) in 33 per cent of its distribution.

Add to that home grown retail knowledge, the higher cost model and tyranny of distance and the playing field is a little more level. Interesting to also note Walmart’s YTD online growth at 63 per cent.

Building Prime content is an expensive exercise with Amazon.

But content is expensive: Amazon paid $250m to sign the three former presenters of Top Gear, the BBC car show. This is one reason why despite the rapid growth in subscriber numbers, analysts are unsure what effect the subscription service has had on Amazon’s underlying financial performance, though most believe that the programme will be profitable in the long term. Jeff Bezos, Amazon’s chief executive, defended its performance in the company’s shareholder letter last year, saying that the service lost money in its first year, but has become one of three pillars of the group’s business alongside its marketplace e-commerce platform and the web services division.

Amazon is not a truly profitable business relative to its revenue line and clearly it’s a bundle business underpinned by its Prime offer – in fact, its retail pricing across many different categories in retail products is, with some loss leader exceptions, similar, same or above its competitors’ pricing.

50 per cent of the 70 per cent of total Amazon retail revenue is in fact retailer re-seller revenue. This means that for close to half of the units sold on Amazon.com, Amazon does not set the price, it just takes a margin. This alone should point to the weakness of the idea that Amazon’s growth is based on selling at cost or at a loss.

Part one of a two-part segment on retailing tactics to Amazon-proof your business.

First published InsideRetail on June 2 2017