AUSTIN, Texas — Amazon Business is a direct threat to your business. If you’re blind to this, it’s time to pull your head out of the sand.
That was the message of Ian Heller, president and COO, Modern Distribution Management (MDM), during his “Artificial Intelligence, Amazon Business & the Future of Distribution” presentation at Heating, Air-conditioning & Refrigeration Distributors International’s (HARDI’s) 2019 Annual Conference, Dec. 1-4 in Austin, Texas.
WHAT IS AMAZON BUSINESS?
Amazon Business is Amazon’s marketplace that sells business supplies to corporate buyers. Formed in April 2015, the B2B distributor generated more than $10 billion in sales volume in 2018.
“In a very short period of time, Amazon Business has become one of the largest distributors in the world,” said Heller, who served as the vice president of HD Supply – White Cap before joining MDM. “They’re achieving this success by leveraging other people’s money. Amazon’s first transaction was done in 1995, when a customer ordered a science book. Amazon billed his credit card immediately, went out and bought the book, and shipped it to him. They’ve had a positive cash flow from their very first transaction.”
Amazon achieved $178 billion in sales in 2017, which was a 31 percent increase over its 2016 sales numbers. The company is expected to reach $230 billion in sales in 2018. So, how is the company making money so quickly, and what does it mean to your HVAC wholesale business?
“In a nutshell, they take orders online and sell other people’s stuff,” Heller said. “These orders are coming from computers, going to Amazon servers, and being immediately sent one of Amazon’s 1.7 million-plus third-party suppliers.”
Amazon is earning approximately 20 percent on each of these transactions, Heller said.
“The third party is paying all of the costs in these transactions,” Heller said. “It’s the supplier’s inventory, and they’re the ones doing the warehousing, shipping, packing, etc. Amazon typically charges around 12 percent, but that doesn’t include marketing costs and other charges.”
Heller examined profit and loss (P&L) sheets for two $20 million companies — one representing the average distributor and another representing Amazon.
The average distributor accrues approximately 4 percent in variable expenses, which equates to around $800,000. Boasting the ability to list hundreds of thousands of SKUs for zero cost, Amazon’s variable expenses hover somewhere between zero and 1 percent. At 1 percent, its variable expenses sit at $200,000.
“For every $1 million in new sales, the average distributor’s variable expenses increase $40,000, while Amazon, at worst, takes on $10,000,” Heller said. “Additionally, the average distributor brings on $30,000 in inventory. Amazon doesn’t house inventory; it relies on third-party suppliers. That’s a $60,000-$70,000 difference in expenses and inventory costs.”
For every $1 million in sales the average distributor adds, it may add $150,000 to its bottom line. For every $1 million Amazon adds, it’s adding $240,000 to its bottom line, Heller said. This profitability gap is only expected to grow over time as Amazon streamlines its processes.
CASH CONVERSION CYCLE
Heller also examined Amazon’s strength in Day Sales Outstanding (DSO), or the measure of how quickly customers pay their bills.
He compared Distributor X, a $10.5 million company, with Amazon Business, which achieved $10 billion in sales.
Distributor X’s average DSO is 46 days, and it typically pays its bills in 42 days. This means Distributor X is paying out money four days in advance to support its sales before it earns its return on investment.
Amazon boasts a DSO of only 27 days and pays its bills in 111 days. This creates a $50 billion to $60 billion float every month for Amazon as well as a strong cash conversion cycle, Heller said.
“Cash conversion cycle is a term people use in finance that attempts to make sense out of DSO, days payable, and days of inventory on hand,” he said. “To achieve this number, you take your DSO and add on your days of inventory on hand and subtract days payable. The lower the number, the better. Distributor X, like a lot of distributors, has a cash conversion cycle of around six days. Amazon, interestingly enough, has a cash conversion cycle of around negative 33 days. They’re getting paid in advance of their inventory purchases. They’re continuing to excel at making money off other people’s money.”
CAN YOU COMPETE?
While distributors should continue to aim to grow their online presence, they shouldn’t get too caught up with the percentage of sales conducted online.
“It drives me nuts when distributors brag about how high they’ve driven their portion of their sales that come in online,” Heller said. “On quarterly calls, you’ll hear companies boast that 50 percent of their sales are booked online and how they anticipate that number reaching 60 percent by the next quarter. Be customer-driven. Don’t follow these shallow, one-dimensional measurements.”
Selling online puts your skills in the bull’s-eye of what Amazon does best, Heller said.
“You need a strategy,” he said. “Track your customers’ activity and only sell items online that are driven solely by customers’ needs, not in pursuit of a mindless sales percentage. You can’t take one number, center everything on that, and believe everything is going to be great because that number has grown. Being a successful distributor in 2019 is not all about online sales.”
If Amazon is such a distribution powerhouse, should distributors consider selling equipment directly through its marketplace? If Heller was running a wholesaler, he said he wouldn’t.
“When you sell on Amazon, you lose your customer relationships,” he said. “You’re not allowed to contact any customer who buys from you on the Amazon Business marketplace except through Amazon’s closed, proprietary email system. You can’t send any marketing or sales information, including links of any kind. These aren’t your customers anymore; they’re Amazon’s customers.”
Heller said selling through Amazon is the equivalent of offering your No. 1 competitor all your transaction data.
“When you sell through Amazon, they learn what you’re selling, to whom, and how much they’re paying,” he said. “You’d absolutely protect this information from your top competitor, yet you’d consider giving it to Amazon to increase sales. On the retail side, even with anti-trust risks, they’re introducing a bunch of private-label products. Using data from the best manufacturers whose products they sell, they’ve identified what products sell well, who to sell them to, and how much to charge. They’re creating products with the intention of taking sales away from people who sell on their marketplace.”
Overcoming Amazon’s advantages in the marketplace is not an easy task. Heller encourages distributors to continue to focus on their own value propositions and be willing and ready to take on Amazon’s technology when it becomes commoditized.
“You should be constantly aiming to improve your value proposition in ways that are difficult for purely digital players to duplicate,” he said. “Go through 1,000 transactions and count the number that could have occurred online without interruption. Find a way to capitalize on sales that customers actually want to conduct online. Finally, over time, technology will become commoditized. The proprietary stuff Amazon is using will become available to you over time. It’s your job to make sure you have the availability to quickly bolt-on this technology and the staff in place to be able to utilize it.”
Heller insisted those who develop customer-centric game plans will be those who flourish in the future marketplace.
“Good ideas don’t come from board rooms, they come from interactions with your customers,” he said. “You better have a good ERP, a good way to manage product data, a flexible pricing system, a good warehouse system, and, perhaps most importantly, a competent IT staff who understands all of this stuff. Paint an exciting future for your company that differentiates your value proposition from Amazon’s. At the same time, be prepared to follow Amazon’s lead in distribution technology. Purchase this technology as it becomes available and utilize it accordingly. Hang onto your customers and continue doing the personal aspects of the job that Amazon is unlikely to do.”
Publication date: 12/20/18