How Amazon Won

The market favors those who take steps to position themselves to take advantage of these scenarios when they emerge.

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Jeff Bezos, CEO and founder of Amazon, holds the new Amazon Kindle Fire HD at the product's introduction in Santa Monica, Calif., Thursday, Sept. 6, 2012.

In our last two posts, we focused on Apple and Google, showing that technological innovation alone does not explain their extraordinary successes. The breakout strategies of these firms have been driven by their ability to capture value left dangling when previously premium items dropped in price. Now we expand this argument by looking at disproportionate winners in the highly competitive arenas of retail and e-tail.

Companies like Amazon and WalMart illustrate how to forge powerful strategies to realize the value of suppressed costs and pass savings on to customers in exchange for loyalty and volume of business.

Jeff Bezos identified an opportunity for digital content distribution to disrupt the value chain for book publishing in his favor. Unlike Apple or Beats, Amazon didn't try to sell hardware at a premium. Instead, Bezos found a different way move the sweet spot to his advantage – by actually driving the dangling value. The short version is that Amazon took away the bargaining power of publishers – and, for digital titles, took a healthy slice of their margins from them, passing part of the savings on to consumers in exchange for repeat business and market share.

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In the golden age of the book publishing business, publishers controlled access to the content from authors. They selected authors, printed their books, developed a market for them, got them to that market and brought in a premium for their services. 

Later, bookseller chains altered the value chain for consumers eager to get book content. After their superstores became the primary channel through which consumers purchased books, these chains could afford to charge less than the Mom and Pop stores of yesteryear. They captured value by drawing even more market share, thereby improving their negotiating power with their suppliers, the book publishers. Even if profit margins were smaller, overall sales volume more than compensated for the difference.

More recently, Bezos and his company came along and moved the sweet spot in the value chain again. First, he took on the bookseller chains, offering selection advantages and crowd-sourced recommendation benefits these chains couldn't match. Then, he took on the publishers themselves. By making e-readers affordable and ubiquitous, he saw to it that readers gained convenience advantages when they purchased their reading content through Amazon. Before long, many consumers needed Amazon more than they needed the bookstores or the publishers.

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Like the bookseller chains before it, Amazon captured value not by charging a premium but by increasing market share and negotiating lower rates from his suppliers further up the value chain. Amazon told publishers they'd need to sell Amazon titles for significantly lower rates, generally $9.99. Publishers didn't like it, but they didn't have much of a choice, if they wanted access to Amazon's customers.

Barnes & Noble, needless to say, took notice and fought back with its own e-reader, the Nook. Nonetheless, the overall position of superstores in the industry's value chain had already changed – no longer were they the scarce point of entry for those who wanted access to books, and today Amazon's Kindle titles lead the Nook's by an average of $2.50 in customer savings per title.

Bezos' approach was widely questioned – especially the major investments he made in pursuing his ambition to move beyond his early strength in books, music and video to be the leading destination for e-tail across the board (in the U.S., at least). More controversial still, when Amazon priced its Kindles at a loss per device sold, the company also forced down the price for wholesale titles delivered digitally. 

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Amazon moved the point of scarcity and forced both publishers and booksellers to dangle their value before it snatched it up. Amazon then passed along these savings to the customer in the form of cheaper titles, in exchange for e-tail loyalty and resulting control of the market. Eventually, of course, it parlayed its centrality as an e-tail destination into further advantages including rich data that enabled improved recommendations and reviews (through collaborative filtering and customer comments), major investments in support of customer service and satisfaction, and logistical advantages, as it brought the warehouse distribution centers in which it had invested to efficient utilization levels. It also used its destination status to build an affiliate model, under which it charged other providers a premium above other e-tailers to sell their goods through the Amazon engine.

In the Apple, Google and Amazon models, the sweet spot in the value chain shifted due to disruptions in digital technology and platforms. Still, the importance of dangling value to monetizing innovation is not limited to these models based around digital tools and content. Public investments can also have a massive impact on the positioning of a sweet spot. 

At one time, Sam Walton's children represented, collectively, the richest family in the world. His company found a way to disrupt the distribution of products customers wanted, based not on new forms of distributing digital content, but rather on box stores with big parking lots.

They did so, the standard MBA account goes, by brilliantly optimizing logistics. They perfected the supply chains, the trucking routes, and the location of new stores in what suddenly was no longer quite the middle of nowhere. Piggy-backing on the economy-wide subsidization of the cost of gas, WalMart made an array of objects available far from traditional retail centers, and at prices far lower than they would have been at the local general store with its high costs for sourcing its wares.

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Huge savings were to be found in the difference between the costs to individuals, families and businesses to drive or transport goods in America vs. the aggregate cost of driving and everything that makes it possible, from well paved highways to oil spill cleanups to maintaining a cheap supply of fuel.  By capitalizing on the dangling value left by public investment, WalMart captured so much of the market that even today it can afford to set its in-store prices an average of 20 percent lower than Amazon's, giving WalMart a seemingly unassailable hold on its formidable market power and enviable profitability in a tough sector.

In this series, we've illustrated how several businesses capitalized on huge changes to carve out new sweet spots in the value chain of an industry. Apple captured a hardware sweet spot amidst disruptive technological changes to music downloading, Google brought in advertising to pay for email services, Amazon took a loss in its play to profit big time from changing consumer preferences, and WalMart became a retail hegemon by capturing the sweet spot created by a societal commitment to underwrite the true costs of trucking and driving. Despite their vastly different business models, each of these winners showed a common focus on capturing value from activities that were cheap or free elsewhere in the chain. In Acceleration Group's work with innovators, we see that these are not just stand-out cases, but rather powerful examples of strategy these innovators apply productively in their own sectors. Whether you have your own business, are an investor in an innovative venture, or are a corporate manager seeking to take advantage of disruption, assessing risks and opportunities from this point of view can be critical. The changes that will lead to the next big wins in your industry are already taking shape. Can you identify the source of the next big shift, and where the dangling value will be?

In a rapidly evolving world, the market favors those who take steps to position themselves to take advantage of these scenarios when they emerge. Where's the next key case of dangling value in your market (or emerging from a sector you thought was outside of it)? If you're an entrepreneur, intrapreneur or investor out for disproportionate returns, how does this question inform your strategy for monetizing innovation?

Alejandro Crawford is a senior consultant at Acceleration Group, and also teaches innovation, enterprise growth and digital strategy at NYU's Polytechnic Institute and Baruch's Zicklin School of Business. He graduated from the Tuck School of Business in 2003.

Lisa Chau is a private consultant focused on social media and cross-platform marketing. Previously, she spent five years working for her alma mater Dartmouth College, as assistant director of alumni affairs and assistant director of PR for the Tuck School of Business.

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