Case Amazon.

com
In 1994, with a handful of programmers and a few thousand dollars in workstations and
servers, Jeff Bezos set out to change the retail world when he created Amazon.com (ticker:
AMZN). Shel Kaphan, Amazons first programmer, assisted by others, including Paul Barton-Davis, used a collection of tools to create Web pages based on a database of 1 million
book titles compiled from the Library of Congress and Books in Print databases. Kaphan
notes that Amazon was dependent on commercial and free database systems, as well as
HTTP server software from commercial and free sources. Many of the programming tools
were free software [Collett 2002]. In July 1995, Amazon opened its Web site for sales. Using heavily discounted book prices (20 to 30 percent below common retail prices); Amazon
advertised heavily and became the leading celebrity of the Internet and e-commerce.

Sales and Relationships

Amazon made its initial mark selling books, and many people still think of the company in
terms of books. However, almost from the start, the company has worked to expand into
additional areasstriving to become a global retailer of almost anything. Some of the main
events include: 1995 books, 1998 music and DVD/video, 1999 auctions, electronics, toys,
zShops/MarketPlace, home improvement, software, and video games [1999 annual report].
By the end of 1999, the company had forged partnerships with several other online
stores, including Ashford.com, Audible, Della.com, drugstore.com, Gear.com, Greenlight.com, HomeGrocer.com, Kozmo.com, living.com, NextCard.com, Pets.com, and Sothebys. Of course, most of those firms and Web sites later died in the dot-com crash of
2000/2001.
Amazon also established partnerships with several large retailers, including Target,
Toys R Us, Babies R Us, and Circuit City. Effectively, Amazon became a service organization to manage the online presence of these large retailers. However, it also uses its distribution system to deliver the products. The Circuit City arrangement was slightly different
from the otherscustomers could pick up their items directly from their local stores [Heun
August 2001]. After Circuit City went under, the relationship ended.
By mid-2003, the Web sales and fulfillment services amounted to 20 percent of Amazons sales. Bezos points out that most companies realize that only a small fraction of their
total sales (5 to 10 percent) will come from online systems, so it makes sense to have Amazon run those portions [Murphy 2003].
In 2001, Amazon took over the Web site run by its bricks-and-mortar rival Borders.
In 2000, Borders lost $18.4 million on total online sales of $27.4 million [Heun April 2001].
Also in 2001, Amazon partnered with Expedia to offer travel services directly from the Amazon site. However, in this case, the Amazon portion consists of little more than an advertising link to the Expedia services [Kontzer 2001]. The deals in 2001 continued with a twist
when Amazon licensed its search technology to AOL. AOL invested $100 million in Amazon
and payed an undisclosed license fee to use the search-and-personalization service on
Shop@AOL [Heun July 2001]. In 2003, Amazon launched a subsidiary just to sell its Websales and fulfillment technology to other firms. Bezos noted that Amazon spends about $200
million a year on information technology (a total of $900 million to mid-2003). The purpose
of the subsidiary is to help recover some of those costsalthough Bezos believes they were
critically necessary expenditures [Murphy 2003].

With so many diverse products, and relationships, it might be tempting to keep everything separate. However, Amazon perceives advantages from showing the entire site to
customers as a single, broad entity. Yes, customers click to the various stores to find individual items. But, run a search and you will quickly see that it identifies products from any
division. Additionally, the company is experimenting with cross sales. In 2002, the Project
Ruby test site began selling name-brand clothing and accessories. Customers who spent $50
or more on apparel received a $30 gift certificate for use anywhere else on Amazon [Hayes
2002].
By 2004, 25 percent of Amazons sales were for its partners. But, one of Amazons
major relationships took a really bad turn in 2004 when Toys R Us sued Amazon and Amazon countersued. The complaint by Toys R Us alleges that it had signed a ten-year exclusivity contract with Amazon and had so far paid Amazon $200 million for the right to be the
exclusive supplier of toys at Amazon.com. David Schwartz, senior VP and general counsel
for Toys R Us stated that We dont intend to pay for exclusivity were not getting [Claburn May 2004]. Amazons initial response was that We believe we can have multiple
sellers in the toy category, increase selection, and offer products that (Toys R Us) doesnt
have [Claburn May 2004]. The lawsuit counters that at least one product (a Monopoly
game) appears to be for sale by third-party suppliers as well as Toys R Us. A month later,
Amazon countersued, alleging that Toys R Us experienced chronic failure to maintain
sufficient stock to meet demand. The court documents noted that Toys R Us had been out
of stock on 20 percent of its most popular products [Claburn June 2004]. Although the dispute sounds damaging, it is conceivable that both parties are using the courts as a means to
renegotiate the base contract.
Small merchants accelerated a shift to Amazons marketplace technology. By 2007,
Amazon was simply the largest marketplace on the Web. For example, John Wieber was
selling $1 million a year in refurbished computers through eBay. But increased competition
and eBays rising prices convinced him to switch to direct sales through Amazon. Similar
small merchants noted that although the fees on Amazon are hefty, they do not have to pay
a listing fee. Plus, eBay shoppers only want to buy things at bargain-basement prices
(Mangalindan 2005).
In 2010, Target ended its contract with Amazon and launched its own Web servers.
Amazon does not report sales separately for its partners such as Target, so it is difficult to
determine what impact the change might have on Amazon. However, Amazon has many
other sellers who offer similar products.

Digital Content
Amazon has been expanding its offerings in digital contentin many ways extending competition against Apple, but also leading the way in digital books. Although it was not the
first manufacturer, Amazon is reportedly the largest seller of e-readers with the Kindle.
Amazon does not report sales separately for the Kindle. Amazon also noted in 2011 that ebooks for its Kindle reader have overtaken sales of paperback books as the most popular
format. The e-books had already exceeded hard-cover books the year before [Wu 2011]. For
many of these reasons, Borders, a bricks-and-mortar competitor to Amazon went under in
2011.
Amazon is also working to expand sales of music. The Web site has relatively standard pricing on current songs, but often offers discounts on older albums. By 2011, Amazon
was also trying to expand into video streaming. Customers who pay $79 a year to join the
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Prime program gain faster shipping, and also access to a library of digital movies and TV
shows. Unfortunately, with limited ties to the movie studios, the offerings initially were
relatively thin. However, other video streaming sites, including Netflix and Hulu, were also
struggling to develop long-term contracts with studios. In September 2011, Amazon announced a deal with Fox to offer movies and TV shows owned by the studio. At the same
time, Netflix announced a similar deal with the Dreamworks studio. It will take time for
studios to determine strategies on streaming video services and for consumers to make
choices [Woo and Kung 2011].
In late 2011, Amazon released its own version of a tablet computer. The company
continued to sell the Kindle e-book reader, but the tablet focused on audio and video, using
a color LCD display screen with a touch interface. Although it lacked features available on
the market-leading Applet iPad, the Kindle table carried a price that was about half that of
the iPad and other competitors ($200). The obvious goal was to provide a device that encourages customers to purchase more digital content directly from Amazon [Peers 2011].

Sales Taxes
Sales taxes have been a long-term issue with Amazon. The Annual Report notes that several states filed formal complaints with the company in March 2003. The basis for the individual suits is not detailed, but the basic legal position is that any company that has a
physical presence in a state (nexus by the terms of a U.S. Supreme Court ruling), is subject to that states laws and must then collect the required sales taxes and remit them to
the state. The challenge is that the level of presence has never been clearly defined. Amazon argues that it has no physical presence in most states and is therefore not required to
collect taxes. The most recent challenges are based on Amazons affiliate program. Amazon pays a small commission to people who run Web sites and redirect traffic to the Amazon
site. For instance, a site might mention a book and then include a link to the book on the
Amazon site. Several states have passed laws claiming that these relationships constitute a
sales force and open up Amazon to taxation within any state where these affiliates reside.
In response, Amazon dropped the affiliate program in several states, has initiated a legal
challenge in the state of New York, and in 2011, negotiated a new deal signed into law in
California [Letzing 2011]. In the California deal, Amazon obtained a delay in collecting taxes for at least a year, in exchange for locating a new distribution center in the state and
creating at least 10,000 full-time jobs. Amazon is also asking the U.S. Congress to create a
new federal law to deal with the sales-tax issue. However, because the state sales tax issue
is driven by the interstate commerce clause in the U.S. Constitution, a simple law will not
alter the underlying principles. However, if Congress desired, it might create a Federal
Sales tax law with some method of apportioning the money to states. But, do not bet on any
major tax laws during a Presidential election year.

Information Technology
In the first years, Amazon intentionally kept its Web site systems separate from its orderfulfillment system. The separation was partly due to the fact that the programmers did not
have the technical ability to connect them, and partly because the company wanted to improve security by keeping the order systems off the Web.
By 1997, Amazons sales had reached $148 million for the year. The big book database was being run on Digital Alpha servers. Applications were still custom written in
4

house. By early 2000, the company had over 100 separate database instances running on a
variety of servershandling terabytes of data.
In 2000, Amazon decided to overhaul its entire system. The company spent $200
million on new applications, including analysis software from E.piphany, logistics from
Manugistics, and a new DBMS from Oracle. The company also signed deals with SAS for
data mining and analysis [Collett 2002]. But, one of its biggest deals was with Excelon for
business-to-business integration systems. The system enables suppliers to communicate in
real time, even if they do not have sophisticated IT departments. It provides a direct connection to Amazons ERP system either through programming connections or through a
Web browser [Konicki 2000].
About the same time (May 2000), Amazon inked a deal with HP to supply new servers and IT services [Goodridge and Nelson 2000]. The new systems ran the open-source
Linux operating system. Already by the third quarter of 2001, Amazon was able to reduce
its IT costs by 24 percent from the same quarter in 2000 [Collett 2002].
By 2004, the supply chain system at Amazon was a critical factor in its success. Jeffrey Wilke, Senior VP of worldwide operations, observed that When we think about how
were going to grow our company, we focus on price, selection, and availability. All three depend critically on the supply chain [Bacheldor 2004]. Almost the entire system was built
from scratch, customized to Amazons needs. When a customer places an order, the system
immediately connects to the distribution centers, determines the best way to ship the product, and provides the details to the customer in under two minutes. The entire process is
automatic.
Dr. Russell Allgor moved from Bayer Chemical to Amazon and built an 800,000equation computer model of the companys sprawling operation. When implemented, the
goal of the model was to help accomplish almost everything from scheduling Christmas
overtime to rerouting trucks in a snowstorm. Allgors preliminary work focused on one of
Amazons most vexing problems: How to keep inventory at a minimum, while ensuring that
when someone orders several products, they can be shipped in a single box, preferably from
the warehouse the company had six that is nearest the customer [Hansell, 2001]. Dr.
Allgors analysis is simple, but heretical to Amazon veterans. Amazon should increase its
holdings of best sellers and stop holding slow-selling titles. It would still sell these titles but
order them after the customer does. Lyn Blake, a vice president who previously ran Amazons book department and now oversees company relations with manufacturers, disagrees
with this perspective. I worry about the customers perspective if we suddenly have a lot of
items that are not available for quick delivery.
Amazons merchant and MarketPlace systems are powerful tools that enable smaller
stores to sell their products through Amazons system. Amazon continually works to improve the connections on those systems. This system caused problems in 2001the main
issue was that the data on the merchant Web sites was being updated only once every eight
hours. The merchants link to Amazons main database servers, and internal applications
transfer the data onto the displayed page as requested. As customers purchased items, the
inventory quantities were altered in the main servers, but the current totals were not
transferred to the display pages until several hours later. Consequently, customers would
be told that an item was in stock, even it had sold out several hours ago. To solve the problem, Amazon installed Excelons ObjectStore database in 2002. The system functions as a
cache management server, reducing the update times from eight hours down to two
5

minutes. Paul Kotas, engineering director for the Merchants@Group noted that with the
growth of this business, we needed a zero-latency solution [Whiting 2002].
In 2003, Amazon added a simple object access protocol (SOAP) gateway so that retailers could easily build automated connections to the system. Data is passed as XML documents and automatically converted to Amazons format [Babcock 2003].
One of the most successful technologies introduced by Amazon is the affinity list.
When someone purchases an item, system makes recommendations based on similar items
purchased by other customers. The system uses basic data mining and statistical tools to
quickly run correlations and display the suggested products. Kaphan notes that There was
always a vision to make the service as useful as possible to each user and to take advantage
of the ability of the computer to help analyze a lot of data to show people things they were
most likely to be interested in [Collett 2002]. The system also remembers every purchase
made by a customer. So, the Amazon programmers created the Instant Order Update feature, that reminds customers if they have already purchased an item in their cart. Bezo
notes that Customers lead busy lives and cannot always remember if theyve already purchased a particular item. He also observed that When we launched Instant Order Update,
we were able to measure with statistical significance that the feature slightly reduced sales.
Good for customers? Definitely. Good for shareowners? Yes, in the long run [2003 annual
report].
Capital expenditures for software and Web site development are not cheap: $176
million, $146 million, and $128 million for 2010, 2009, and 2008 respectively (2010 Annual
Report). But, in comparison, in 2010, net income tax provisions were $352 million.

New Services
Amazon requires huge data centers and high-speed Internet connections to run its systems.
Through vast economies of scale, Amazon is able to achieve incredibly low prices for data
storage and bandwidth. Around 2005, the company decided that it could leverage those low
costs into a new business selling Internet-based services. The company offers an online data
storage service called S3. For a monthly fee of about 15 cents per gigabyte stored plus 15
cents per gigabyte of data transferred, any person or company can transfer and store data
on Amazon servers [Markoff 2006]. Through a similar service (EC2), any company can use
the companys Web servers to deliver digital content to customers. The company essentially
serves as a Web host, but instead of paying fixed costs, you pay 10 cents per virtual server
per hour plus bandwidth costs. Amazons network can handle bursts up to 1 gigabit per second. The system creates virtual servers, running the Linux kernel, and you can run any
software you want [Gralla 2006]. By 2011, the company had several locations providing S3
and EC2 Web services. It also offered online relational database services using either
MySQL or the Oracle DBMS. Anyone can pay to store data in the DBMS, with charges being levied per hour, per data stored, and per data transferred. The point is that Amazon
handles all of the maintenance and other companies avoid fixed costs. Even government
agencies are adopting the benefits of storing data in these cloud servicesincluding those
run by Amazon. For example, the U.S. Treasury Department moved is public Web sites to
the Amazon cloud. [Pratt 2011].
Perhaps the most unusual service is Mturk. The name derives from an 18-century
joke where a mechanical chess-playing machine surprised European leaders and royalty
by beating many expert players. The trick was that a human was hidden under the board
and moved the pieces with magnets. Amazons trick is to use human power to solve prob6

lems. Companies post projects on the Mturk site and offer to pay a price for piecemeal work.
Any individual can sign up and perform a task and get paid based on the amount of work
completed. Amazon takes a 10 percent commission above the fee. For example, the company
Casting Words places audio files on the site and pays people 42 cents to transcribe one minute of audio files into text [Markoff 2006].
The Amazon EC2 and S3 services suffered some problems in the summer of 2011. A
configuration error during an upgrade in the East Coast facility triggered a cascade that
delayed all services in the facility. Internet services including Foursquare and Reddit that
used the facility were impacted by the problems for almost a week [Tibken 2011]. Amazon
engineers learned a lot from the problems and the same issue is unlikely to occur again
[http://aws.amazon.com/message/65648/]. But, the outage points out the risks involved in
any centralized system. Ironically, the main problems were caused by algorithms designed
to copy data to multiple servers to reduce risks. On the other hand, with multiple facilities,
Amazon provides the ability to spread content and risk across multiple locations.
Adam Selipsky, vice president of product management and developer relations at
Amazon Web Services observed that "Amazon is fundamentally a technology company;
weve spent more than one and a half billion dollars investing in technology and content.
We began by retailing books, but it was never in our business plan to stay with that
[Gralla 2006].

Financial Performance
When Amazon started, it spent huge amounts of money not only building infrastructure,
but also buying market share. It took Amazon nine years to achieve profitability. And the
profits started to arrive only after the company changed its pricing modelfocusing on retail prices for popular items and smaller discounts for all books. In the process, the company lost almost $3 billion. It was not until 2009 that Amazon had generated enough profits
to cover all of its prior losses (ignoring interest rates and debt).
Year
Net Sales
Net Income
2010
34,204
1,152
2009
24,509
902
2008
19,166
645
2007
14,835
476
2006
10,711
190
2005
8,490
359
2004
6,921
588
2003
5,264
35
2002
3,933
(149)
2001
3,122
(567)
2000
2,762
(1,411)
1999
1,640
(720)
1998
610
(125)
1997
148
(31)
1996
16
(6)
1995
0.5
(0.3)
($Million. Source: Annual Reports.)

Debt (LT)
1,561
1,192
896
1,282
1,247
1,480
1,835
1,919
2,277
2,156
2,127
1,466
348
77
0
0

Equity
6,864
5,257
2,672
1,197
431
246
(227)
(1,036)
(1,353)
(1,440)
(967)
266
139
29
3
1

Employees
33,700
24,300
20,700
17,000
13,900
12,000
9,000
7,800
7,500
7,800
9,000
7,600
2,100
614

The companys financial position has improved since 2000. Most of the improvement
is due to increases in saleswhich is good. But, those sales increased largely by selling
products for other firms, and from one more twist. Amazon no longer discounts most of the
books that it sells. In fact, it is generally more expensive to purchase books from Amazon
than to buy them from your local bookstore. For competitive online pricing, check
www.campusi.com, which searches multiple Web sites for the best price, but the selection
might not be as large.
Another source of increased sales is the international market (largely Britain, Europe and Japan). Notice in the table that media sales (books, audio, and movies) are higher
in the International market than in North America. More products are sold in North America, but clearly the growth path is the international market.
Net Sales 2010
North America
Media
$6,881
Electronics + gen. merch.
10,998
Other
828
($Million. Source: 2010 Annual Report)

International
$8,007
7,365
125

Out of curiosity, where did all of that money go? In 2003, Bezos noted that $900 million went to business technology; $300 million was spent on the fulfillment centers; and
$700 million on marketing and customer acquisition [Murphy 2003]. That last part largely
represents selling books at a loss or offering free shipping while trying to attract customers.
Those numbers add up to the $1.9 billion debt, but what happened to the other $1 billion in
net losses? Interestingly, according to the 2010 Annual Report, Amazon still runs a loss on
shipping. In 2010, the company declared shipping revenue of $1.2 billion, against outbound
shipping costs of $2.6 billion, for a net loss of $1.4 billion!
Amazon continues to expand aggressively. In 2011, Amazon estimated revenue increases of 28-39 percent but increased operating expenses by about 38 percent. Tom
Szkutak, Amazons finance chief noted that When you add something to the magnitude of
23 fulfillment centers, mostly in the course of the second half of last year, you have added
costs and youre not as productive on those assets for some time, [Wu 2011].
For the longer term, Amazons leaders clearly indicate that they are aware of the
stiff competitionboth from bricks-and-mortar retailers and from online rivals including
small start-ups and established rivals including Apple and Google.

Case Questions
1. Who are Amazons competitors?
2. Why would customers shop at Amazon if they can find better prices elsewhere?
3. Why did Amazon create most of its own technology from scratch?
4. If Amazon buys products from other firms and simply ships them to customers, why
does it need so many of its own distribution centers?

5. Will other retailers buy or lease the Web software and services from Amazon? Can
Amazon make enough money from selling these services?
6. Write a report to management that describes the primary cause of the problems, a
detailed plan to solve them, and show how the plan solves the problems and describe
any other benefits it will provide.