Amazon: The Mercantilist In Our Midst

OK.  Mercantilist is probably not the right analog, but it does share some elements of what is occurring in the world as shaped by Amazon.  Mercantilism is a State policy and Amazon is not a State…yet.  Mercantilist states seek to accumulate specie through positive policies enabling foreign trade, or at the very least substantial market leadership and market share regardless of profit.  Japan in the 1970s and 1980s and China today are examples of modern mercantilist states at work.  Amazon too uses pricing to gain market share regardless of the profit it generates.  They have notoriously low margins.  Profits as a percentage of sales have historically been below zero.

The more precise term for what Amazon does is Predatory Pricing.  In the aftermath of the Great Depression, predatory pricing actions were far more frequent than today.  As a part of Antitrust law this area largely withered on the vine because the low prices are generally favorable to consumers and in the world of retailing or even wholesaling, barriers to entry are generally low.  The pricing they can accomplish are composed of three parts; the price of the product, taxes and shipping.  By having the ability to sell without sales tax until recently, and by subsidizing shipping costs and also by charging little to no markup on the price, or even negative markups, Amazon has threatened the existence of both small and larger established sales outfits nationwide.  This follows the shakeout of the retail space already started by the rise of Walmart.  The result is that strip malls and even large malls have been losing tenants and the number of retailers has fallen, as has the number of people employed in the retail sector.

And therein lies the risk for Amazon.  While the consumer has gained greatly by the ability to find literally anything and have it shipped in two days at what is almost always the lowest price available, the sheer carnage wreaked upon the economy as a whole has become so large that it will start to garner the attention of policy makers in Washington and of the Justice Department.

Now this is a near run thing because much of what Amazon has done is sheer genius.  In pioneering the new best distribution model, where items are sent to logistical hubs which produce least time and least cost routes to consumer end destinations, they needed massive computing resources.  And massive computing resources are expensive to acquire and maintain.  What better way to fray the cost than to share out the computing infrastructure to the world at large and in so doing paying for your own computing needs?  And so the entire Cloud Computing industry was born.  It is their most profitable business and the profits from that pay for losses from their actual retailing business.  And so their stock price has rocketed higher.

The other major element of their genius was building a go to first relationship with people via the Prime program.  This gets people two day free shipping.  This means when you go to Amazon you know exactly how your life is going to go.  No uncertainty.  I ordered this now.  I will have it in a couple of days.  Oh I also get some free videos and some other stuff.  Great.  The whole point is that when people want to buy something, people go to Amazon first, and only if there is some overriding concern do they consider buying from somewhere else.

As the saying goes, in the long run the stock market is a weighing machine, in the short to medium term it is a voting machine.  And as a voting machine it depends entirely on narrative, of which actual fundamentals like the state of the balance sheet and income statement play only a small part.  A stock’s price in the short to medium term is all about the Story.  The more the Story engenders a stars-in-the-eyes response in investors the higher the stock price and the higher the multiple.  Amazon has created a very sexy story.  And so they have nearly limitless access to capital with very long term tolerances that their competitors large and small lack.  They can afford to sell at a loss.  Investors love their story so they don’t care.  In fact it makes the stars glow in their eyes all that much more because once they have vanquished everyone else they can raise margins and print money.  Of course that is the end result of Predatory Pricing schemes.  Kill off the competition, then raise prices.  You can probably consider the costs of computing and creating the logistical network necessary for the new retail distribution model pretty high barriers to entry, which is the other element necessary to allege Predatory Pricing.

So if I were Target or Walmart or Best Buy or whoever is threatened by Amazon, I would be undertaking at least a three pronged attack against the Seattle SuperGiant’s pricing strategies.  First you have to do what Amazon does best, optimize your distribution model to lower costs (Walmart pioneered this) and enable seamless sales experiences for people with little to no uncertainty, by which I mean if someone orders from you they can be nearly certain when they are going to get what they ordered and confident in what their experience is going to be whether they are interacting in person or via the web.   Leverage your physical stores to make consumer experiences even better than what Amazon can do.  Second, have lobbyists making the antitrust case to Congress as well as the DoJ and even the best antitrust experts at leading law schools to create and reinforce a meme that what Amazon is doing is ultimately bad for the country as a whole and which overwhelms the benefit of lower costs to the consumer.  Finally, attack their tax advantage.   I do not think you argue they should pay the full state sales tax in every jurisdiction.  Where they do not have a physical presence, the state does not incur the physical costs to justify charging the full tax.  But everything is delivered over roads in the states where the deliveries take place so the states do incur some costs.  Maybe half the sales tax rate should be charged for online sales for retailers over a certain size.

This just barely touches on what is one of the most interesting developments of modern times but Amazon is not invulnerable.  At some point competitors with their eye on the ball and the ability to take the long view will be able to blunt the juggernaut that is reshaping the retail landscape.

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