Amazon is a different beast from when it first conceptualized in 1994, where Jeff Bezos had the idea of building an online bookstore with millions of titles. Bezos knew that the opportunity with ecommerce would be huge but he started with books because:
a) people wanted them,
b) physical stores were limited in what they could carry,
c) books were easy to pack,not fragile and
d) Amazon was located strategically near a major book distributor, so a warehouse inventory was not required to get started
In the early years, Bezos packed the books himself. With him and his small team (including his ex-wife) spending many back breaking nights packing books on the floor and rushing them out for shipment. This was when the norm for ecommerce delivery was anywhere between 2 weeks to 5 weeks!
With the current amount of data optimization for delivery, storage, and automation in Amazon’s warehouse, it makes it difficult to believe that back then the biggest productivity scheme was to pack books on tables rather than on the floor.
Excerpt from The Everything Store
Amazon soon began selling music, DVDs/videos, toys, and everything else. Extending into toys presented a challenge because it was difficult to predict holiday season demand, unsold toys are not returnable to manufacturers, and it is extremely fad-driven. For a young company like Amazon, manufacturers were giving their best selection to giant retailers such as Toys “R” Us. Bezos would drive his Honda Accord to Toys “R” Us and max out his credit card to get his hands on the most popular selection for Amazon.
Amazon’s Early Days: 1P Marketplace
Notice that up till now, Amazon has been operating a 1P marketplace, where they will buy the inventory and sell directly to internet users. Contrast that to eBay who operates a 3P marketplace, where they do not take inventory, instead, they are merely a platform that earns a commission by bringing third party merchants and consumers together.
A 1P marketplace will have a much lower profitability profile. Since Amazon has to purchase the product before reselling to consumers, its cost of sales is much higher compared to eBay. eBay’s costs would typically only be payment processing, customer support and data server usage.
In the following chart, we can see that Amazon gross profit margins are significantly lower than eBay’s, at ~23% and ~79% respectively.
Also, cash will be locked up for working capital requirements under the 1P model, because Amazon has to spend cash first to hold inventory in the warehouse, before getting paid by customers later. eBay on the other hand, would receive cash from customers first for a sale, before having to pay third party merchants.
As a result, we can see that cash from operations as a percentage of revenue for eBay being significantly higher than Amazon.
Having a 1P marketplace is not a bad thing in itself. It provided Amazon with control over its customers’ experience and, because of its size, it gained unrivaled logistical prowess in the United States.
Today, Amazon (and Jeff Bezos) is a different beast. The profitability of the business has improved considerably. With the growth of its high margin segments such as
(1) 3P marketplace,
(3) AWS and