"Your margin is my opportunity"

Feb 12, 2014

Table of contents:

The Amazon Strategy
What is disruption?
The unbundling of high margin industries
Examples and case studies
How to find opportunities
Conclusion

One of the most famous quotes from Amazon founder Jeff Bezos is, “Your margin is my opportunity”. Over the past decade, Amazon have mercilessly targeted industry after industry to cut the margins of the existing companies in order to offer a lower cost alternative to consumers.

Whilst Amazon have become better known for applying this strategy than for selling books, “your margin is my opportunity” is actually an extremely nuanced view of how technology and the Internet is shaking up old industries.

In this post I’m going to be look at the opportunity in high margin incumbent industries and how you can find ways of providing a better service to consumers at a lower price.

The Amazon Strategy

Amazon has come a long way since the early days of selling books online. You can now purchase almost anything on Amazon these days and have it shipped to your house in just a couple of days.

Amazon has quickly moved from category to category to become the undisputed number one online retailer. By moving into new industries and drastically reducing the price for consumers, Amazon can use it’s considerable resources to force competitors to reduce their prices too.

The interesting thing about this strategy is, Amazon can lose money in a category for years at a time because the company is so large. Existing incumbents therefore have to deal with a new competitor who will not only slash their margins, but is also willing to lose money on selling to consumers. This is just too difficult to compete against when you have only one source of revenue.

Amazon is executing this strategy in many different categories often in concurrency. This means that many sections of Amazon are losing money at any one time. Amazon is able to maintain forward momentum by investing the profits back into this strategy.

Another interesting thing that Amazon is doing is to go up against Apple and Google with their Kindle range.

Apple earn the majority of their profits from the margin they make on hardware sales. Google earn the majority of their profits from selling advertising. Amazon is aiming to earn their profits from selling services and content to the consumer.

These totally different strategies are playing out in the smartphone and tablet market where each competitor is able to take a completely different path. Apple for example aims to sell high end devices, whereas Amazon effective gives their devices away for cost price in order to earn money through a recurring revenue relationship.

What is disruption?

I’ve wrote about disruption a number of times on Culttt, so I won’t go into great detail once again.

The main thing to remember when thinking about disruption is, the disruption happens in the market, not the technology. If you are releasing a better product, that is not disruption that is just an iterative improvement in technology.

To read more about disruption, take a look at the following posts:

The unbundling of high margin industries

In my previous post How to disrupt an industry through unbundling I wrote a lot about the theory behind unbundling high margin industries.

In this post I want to talk about more of the specific opportunities as well as a couple of companies who have already started taking advantage of this shift.

When companies bundle complementary products, each consumer gets the same deal, no matter what that particular customer’s needs are. This means some percentage of buyers end up paying extra for stuff they do not need.

The opportunity in unbundling is therefore to break up the bundle into individual components so consumers can pick and choose only the bits they actually need. This reduces the complexity of the product and ensures the consumer is not paying for unnecessary extras.

Examples and case studies

Unbundling is certainly not a new idea and so there are many great examples of Internet first companies who have taken an existing offline bundle and broken it up online.

The funny thing is how many incumbent offline companies are still clinging to the hope of their high margin bundles trying to ignore the shifting tide of consumer spending.

iTunes

Whilst iTunes was fairly late to the online music scene, it was probably the first big successful way that consumers could legally purchase music online.

Before Napster and the peer-to-peer music explosion of the late 1990s the only way you could get music was if you bought an album. The album is a bundle where the most popular songs are sold alongside album tracks in order to increase the price of the product. The consumer probably only wants to buy the popular songs, but before the Internet, you couldn’t select only the songs you wanted to buy.

Whilst iTunes was able to convert many illegal music sharers to legal music downloaders through convenience, the real shift was the unbundling of the music album. What iTunes represented was the first real opportunity to buy individual songs. iTunes was able to attack the high margin album sales to offer individual songs to consumers.

Netflix

Netflix started out as an online version of the movie rental company Blockbuster. Instead of going to a Blockbuster store, Netflix customers could simply order movies and have them delivered to their door.

However in recent years Netflix has moved away from delivering movies to a full streaming service. This move has also coincided with their attempts at unbundling cable television.

Netflix is now more of a competitor to cable television companies than it is to movie rentals. Whilst it is hard to make an apples to apples comparison because the television industry is so fragmented, Netflix is clearly moving towards this goal.

Cable television is expensive and includes a lot of content and channels that the average viewer will never watch. Cable television is therefore clearly an opportunity to unbundle the expensive, high margin product into individual lower margin products where the consumer can pick exactly what they want to watch.

The television industry remains very fragmented, so only time will tell if this actually plays out. Perhaps this fragmentation can ultimately save the cable companies.

Airbnb

Airbnb is typically seen as one of the great collaborative consumption companies of the last couple of years. By creating a marketplace for individuals to advertise their own homes to guests, Airbnb has created a new economy for those who want to sublet their extra space to guests in order to make a side income.

However, I think the bigger movement that Airbnb represents is the unbundling of the hotel and leisure industry.

Typically staying in a hotel in a major city is really expensive. The problem is, as guest you end up paying for the restaurant, the gym, the bar amongst many other amenities that you probably don’t want. Hotels are simply a bundle of leisure services wrapped up as one package.

If you are a traveler on a budget, you probably only want to have a nice room, and not all of the other amenities of a hotel. If you cut the cost of the restaurant and the gym and only charge for the room, the cost of travel suddenly begins to plummet.

Airbnb therefore is not just part of the collaborative consumption movement, but also the unbundling of the incumbent hotel industry.

How to find opportunities

Finding opportunities to unbundle an industry or product is therefore all about looking for situations where the consumer isn’t able to self select the components of the package that they desire. When a customer is forced to purchase the whole product rather than only the bits they require there is an opportunity to unbundle because you will be better at servicing that particular customer segment.

Focus

Focusing on a particular customer segment is one of the classic opportunities of disruption. This is because you are probably removing quite a bit from the product and so making it less functional, but you are reorganising the market to better serve that particular consumer.

Move offline to online

There are many industries that have not made any forward movement online. These types of industries represent one of the best opportunities because there is so much open space. It is always going to be difficult to be the number 2 company in a movement. Try to find an untouched opportunity where the existing offline incumbents are going to refuse to lower their cost structure and move online.

Appeal to the characteristics of the Internet

You can’t just break up a product and move it online because it won’t just magically work. Instead you need to understand how the Internet significantly improves the value of that product.

iTunes for example can deliver any song from the long tail of the music industry instantly to your computer. This unlimited shelf space is a clear advantage the Internet has over the offline world.

Conclusion

Whilst Jeff Bezos is known for his brash attitude and mercilessly outlook to business, he clearly understands the rising tide of the Internet. Amazon was one of the first companies to take action to breakup the high margin opportunities of the offline world.

Removing the margin from an opportunity can seem like a crazy idea in the world of capitalism. However by removing the margin and providing an unbundled product, you increase the total opportunity.

By striving to provide a more value for money product to consumers, you are able to increase the size of the pie, and not just your share of it.

One of the big advantages that a new startup has over incumbent companies is, you can reinvent the pricing structure of your industry. By completely moving the emphasis of the market you are able to make incumbent business models obsolete.

Amazon continue to use this strategy in every category they touch. It’s only a matter of time before more and more industries are inflicted with it too.