Amazon.com's Attack on Retail

Given all the hyperbole that surrounds retail these days, you'd be forgiven for envisioning Generic Retail Co. chained up in some dingy cell at Amazon.com's (Nasdaq: AMZN  ) headquarters, contemplating the cyanide capsule tucked in its molar. In fact, Bloomberg TV recently wondered whether electronics retailer Best Buy (Nasdaq: BBY  ) had become nothing more than a showroom for Amazon. That might actually be true, but let's look past the mainstream hype and see what's really going on in retail.

Thin margins are like thin mints: best served en masse
First, let's talk about money; Amazon basically prints it all year long. Last quarter, the company bought in $13.2 billion in revenue, which is just silly. But along with all that moneymaking comes money burning. Having low, low prices and shipping deals cuts into the bottom line. Amazon has opted to sell lots and lots of stuff at a 1% net margin instead of selling a few things at 10%. That means the $13 billion it brought in turned into $130 million in actual income.

On Main Street, Best Buy is feeling the pinch, and here's the reason: branding. For lots of electronics, DVDs, and video games, the brand of the retailer is not nearly as important as the brand of the product. If you want to buy a Sony TV, the important thing is that it's made by Sony, convenient to buy, and cheap. More often than not, that means buying from Amazon.

But those same bargain hunters can't hurt lululemon athletica's (Nasdaq: LULU  ) sales. The yoga-clothing retailer pulled down a 20% net margin last quarter, and sales keep growing. The huge margin is due to brand strength that Amazon can't touch. You can get cheap pants from Amazon, but they aren't lululemon pants, so people buy directly from lululemon instead.

Mo money, mo products
The other reason Amazon is dominating the industry is its ridiculous, Freddie Mercuryish range of selection. Companies like Barnes & Noble (NYSE: BKS  ) are fighting the often-discussed "long tail" that Amazon houses. When you go into a physical store you're limited to what happens to be on the shelves at that moment. Amazon gives shoppers seemingly infinite choice, and it's hurting those other companies. Barnes & Noble took a $74 million loss last year and has had to take on new funding and friends, teaming up with venture capitalists Jana Partners and tech giant Microsoft to save the ship.

But the long tail doesn't touch companies that sell exclusive products. Look again at lululemon; it provides the only place to buy its products. There are no retail outlets to purchase lululemon clothes except for company stores and small yoga shops. Amazon can't get a part of the action because, once again, lululemon has locked it out completely.

Even kings fear assassins
Amazon's final strength is also its most interesting weakness. The reason the company has dominated the retail landscape is that it envisioned a different kind of retail before anyone else did. In classic rule-breaker fashion, Amazon turned the online sales system on its head. But now, the new online system is becoming more mainstream. Companies from Target to Best Buy now have online stores that look surprisingly like Amazon's. But the norm is always subject to disruption. Shoe retailer Zappos and other smaller retailers moved into Amazon's space, and in 2009 Amazon had the good sense to buy Zappos out.

Other companies are turning up the heat on Amazon as well. Newegg.com, an online computer and electronics retailer, filed for an IPO in 2009 before withdrawing in 2011. The company brought in $2.5 billion in revenue in 2011 and shows no signs of slowing down. That's $2.5 billion that Amazon didn't sell in 2011, and to preserve market share, Amazon will probably have to fight it off or buy it out.

The options
Given these insights, there are two ways for investors to get around Amazon's strength. The first is to just buy Amazon shares. They're never cheap, but that hasn't hurt performance so far.

As an alternative, you can spread out across retailers that fit into these categories:

  1. Strong brand value that produces high margins.
  2. A proprietary product.
  3. A disruptor in the online market.

To summarize, Amazon will never dominate all of retail -- just a few huge, very lucrative segments. The Fool has picked out three other companies that are set to dominate the globe. These guys make the board game Risk look like a corporate strategy. Our analysts have explained how they're going to do it in a special report, which you can download for free. Grab your free copy of the report now.

Fool contributor Andrew Marder owns none of the stocks mentioned in this article. The Motley Fool owns shares of Best Buy, lululemon athletica, and Amazon.com. Motley Fool newsletter services have recommended buying shares of Amazon.com, and lululemon athletica and writing puts on Barnes & Noble. The Motley Fool has a disclosure policy. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.


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