How Amazon Is Becoming the New Retail Showroom

Amazon's wide selection of products make it the first place for comparison shopping, or becoming a showroom for other online retailers.

Jul 16, 2014 at 1:20PM

In May, I dropped my Prime membership for Amazon.com (NASDAQ:AMZN) when the company decided to raise its price to $100 per year. But that didn't deter me from using the site regularly, particularly on my mobile devices.

However, today, my Amazon experience has changed from my Prime days. It's more about browsing for goods I may or may not buy somewhere else than it is about buying things from Amazon. In fact, whereas Best Buy may have been a showroom for Amazon for years, it may now be Amazon that is showrooming for everyone else. 

Amzn Box Image Tmf

Amazon ships millions of items per year, but that selection makes it a destination for comparison shopping.

The curse of massive selection
My realization that I was using Amazon as a showroom came from a fairly mundane item I needed: a bug zapper for my new home. I assume that my local hardware store carries a perfectly good bug zapper, but I always like to do some research before shopping, so I went online. But where do you start when looking for bug zappers? I Googled "bug zappers," but I also opened a window with Amazon.com. After all, Amazon has everything.

And there lies both Amazon's opportunity and its curse. It has everything, so it's a first-stop shop for consumers, but it's also a price-comparison tool for those same consumers. Amazon has to have the lowest price or risk losing business to improving sites from competing retailers and the very manufacturers of the products it sells. And that's where I see the biggest challenge long-term.

Amazon's emerging margin problem
I'm sure that Amazon would be happy that I'm searching for new items on its site, but the problem is that it doesn't always have the best prices. In fact, I've found Amazon's prices increasingly uncompetitive with manufacturers' prices, and that makes sense at the end of the day.

For years, retailers have been trying to gain a price advantage by cutting out unnecessary pieces of the value chain. Wal-Mart was known for eliminating distributors and going straight to product manufacturers because with its scale, the distribution network simply wasn't necessary.

Amazon has forgone the sales floor for warehouses where manufacturers can directly ship their products. Eliminating the cost of a brick-and-mortar store and eliminating shipping from distribution centers to stores saves costs -- although some of that cost comes back in the form of shipping costs:

Amzn Shipping Cost

One problem with Amazon's business model is that shipping costs continue to rise, squeezing margins. Source: Amazon earnings releases.

But the even more efficient model would be to ship products straight from the manufacturing line to a customers doorstep. It's not impossible; it just wasn't the way these businesses were set up. Yet that too may be changing.

More and more manufacturers are setting up websites with competitive prices and even free shipping. If they can get even close to Amazon's efficiency in inventory and shipping, they'll be able to compete because as the manufacturer, their cost of goods is lower.

The problem then for Amazon is that it'll have to keep costs low, meaning lower margins, and may not be able to use its scale to squeeze higher margins from manufacturers. Below, you can see how, despite higher margins in recent years when you include shipping and technology costs, the company's margins are flat, which is why it's still reporting little to no net income.

Amzn Gross Margin

Amazon's margins including shipping (what I've called the "Real Gross Margin") have been flat over the past three years, despite Amazon's growth in scale. Source: Amazon earnings releases.

If Amazon is constantly being compared to other online retailers, it'll have to have lower prices by definition to compete. If manufacturers start to ship their own products more efficiently, that model will come under even more pressure.

Amazon's core long-term problem
The biggest challenge for Amazon long-term is that it's built a business that sells itself by having lower prices than competitors. But if they choose to become retailers, manufacturers of goods should have the lowest costs because the supply chain is shorter. If product companies continue to improve their online retail offerings, it's Amazon that will become the showroom. Long-term, that will be bad for investors. 

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Travis Hoium is short shares of Amazon.com. The Motley Fool recommends and owns shares of Amazon.com. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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