For years, there's been talk of a bubble forming in Silicon Valley. Investors have dubbed tech start-ups with valuations north of $1 billion "unicorns," an appropriate name considering the magical and mythical nature of the imaginary creature. In the process, they have slapped eye-popping valuations on such companies as Uber, Airbnb, and Snapchat, companies whose names have entered the lexicon in just the last few years.
"Uber" has gone from being a German prefix to a $62-billion transportation company seemingly overnight. Why? Because of the winner-take-all nature of much of the start-up world.
In a recent New Yorker article, Om Malik outlined this theory, explaining how today's tech-based businesses are often built on network effects, meaning that the business becomes more valuable and useful as it attracts new members. Two of Silicon Valley's tallest giants, Alphabet (NASDAQ:GOOG) (NASDAQ:GOOGL) and Facebook (NASDAQ:FB) have become two of the most valuable companies on the planet in less than 20 years because of the power of network effects and winner-take-all. Google recognized the power of algorithmic search early on, committing to it with investments in its own infrastructure and developing a better algorithm than the initial industry leaders. That attracted more users, who helped make the search function even better as it learned from the entries and selections users made. Today, Google controls a 70% share of search in most major markets, a level considered to be a monopoly. That dominance and the huge advertising business it enables are the primary reasons why Alphabet is now worth $500 billion.
Facebook may provide a better example of network effects. The social networking giant quickly left MySpace in the dust after it opened its platform to all users, and today counts more than 1.5 billion members. While other social media sites have popped up for other purposes, like Twitter for news and live information, Instagram for photo-sharing, and SnapChat for disappearing messages, there is no real competitor to Facebook, no No. 2, and there probably won't be. While the business is simple enough to imitate, drawing all those users away from Facebook would be nearly impossible. A social network is only as valuable as the other active users in the network, and having most of your friends and family on Facebook means you're unlikely defect for another option.
The power of an idea
Winner-take-all is a powerful idea. It's what all businesses want for themselves: a monopoly. Not all industries lend themselves to the model, however. Coca-Cola dominates the beverage industry, but it's far from a monopoly. It's just as easy to reach for any other of dozens of beverages, and the popularity of Coke doesn't make it taste any better, though the effect of social proof might influence your decision.
And then there's retail. Think of the traditional open-air market or bazaar, with dozens of stalls -- each merchant hawking their wares. It's classic free-market commerce -- the opposite of monopoly. In America, that concept evolved to a Main Street full of mom-and-pop stores, and from there to big-box chains in malls and suburbs outside of downtown areas. No company has taken more blame for the gutting of small-town America than Wal-Mart (NYSE:WMT) , as independent shops and other chains found themselves unable to compete with its low prices and wide selection. Today, Wal-Mart controls nearly one out of every 10 retail dollars spent in the U.S., but even it has hit a roadblock in its quest to take all.
Now, all eyes in the industry are on Amazon.com (NASDAQ:AMZN). While Amazon's annual retail sales are still less than a quarter of Wal-Mart's, it passed its big-box competitor in market cap last summer, a sign that investors believe Amazon has the more profitable future ahead of it.
The e-commerce juggernaut has more than five times the online sales of its closest rival, Wal-Mart, which rang up $14 billion last year, compared to Amazon's $79 billion.
And despite its size, and its rivals' recent efforts to regain ground, it continues to gain share. Amazon's North American sales grew 24% last quarter over the year-ago period, compared to a 15% overall growth in domestic e-commerce sales.
Mainstream retailers like Wal-Mart are shuttering stores after a weak holiday quarter, while Amazon changes the retail landscape. Though it only controls about 19% of online sales, its effect on other merchants is much larger than that. According to one study, it grabbed 51% of applicable retail growth in the fourth quarter.
Let's take a look at some of the other ways Amazon is moving toward a retail monopoly.
The power of Prime
Amazon Prime is probably the most successful loyalty program in the history of retail. In 10 years, the company has attracted 54 million domestic members to the program, according to estimates, by offering free two-day shipping and other perks. The company's practice of stuffing it with a growing list of side benefits like Prime Video and promotions like Prime Day shows that management sees it as a key growth driver. Membership fees alone drive $5 billion in revenue to Amazon, and researchers believe Prime members spend in the neighborhood of twice what non-Prime members do on the site. Retention rates are also believed to be upwards of 90%.
Prime Now, its new service that offers same-day and next-day delivery, is rapidly gaining wide adoption, according to a study from Cowen & Co. The research firm found that 25% of Prime members have used the speedier delivery service. A little more than a year after its launch, Amazon has introduced it in 24 markets that cover about half of the U.S. population. Amazon's partnerships with third-party retailers have also been a boon to Prime Now, as 26% of shoppers bought goods from a local grocery using the service. The popularity of such services should only continue to fuel Amazon's strong growth rate.
Amazon got a head start in e-commerce and hasn't stopped racing ahead since. It doesn't release figures on the number of fulfillment centers it has, but it's estimated to have 104 such distribution centers in North America. In recent years, it has added dozens of warehouses near major metropolitan areas to speed up delivery. By comparison, Wal-Mart has 158 distribution centers in the U.S., but almost all of them are designed to support stores, with items organized in bulk on pallets. At an e-commerce distribution center, products are sorted individually for piecemeal shipping, so converting one type of distribution center to the other is difficult. Wal-Mart is quickly opening up new e-commerce facilities, and has touted the capacity of its stores to serve as distribution sites and points of pick-up, but thus far, its online growth efforts have not gained much traction. Its e-commerce sales grew just 8% in its last quarter.
Amazon is now extending infrastructure past storage and sorting to shipping, investing in its own fleet of trucks and planes to compete with FedEx and UPS. As it grows, expect this in-house delivery service to become yet another competitive advantage.
Amazon, perhaps more than any other company, approaches experimentation and failure without fear. The company regularly launches big ideas. Some, like the Fire phone, fall flat, while others, like Amazon Web Services, have turned into gold mines. The company continues to push the boundaries of what it can be for its customers, and monopolizing the retail industry seems to be the end goal of its strategy.
It may never have the market share that Google and Facebook do, but it doesn't need to in order to upend the retail industry. The company is already remaking it with less than a quarter of Wal-Mart's sales. As it continues to grow, it may not take all of retail, but as its market value reflects, there is no No. 2 anymore.
Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Jeremy Bowman has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Alphabet (A shares), Alphabet (C shares), Amazon.com, Facebook, and Twitter. The Motley Fool recommends Coca-Cola. 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.