Amazon's Business Model: Growth Through Vertical Integration

The Amazon Business Model: How Do You Grow If You’re Already The Largest?

Founded in 1994, in 2015 Amazon became the fastest company ever to reach $100 billion in annual sales. Once Amazon has become the global major book seller, how could Amazon still grow substantially? The answer is: by offering new, different services. There’s only so much you can grow in one business. Therefore if you want to grow more, you need to diversify. You need to develop new types of offerings:

Offer adjacent offerings (related to your existing ones); or
Take over roles of other companies in your own supply chain; or
Offer completely new offerings (the latter is more difficult).

The Amazon Business Model is consistent along the company’s various product launches.

What Is Vertical Integration?

The examples presented in this article demonstrate what I consider Amazon’s vertical integration strategy. We explain this strategy by analyzing three examples. But before we dive into the Amazon vertical integration strategy, one should understand what is the definition of vertical integration.

In short, vertical integration is defined as “the combination, under a single ownership, of two or more stages of production or distribution (or both) that are usually separate” (“separate” means that usually these activities are done by suppliers or business partners). The examples below answer the question “why does Amazon use vertical integration?”; to kick-off the discussion, consider some key benefits of vertical integration: reduced transaction costs, reduced supply chain risk / supply chain dependence, and creating higher entry barriers.

Amazon Web Services

Amazon Web Services (AWS) may be one of the brightest ideas of Amazon. The service was launched in 2006, and offers on-demand cloud computing platforms. While competing in a market of giants (Microsoft, Google and IBM are key competitors), AWS owns 34% market share. Its largest competitor Microsoft has just 11% market share. In my view AWS is unique in the landscape of Amazon’s offerings not just because of its success ($17.4 billion revenue in 2017) but because of how it was conceived. Amazon Web Services started from Amazon’s own need for a robust cloud-based IT infrastructure. Once they had developed the capability for internal purposes, the next obvious thing was to monetize it and sell it as a service. In other words: Amazon grows by developing a capability for itself, doing it very well, and subsequently offering the same capability to clients.

Amazon Delivery Service (Logistics)

Similarly to its need for robust IT, Amazon is also well-known for having optimized supply chain management, i.e. logistics. The company’s ability to predict the demand for its products, to distribute products efficiently and to ensure fast delivery to its clients has become a major differentiator: people buy on Amazon (among others) because delivery is fast and reliable, i.e. predictable. Amazon’s Delivery Service capitalizes on this capability.

Amazon will be able to reduce costs of their own deliveries (the costs of their internal delivery service are likely to be lower than the costs of using DHL, FedEx or UPS)
Delivery service providers that work with Amazon will benefit from large volumes, thereby ensuring a steady revenue stream
When Amazon offers its delivery service to other merchants (imagine e.g. that you buy products online from your favorite retailer, and the shipment is done by Amazon), it will have a new revenue stream, and at the same time it will have stronger negotiation power towards delivery service providers in its network (due to increasing volumes). UPS, DHL, FedEx: prepare for a tough battle.

Amazon Prime

Amazon Prime Video is another interesting example. In this service Amazon is competing with yet another major rival: Netflix (and a few others). Also here the idea is brilliant in its simplicity. If people already come to Amazon to buy products online, why not offer online (digital) products? A core capability for realizing this service is a very robust IT cloud Infrastructure. But we’ve already established that Amazon is the global leader in this service (AWS). Therefore, the road to launching Amazon Prime Video was short. The interesting element is that Amazon bundled the Prime Video service with its loyalty program Prime, which allows free fast shipments of physical products. That is very interesting, because the costs of shipment may often be an obstacle for people to place an order of physical products. If someone buys a Prime subscription for the TV/movie streaming service, they can enjoy free shipments of physical products at no additional cost, and thus the probability that they buy more physical products on from Amazon increases. The result: more revenue for Amazon.

Much more can be written about Amazon. But this suffices for now. The core message of this blog post is the observation that Amazon is consistent in deploying a vertical integration strategy to keep growing its business. While other companies try to grow their share of their existing pie, Amazon keeps introducing new pies, and subsequently, they strive to have the major market share in each and every pie.

Suggested reading: