How Amazon Exploits the “Mid-Tail”

Last October I wrote a post about how Amazon uses data from sellers like us to gain a competitive advantage. You can pretty much sum up the entire post with this promo image of Amazon’s that I “amended” to reflect our experiences:

Amazon and the Mid Tail

We’ve since stopped selling on Amazon, but I’ve continued to receive emails about the post. Once such email was from a graduate student, Baojun Jiang of Carnegie Mellon, who was writing a thesis on the topic of topic. I think it’s absolutely awesome that someone would want to delve deeper into Amazon’s awkward relationship with their sellers. He asked for my permission to cite my post, which I of course gave him, and we exchanged several more emails about the details of our experiences with Tastefully Driven.

The paper was finally published online last week. The math was waaay over my head (it’s been quite a while since I took calculus and differential equations, and even then I’m not sure if I’d “get it”), but I nonetheless found the paper very interesting to read, especially considering that this potentially controversial topic doesn’t seem to garner very much attention.

Here is an excerpt from the paper, sort of a “guest post” by Baojun and his partners:

While millions of products are sold on its retail platform, Amazon.com itself stocks and sells only a small fraction of them. Most of these products are sold by independent sellers, who pay Amazon a fee for each unit sold. Empirical evidence clearly suggests that Amazon is likely to sell the high-demand products and leave the long-tail products for independent sellers to offer. However, for “mid-tail” products, those that it cannot classify with certainty as either high-volume products or low-volume products, Amazon’s strategy is less clear. While Amazon may let independent sellers offer such a mid-tail product, it may be tempted to offer the product directly, especially if the product shows the promise to become a bestseller. Amazon’s “cherry picking” of the successful products, however, gives an independent seller the incentive to hide any high demand by lowering his sales with a reduced pre-sale service level unobserved by Amazon.

A closer examination of product sales on Amazon’s platform reveals an interesting fact – Amazon indeed sells a disproportionately large number of products with high demand. For example, though Amazon directly sells only 7% of all electronics products listed on its website, it sells 64 of the top 100 bestsellers in that category. Digging a little deeper, for the “Digital SLRs” camera subcategory (with 928 products listed), we find that the percent of products sold by Amazon decreases sharply as we go down the list of bestsellers—Amazon carries 16 of the top 20 bestsellers, but only 5 of the products with sales ranks from 150 to 250

For a mid-tail product whose sales potential is not readily obvious, Amazon can initially let the independent seller sell it, track the early sales of the product, and then decide whether or not to offer the product directly. And therein lies the inherent risk faced by a midtail independent seller: If the product sells well, Amazon can observe this (since it processes all sales orders on its website) and is likely to enter and offer the product itself. In doing so, Amazon can eviscerate the independent seller’s market, driving him out of existence. [Amazon’s] agreement with independent sellers allows it to terminate any seller at any time without notice for any reason. But Amazon does not actually have to take such an extreme action. After it starts selling the product directly, Amazon can boost its own sales in various ways. For instance, it can display its own offering very prominently, and given its advantages in scale and not having to pay its own sales fee it typically offers lower prices along with free shipping, etc.

Anecdotal evidence from popular discussion blogs suggests that Amazon indeed does this kind of cherry picking of relatively high-demand products, and that once Amazon starts selling a product directly, independent sellers essentially lose most if not all of their sales to Amazon.

This creates a dilemma for the high-demand independent seller. He may make more profits early on by selling many units of the product, but if he sells too many units, Amazon will learn that this product is worth selling directly, and the seller will lose substantial future sales. Thus, if the seller has a relatively high-demand product, he has an incentive to reduce his unit sales, perhaps through a lower pre-sale service level to the potential buyers. For instance, he may carry a lower inventory level and periodically post out-of-stock notices. He can also devote less time and resources to dealing with consumers’ inquiries about his product or related post-sale services (e.g., he may answer inquiries less conscientiously and with a longer time lag, hence losing some potential sales). Such pre-sale interactions with consumers typically occur outside Amazon’s sales platform and cannot be directly observed by Amazon. Moreover, with hundreds of thousands of independent sellers, Amazon may find it too costly to monitor even the somewhat observable aspects of seller services. Hence, Amazon may face a demand-learning problem for mid-tail products—if it observes not-so-high unit sales for the seller’s product, it may not be able to infer whether or not the product has the potential for high-enough sales to warrant direct selling, because the observed not-so-high unit sales may be due to either a not-so-popular product or a popular product but not-so-good seller services/efforts.

Therefore, the mid-tail products on online retail platforms give rise to an interesting market in which the independent seller benefits from selling on the platform, but he may also be in competition with the platform provider itself. We find that if Amazon’s ex ante belief is that a product has high demand with a high-enough probability, it will set a large fee such that only the high-demand seller chooses to sell on Amazon’s platform. Therefore, Amazon will be able to identify the high-demand product and sell it directly in the later period. But if the probability of high demand is small, then Amazon will charge a low fee such that both types of sellers will sell on the platform. This, however, allows a high-demand seller to mask himself as a low-demand seller by under-investing in service. As a result, Amazon is unable to learn the seller’s true type; in the first period, both types of sellers will have the low-type seller’s first-best sales (conditional on Amazon’s fee), and in the second period, the high-type seller will choose his own first best service level and price. In this case, Amazon will actually make a higher expected profit if it commits ex ante to not selling the product in the future.

Furthermore, we find that both types of sellers may make higher profits if Amazon keeps its entry option than if it forgoes it. This is because if the probability of high demand is not large, the possibility of the low-demand seller will deter Amazon’s entry, while the possibility of a high-demand seller mimicking a low-demand seller results in a lower fee charged by Amazon. In addition, we find that Amazon’s threat of entry may actually reduce consumer surplus in the early period though it increases consumer surplus in the future period. This is because in the case of a high-demand seller, the lost demand in the first period due to his reduced service level to mimic the low-demand seller more than offsets the consumers’ benefit from the seller’s lowered price.

15 comments on How Amazon Exploits the “Mid-Tail”

  1. Tim says:

    As much as I think this activity may be a little shady, I kind of admire what Amazon has created. I think any of us in their shoes would probably do the same thing. Where does the 800 pound gorilla sit? Exactly.

    • Adam McFarland says:

      Oh totally. In the previous post about this I called it brilliant. It’s business. It would be nice if you knew about this possibility going into it as a seller (I think it becomes evident after it’s happened but isn’t overtly obvious up front), but otherwise I have no problem with it other than there being less money in my pocket 🙂

  2. Rob says:

    It is a very smart setup on their part. I’ve now begun getting emails from amazon asking if I want to sell my products through them. I think given what you’ve said here I’ll give it a wide berth for now…

    • Adam McFarland says:

      Rob you might want to try to “study” your niche a bit and see how Amazon handles it. For instance, do they pick up your competitors best sellers? It takes some time to study, but all of the best seller data is available freely on their site. It might be one of those areas where they just let sellers be, in which case it could be a great way to expand your business.

      For us, the health and fitness stuff on TD was just too big of a category. Every time we started to sell a lot of something (a lot being a few per day, 60-90 per month), they’d generally start stocking it and our sales would drop off. One product we still “beat” them because we had a lower total price (even with their free shipping) and on our listing we had better reviews (same product, total chance) so we outranked them in their own search engine. For that product, they really wanted us to use their fulfillment. After a while the emails and calls got annoying. I do at least give them some credit for being fair – they could have manipulated the system to merge the two products into one or to make theirs come up #1 in the search and they didn’t.

      • Rob says:

        Okay, I’ll certainly have to have a look into that. Am I to understand from the essay above that different products have different sales commissions? I read somewhere that it was 15% flat, that seems quite high. Also, how do they go on with postage allowances?

        Regarding your sales dropping off, were you still better off after going through them or before? Eg. If sales were 100/mo before signing up to Amazon, then they jumpted to 150/mo including 50 amazon sales, when they took over that product and your sales dropped off, did they end up being higher or lower than 100? Was it an overall positive experience or did you regret letting them in on a good seller as it was detrimental to your own success in the long run? I presume Amazon will probably rank very highly for that product, possibly higher than you, and people may be happier to purchase from a brand they’re familiar with.

        Also, how on Earth were you getting a better price than Amazon?

  3. Adam McFarland says:

    Good questions.

    Yes, there are different referral fees (see: http://www.amazonservices.com/content/sell-on-amazon.htm?ld=SCSOAlogin although it might show differently in the UK), however all of our categories were a flat 15% I believe.

    For shipping, we could either charge a set price per lb or a set price based upon the price of the item, neither of which are “real world”. FedEx charges us a flat rate plus an additional price per lb, which varies based upon location. It sucks that Amazon can’t simply use the FedEx/UPS/USPS APIs and program those into their system.

    The question about our sales dropping off is a tough one to answer. In most cases, if someone can get something cheaper on Amazon they don’t seem very receptive to switching to your site, and understandably so. We even got a bad seller review because we included a coupon to our store in someone’s order – they called it “SPAM” in their package. With both TD and DI, I can’t say that we were better off for having done Amazon. There might be a few examples of people who found us that way, but it was very very minimal. We generally included a coupon with their order, and then sent an automated follow-up email asking them to rate us on Amazon and included a 10% off code to come shop with us. Those basically converted at 0%. A few conversions on thousands and thousands of transactions. Maybe there’s a better way. To us it didn’t seem like there was much to work with though.

    Our Amazon business was profitable, just much less profitable than the rest of our business when you factor in the 15% (+ $39.99/mo), inaccurate shipping quotes, and lower prices in general because you’re competing with other sellers. There’s also the constant worry that someone is going to come in and undercut us and take away all of our sales. Just takes one crazy seller in your industry who is willing to take a loss to move products or gain supposed market share and you’re screwed.

    Probably the best thing we got out of it was that we knew we were stealing sales directly from our competitors. Then again, that’s an increase in time spent packing orders, customer service, etc.

    Finally, it wasn’t that we were getting a better price than Amazon on the one product, it was that we were getting the same price and undercutting them. The company was very small and only had 1 tier of pricing if you spent $1500+ on an order, which we always did. Roughly, we got the product for $15 and sold it for $30 on TD. Amazon had it listed at $34.99 plus their free super saver shipping. We listed it for something like $27.99 + $5.99 shipping to undercut Amazon and other competitors. After the 15% we still made ~$8/unit and sold ~3/day, which worked out to about $9k in profit per year. Unfortunately there were a ton of returns on the product, which, without getting too into it, were a total pain. And that was the only product like that. The rest we either broke even on or barely profited. It just made sense to focus our time on the other parts of our business that are actually very profitable.

  4. Rob says:

    Thanks Adam – yeah, looking at http://services.amazon.co.uk/services/sell-on-amazon/how-it-works/index.html#/services/sell-on-amazon/pricing/ it seems to be 15% for the “any other” category that we would likely be placed in.

    I realise this is a rather blunt and open question, but I don’t know what regular markups are on products. I’m so used to selling a service where the vast majority of the costs are staffing and things other than inventory that I have very little idea. I’d assume it’s in the range of 5-500% depending on the market and product, does that seem reasonable? Obviously for some of these a 15% fee is going to be peanuts, but for others makes you totally unprofitable. What is the range of markups you’ve typically had on your products? Is that too intrusive? Feel free to not answer! Is the example you gave before (100% markup) typical? As we’re presently buying from a distributor rather than directly from manufacturer we’re not getting the best deal, but at 15% it’d be tight on a lot of products.

    I think the bad seller review is a bit out of line – they’d purchased from you, amazon just facilitated the purchase, so I think it’s perfectly reasonable that they should get some of your literature. Amazon send me enough crap about virgin wines every time I order ffs.

    Would I be right in saying that selling through amazon is a good way to turn over inventory faster but not necessarily profit or benefit a ton in the long run?

    • Adam McFarland says:

      Rob –

      Most of our mark-ups are similar to that example I gave (around 100% – i.e. we pay $10, we sell it for $20), although some things can be much more and some things are much less. It depends a lot on the type of product. If we pick up and push a low margin product, it’s usually because the accessories that are often purchased with it are high margin. The more we buy from a company, the more we can negotiate down our cost on the product. Our margins keep getting better as we go along, and I think they’ll continue to do so for a long time. You’ll get there eventually once it makes sense to bypass the distributor.

      Completely agree with your statement about Amazon. It’s a good way to turn over inventory. We still have our account for that reason – in case a new product comes along (or we catch word that a new product is coming along) and we need to blow out of the old version at a high discount fast. It’s also a good way to take sales directly from your competitors like I mentioned earlier, although that’s personally not really a reason I care much about.

      My *guess* is that if most sellers reviewed their Amazon sales as in depth as we did, they’d find that it wasn’t worth their effort and Amazon might have to adjust their system a bit. As it stands though, I don’t think that will ever happen until there’s a competitor with equal reach and better terms. I know Walmart is trying…they’re probably the best bet (not that I love Walmart or anything, but I like good competition). I feel like eBay could have competed but it might be too late now. I think that platform is just a total mess to sell on.

  5. Steve Stroh says:

    There’s a factor you’re overlooking. When listing the same item sold by Amazon and sellers, I have a STRONG preference for Amazon.

    1 – Amazon has a good reputation for fulfillment.
    2 – Amazon offers free shipping.

    In my shopping I often see items where Amazon ISN’T the lowest price seller, and I buy the item from Amazon anyway anyway.

    • Adam McFarland says:

      Hi Steve –

      Thanks for the comment.

      Good point, although I don’t think we’re necessarily overlooking that fact. We’ve definitely referenced the free shipping side of things in the posts/comments. And I think it’s generally assumed that buyers strongly prefer buying from Amazon. I know that as a seller we always knew that if Amazon was close to us in total cost (product + shipping), the customer would choose Amazon. It’s just one more thing that sellers have working against them.

      That same brand loyalty to Amazon is probably the #1 reason that it’s impossible for sellers to ever convert customers over to their website from Amazon. Some people don’t even notice that they’re buying from a 3rd party. From their perspective, they’re buying from Amazon. Now, I know and you know that, but the average customer is buying from the Amazon brand and is very loyal to it.

      I’m not angry about this – I do the same thing. I’ll buy from Amazon for the same reasons, both when they are the seller and when they aren’t. I certainly prefer when they are the seller, but I’d rather buy from a 3rd party on Amazon than some random website I’ve never heard of.

      Adam

  6. Clare says:

    I see exactly the point. We did not use FBA for our popular products even though Amazon kept bugging us to try it. But sometime later, they started selling some of our best products! Shit, I don’t know whether they wouldn’t have done that if we used FBA. But we didn’t want to pay for those extra fees since we already have our own storage and can pick and pack for ourselves.

    I read other posts and agree we definitely want to avoid being “noticed” by Amazon for your best products. If they sell your products, you are dead. Period. So, we are actually trying to control our costs by limiting our inventory. Well,if we lose some sales because we happen to be out of stock for some days. Who cares? We save some money and reduce our risks. Now we’d sometimes spend less time on serving our most popular products. When we get many things to deal with, we first devote time and energy on our other products, before we handle requests for our top selling products. My partners precisely made the point of not giving Amazon more reason to jump in on our products. We may lose some sales on the popular products, but we get to develop our other products and save some money on costs. If we can sell those very profitable products for a longer period time, it is worth it. It takes so much time and effort to identify some good products to sell; we’re not going to let Amazon rob our profits away easy. So, better watch and manage your sales.

    I mean, if you have a stream of profitable products coming in, maybe you don’t care too much. In that case, you just take all the profits you can quickly and move on. But for us, getting hold of some good profitable products is not easy. So, better watch out for Amazon.

    And, if you can, never provide any hint whatsoever as to where you sourced your products. Don’t make it easy for them.

    • Adam McFarland says:

      Clare – thanks so much for sharing your story. It’s great to hear from other business owners who have had the same experiences with Amazon that we had.

  7. Clare says:

    Adam,

    Good luck to all of us. We are seriously considering establishing our own brands and trademarks. Very tough being resellers as we all know. You get competition from other resellers and you might also get squeezed out by Amazon. With your own brand name on the product, at least they cannot directly compete with you under your product listing.

    Well, we’re learning the ropes.

    Clare

  8. googlevisitor says:

    I found this post while trying to establish if Amazon was still involved in dynamic pricing. I realize they supposedly stopped doing this, but I believe I was just victim of it. Reading this post and the “shadyness” it implies re-enforces that feeling. Thank you for the interesting read.

    • Adam McFarland says:

      I’m glad you enjoyed the post, and thanks for taking the time to comment. Depending on what happened in your situation, you may want to contact them, if for nothing else to see how they respond.

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