Thursday, January 20, 2005

Business Paradigms: eBay versus Amazon

The dynamics of human interaction in a marketplace have not changed all that much since the first axehead was traded for a shiny stone. The maximization of value, profit and satisfaction are still the critical success factors in a commercial transaction. The exploding digital economy has introduced various new channels for connecting buyers and sellers. These channels range from manufacturer catalogs to retail stores online. An alternative model, one that represents a commercial undercurrent as old as traditional commerce, is represented by the eBay model.

eBay provides a fluid, ever-changing marketplace to anyone with a modem and an axehead to sell. The pricing dynamics are far more fluid than a traditional store or market, and constitute greater involvement of the purchaser in the pricing decision.

Amazon represents the other, more formal, model of online sales. While Amazon does have it's own auctions fora, it is more identified as an intermediary between manufacturers and consumers, like any other retailer. Because of it's sheer economic heft, Amazon is able to extract savings from the suppliers and pass some on to the customers, much like the more well-known gorilla, Walmart.

While it is not the case that one model will win out over the other in the long term, I find better value in the Amazon model. The price arbitrage in the eBay model is short-lived and not significant when you factor in shipping costs, and I have observed pricing for different categories in eBay tend to seek certain levels, a topic for another time. The significant advantage of eBay is as a forum for disintermediation of the buyer and the seller, and as a seeding ground for a thousand Amazons, as it were.

eBay margins, themselves, are rapidly shrinking. Recent quarterly results were below expectations. This was caused by, according to the management, because "Holiday sales, on which many of the small retailers who have set up shop on eBay's site depend for fourth-quarter sales, were "weaker than expected in the United States and Germany," Other reasons cited were "rapid growth in low-margin related businesses" that helped gross margins erode to 30% in the quarter from 31% in the previous year, and a $7.6 million loss related to "a foreign exchange hedge that impacted our bottom line." While one bad quarter does not a failure make, there will be serious rethinking underway in business circles. Notably, eBay's gross merchandise volume -- the total amount of goods traded through eBay -- as well as the number of new listing, both gained by 39% in the fourth quarter. This is the first time they have been below 40%. In effect, they are seeing saturation in their space.

From being a back-alley phenomenon, the business model represented by eBay has come a long way. There is no let up in the growth of the Amazon business model however. The challenges between the two business models finds a corollary in the technology space as well - the open source movement has made great gains against commercial, closed-source software. Eric Raymond's seminal paper "The Cathedral And The Bazaar" captures some of these dynamics. Here too, there is ample scope for both models to continue to develop and deliver business value, despite partisan opinions. If you disagree, I've got a shiny axehead for you.

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