Is Amazon Going Brick & Mortar? You Heard it Here First! (UPDATED)

Update: Four days after I published this post, the Financial Times reported that Jeff Bezos was considering opening “Apple store-style” outlets.

Amazon may be the quintessential online retailer – but with the looming expiration of its sales tax advantage, Amazon is already planning to open opening warehouse locations in its largest sales regions. I believe the natural next step will be to open hybrid warehouse-retail locations that will allow it to address its competitors’ (Target and Wal-Mart) last remaining advantage: instant gratification.

(Note: the contents of this post is mere speculation and, needless to say, is not founded on any discussions or inside knowledge of Amazon’s plans. That said, it is darn good speculation).

Let’s start from the present situation. Amazon’s present business model is simple and effective – but it has two glaring weaknesses.

First, Amazon’s reliance on costly partnerships with shipping companies like UPS are contributing to the firm’s razor-thin (and unsustainably low) margins. At present, Amazon it is all but subsidizing its partners’ revenues, while focusing on reaching as many customers as possible. The model works. Amazon’s sky-high valuation (with a P/E ratio in the thousands) will require some serious business-side innovation, and soon.

Amazon’s second weakness is its reliance on its competitors to showroom its products. In some cases, as with the Kindle, this is explicit. In most others, it is a side-effect. That’s worked to Amazon’s advantage in the past. However, relying on your competitors to showcase your high-margin products is a dangerous proposition. Amazon is literally encouraging its customers to enter its competitors stores, absorb half an hour of advertising and customer service, compare prices, hold the product in their hand – and then come home, order it from, and wait three days.

Under the circumstances, I wouldn’t be surprised if Jeff Bezos et al. were not scratching their heads trying to come up with a better model. And brick and mortar might be the answer they come up with.

Here is how it would work. Amazon is already moving warehouses from low-volume states (constructed to avoid sales taxes in markets like New York and California) “inland,” owing to new laws that will close its sales tax loophole advantage. This move is aimed at further lowering shipping costs. What if those warehouses were not just located in major markets, but in major cities themselves? Amazon would, of course, maintain online delivery – those deliveries would be even quicker. At the same time, warehouses could set up retail frontends that would allow customers to come in, try out new products, and purchase them then and there. The warehouse could either be open to the public (a la Costco) or feature an ordering desk (a model used to great effect by Argos in London, where customers purchase things in store from a magazine and receive them in 5-10 minutes). Either way, a portion of the store should allow users to see and touch products like tablets and laptops.

Such a would also allow Amazon to make a foray into the elusive clothing market, where fit and feel – two things the Internet cannot currently provide – are everything.

So, to summarize, here are the advantages of setting up warehouse-retail locations to serve Amazon customers:

  • Lower shipping costs (closer proximity to delivery customers)
  • Enables Amazon to directly compete with Target and Wal-Mart for customers who must-have-it-now
  • Allows entry into new markets (clothing, heavy or large items that are inefficient to deliver)
  • Frees Amazon from reliance on shipping partners

Here are some reasons Amazon might shy away from the idea:

  • Retail space is expensive – Amazon margins would suffer in the short-run
  • Current warehouses likely receive preferential tax and transportation incentives. A warehouse in L.A. or Boston will not
  • Higher labor costs

I’d love to hear your thoughts on this one.

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