Tuesday, 13 November 2012

Asos vs Amazon; Delivery vs Marketing

In the P.S. to my last post on delivery charges, I highlighted the gem in the small print of Asos's latest annual accounts: reclassifying delivery costs as a marketing expense. This seemed an interesting enough idea to take a look at what Amazon does, and in fact to generally compare the two. (Especially in the light of rumours that Amazon is considering making a bid for Asos, presumably along the same lines as its Zappos move a couple of years ago).

So, a trawl through the latest Amazon 10-K, and sure enough, Amazon also makes a similar comment:

"While costs associated with Amazon Prime memberships and other shipping offers are not included in marketing expense, we view these offers as effective worldwide marketing tools, and intend to continue offering them indefinitely."

Slightly different approach, but basically the same statement: free/discounted shipping is a marketing cost. How big a cost? Helpfully Amazon provides the information. In 2011, income from shipping fees was USD 1.5 Bn, and shipping costs were USD 3.9 Bn i.e. the net cost of this "marketing tool" was an eye-watering USD 2.4 Bn worldwide! Compare this with the actual spend on marketing of USD 1.6 Bn. Shipping offers cost Amazon 5.1% of turnover (up from 4% the previous year), compared to marketing at 3.8% of turnover. In reality, 5.1% actually understates the figure, because the turnover includes a substantial slice of income from services and fees (such as marketplace and hosting); with these excluded, the shipping offer actually represents almost 6%.

A look at the same numbers for Asos reveals shipping fee income of GBP 10.7M, 2.2% of sales compared to Amazon's 3.5%. Asos doesn't actually directly break out the cost of its shipping, but it is possible to estimate it from the other numbers published, to be around GBP 25.5M, around 5% of turnover. So the net cost to Asos of treating shipping as a marketing expense is GBP 14.8 M, or around 2.9% of sales. Not quite as startling as Amazon, but certainly comparable. However Asos spends a slightly higher percentage of revenues on "true" marketing, around 4%, so it has not YET reached the point like Amazon where free/subsidised shipping is its primary marketing tool. Judging from the statements made in the accounts regarding ongoing developments in this area, however, it won't be too long before this is so.

Of course the other big difference between the two is that Asos can afford it! It is genuinely profitable - net profits are around 8.3% of turnover, despite continuous investment in overseas growth, new IT systems etc i.e. all the excuses that Amazon seems to use to explain its perpetual hovering around the boundaries of break-even: profit was 1.7% of turnover in 2011, and it actually made a loss in 3Q12.

Obviously this difference is not unconnected with the difference in gross margins. Asos has gross margins of 49%, Amazon only 22%, a situation it dismisses with the explanation:

"We believe that income from operations is a more meaningful measure than gross profit and gross margin due to the diversity of our product categories and services."

While this is probably plausible, measuring gross margins for an online (or mail-order for that matter) business is not meaningful in another way; I believe the right measure should anyway be delivered margins i.e. including delivery fees, shipping costs and returns processing. And given Amazon's mix of categories, the underlying implication in these numbers is that quite possibly Amazon is operating some categories below break-even delivered margin.

Getting off-topic a little, investors seem to still believe in the Amazon go big or go broke strategy, and don't require it to make reasonable profits, presumably on the assumption that if it eventually stops investing in growth then actually the underlying business is profitable. If you are the punting type, you might fancy a bet on the dual scenario that the US as a whole follows the trend in some states to put purchase taxes on an even footing between offline and online, and then that BestBuy (and others) accept the logic published recently by Media Markt (see my previous post) and go for a big cut in gross margins themselves, thereby putting themselves on a more even footing on price with Amazon. Whither then Amazon?

What then should a true multi-channel retailer do with regards to this whole "shipping as marketing" idea? Firstly, take a look at this photo, taken in a London Underground station recently:

Amazon Locker, Hammersmith Station

Yes, it's one of Amazon's attempts at click-and-collect. But... there's no in-store additional sales to help the business case along. As I suggested recently, customers like click-and-collect, but retailers like it even more because it leads to incremental sales. And a certain lack of convenience doesn't seem to hamper customer take-up: Marks-and-Spencer stores, for example, are not exactly handy in general - they tend to be in town-centre locations not residential areas, especially outside of London.

My proposition then, is that multi-channel retailers should reinforce click-and-collect, using the same mindset that leads Asos and Amazon to treat fulfilment as marketing cost, but focussing on stores as a competitive advantage. The most obvious way to do this is some sort of coupon/voucher that is valid for further spending when associated with a collection. I'm not aware of this being done yet, but I'm sure someone somewhere is already on to it - the results will be interesting.