“Data-Driven Thinking” is written by members of the media community and contains fresh ideas on the digital revolution in media.
Today’s column is written by Jonathan Opdyke, CEO and co-founder at HookLogic.
It’s no secret that Amazon has retailers scrambling as it strives for global domination. Price transparency and competition make it challenging for most retail ecommerce sites to make a meaningful, sustainable profit, not to mention the challenges faced by physical stores as sales shift online.
The most profitable large-scale ecommerce sites have actually been those that don’t bother with fulfillment and instead operate on different financial models than most retailers. EBay churns out billions in profit per year, for example, primarily through listing and transaction fees. Alibaba delivers the retail ecommerce industry’s largest profits with a model relying heavily on advertising revenue.
Amazon Media Group has quietly become Amazon’s next billion-dollar business. It leverages its reach and rich shopping data to generate profitable advertising revenue. Perhaps not so quietly, that extra margin finds its way back into the lower prices Amazon charges consumers, making it harder for other retailers to compete. Take away profits from advertising and Amazon Web Services and Amazon still loses money in its core retail business.
Traditionally, the retail model hinged on the markup on product sales, which covered fixed real estate, distribution and labor costs. For online retail, the equation has shifted to buying traffic, generating revenue on product sales and trying to eke profit from the difference. With media costs rising and product prices eroding, it is increasingly difficult to generate profit online.
The natural question then is how to generate more revenue from a given set of traffic. Retailers can and should focus on improving conversion rate and basket size to the extent they can. But in most cases that won’t be enough. Increasingly retailers need to add new revenue streams to monetize their traffic.
Advertising is an obvious answer, as illustrated by Amazon's and Alibaba's successful advertising models. Advertising can contribute disproportionately to the bottom line compared to additional product sales, which may generate 2% to 10% margins.
Most retailers are experiencing an existential crisis over whether selling advertising should be part of their business model and if a focus on advertising is compatible with a great customer experience. My emphatic answer to both concerns is yes, with an asterisk.
Let’s start with the yes. In a traditional advertising-driven model, the goal is to assemble an attractive audience by creating good content, then selling access to that audience to advertisers. Do The New York Times or NBC see their primary purpose as selling advertising? No, they strive to be great content companies. Advertising is one of their business models, along with subscription and syndication fees.
By that logic, retailers can still strive to provide great value and customer service, with advertising as part of their business model. But does that mean retailers need to become content companies? They already are. Retailers have the content consumers value for shopping, including product content, reviews, videos and buying guides. They also already have large, highly segmented, very desirable in-market audiences. Every retailer has the key ingredients of a great media property, with the key benefit for their advertisers of having proprietary shopping and sales data on which to target and measure advertising results.
Why, then, the asterisk? Retailers have a challenge that most media companies don’t, in the form of a conversion path. If advertising disrupts conversion rate, say by applying clickbait-style pop-ups from semi-distasteful advertisers, then a retailer may be gaining ad revenue while losing transactional revenue.
Then comes the challenge of actually selling advertising. The reality of the US digital media industry is we have experienced dramatic consolidation in the past few years. Two companies now dominate the space: Google and Facebook. With $31.5 billion and $9 billion in US advertising sales, respectively, they represented nearly 70% of US digital advertising spend in 2015, based on eMarketer’s estimates for the year. And that share is growing.
So what does that mean for everyone else? The job of selling advertising is getting harder. Marketers prefer working with fewer parties to consolidate spend. Historically, that meant consolidating TV spend through ABC, NBC and CBS. Today, Facebook, Google and, increasingly, Amazon could be considered the new Big Three. Facebook’s social data, Google’s search, email and video data and Amazon’s shopping, media consumption and transactional data are probably the three largest unique, consolidated, cross-device data sets in the US. And rich, scalable data is the fundamental key to effective advertising.
Of course, other retailers besides Amazon own massively rich consumer shopping interactions and purchase histories, both online and offline. The activation of these rich data sets is core to competing with the Big Three. But retailers cannot do it alone. Most retailers struggle to obtain the large media budgets of brand advertisers because they can’t engage ad agencies and core brand teams with the scale and intensity of the Big Three or even the next tier of digital media publishers, for that matter.
Few consumers besides the last shareholders lament the loss of Tower Records, Borders or Circuit City as other retailers and new media have moved to fill their place. While the digital battleground may be the minority of sales for many retailers, it’s the battleground that determines the future. With Amazon now moving into physical stores, it’s only a matter of time before the battle widens.