Endless Two-Step: Real reason Amazon bought Zappos

There are few events that knock an 800 lb. gorilla off its particular perch. Sometimes laziness, atrophy, the lack of ability to adapt will do the beast in. Sometimes a competing gorilla that is younger, more aggressive, has access to better technology will usurp the spot. On rare occasion two 800 lb. gorillas will meet and marriage will do the trick.

Such is the case with Amazon’s purchase of Zappos.

A Tale of Two Gorillas

Amazon’s marketplace is a juggernaut. In Q1 of 2009 Amazon posted $4.89 billion in net sales an increase of 18% over Q1 of 2008 which should be considered an epic feat in a down economy.

Amazon not only owns the book vertical but seeks to replicate Google’s clout in search within the online retail space. Thus it has aggressively gone after every leader in a retail vertical: Ebay, Buy.com, Overstock, and of course Barnes and Noble. Amazon has paired its aggressive strategy with the production of cutting edge consumer products like the Kindle and a near zealous acquisition of numerous patents (they own the patents to 1-click checkout and 404 error pages).

Now in its 10th year Zappos owns the shoe vertical with over $1 billion in sales reported in 2008. Think about that; $1 billion dollars on a product where fit is crucial. You don’t just wear shoes one size too large “just around the house”.  Zappos achieved such growth through two key tactics: 1) aggressive purchasing of product lines from shoe manufacturers; 2) unique approach to customer service keenly focused on repeat sales.

On the purchasing side of the business Zappos buyers are often known to buy whole lines of popular products from shoe manufacturers or at least all the most common sizes of a particular shoe line.  On the customer end Zappos alleviates the worry about fit by offering free shipping both ways and unheard of 365 day return policy. More importantly personal touches as the recent BoxBreak promotion with Magnify.com, earn customer loyalty. According to a BrandWeek interview with Zappos CEO Tony Hsieh, approximately 75% of sales come from repeat customers.

Driving Forces behind the Purchase

Amazon was able to smother many competitors like Ebay’s Half.com or outright buy them like AbeBooks, but; they were never able to make much of an in-road into the shoe vertical.  Zappos’ presence was just part of the issue. The shoe vertical is a very competitive and crowded space where consumers often have a hard time differentiating between retailers (Shoes.com and Onlineshoes.com for instance).

Amazon amplified their effort with the launch of Endless.com in 2007. Boasting a far more elegant site than either Zappos or Amazon, Endless featured a UI design that made it feel like an upscale boutique. Endless also launched with a tactic right from Hsieh’s playbook, free overnight shipping on all orders. The tactic was designed to gauge into some of Zappos’ market share.

The result? While it did prompt competitors in the vertical to  redesign their own sites to improve the browsing experience for their customers, Endless gained relatively little market share.

The problem was that Amazon now had skin in the game and the costs associated with building and advertising Endless were not cheap. It was perhaps Endless’ failure to dethrone Zappos that  made Amazon think of buying. What’s more, Zappos made themselves an appealing target because they were not just beating Amazon at selling shoes; Zappos was beating them in creating buzz.

Zappos had become the corporate darling in the Web2.0 world of transparency. The company had almost co-opted Twitter with hundreds of Zappos employees actively participating in conversations about themselves and the corporate brand. Hsieh was like a rockstar at the forefront of the media blitz from SXSW to Affiliate Summit. Hsieh even started a consultancy targeting the Fortune 1 Million  to teach other corporations the benefits of developing an open corporate culture. Best Buy, Southwest Airlines and dozens of others got in line.

What buzz did Amazon have going? Well they did earn tremendous growth in ’09 but most of the media focus seemed to be on iterations of the Kindle or on the various affiliate nexus laws, nicknamed the Amazon Tax.

What a Deal

According to TechCrunch,  Amazon brokered a deal with Zappos consisting of $880 million in shares with an additional $40 million in cash. Now $920 million may sound like a lot of money but really is quite a deal with Zappos having posted sales of $1 billion in ‘08. Now Amazon President Jeff Bezos and Hsieh may have struck a meeting of the minds when they met earlier in the year as Mashable claims; why wasn’t the purchase price significantly higher?

Well, it comes back to those tactics key to Zappos’ customer success. The fact is free shipping both ways and a 365 day return policy, as Hsieh puts it mildly in the BrandWeek interview “gets very expensive”. It’s been long rumored among Zappos’ competitors that the company must be hemorrhaging money. Whether that’s true it is apparent that Zappos’ net earnings were significantly lower than its’ $1 billion gross sales.

Perhaps the biggest winners are the venture capital firms Sequoia Capital and Venture Frogs whose investment in Zappos’ “quirky” strategy paid off.

Potential Impact on the Affiliate Channel

Initial outlook of the deal indicates that things will remain the same in many ways. Zappos will remain in its Henderson, NV headquarters with its brand, operating methods and leadership intact.

Both companies can credit a large portion of their growth to the affiliate channel. Zappos has had an affiliate program as part of the Commission Junction network since 2000 and has consistently been one of CJ’s top merchants. Amazon Associates is one of the first and largest affiliate programs claiming 900,000 members world-wide.

Lately Amazon seems to be systematically chipping away at the channel that helped it achieve its growth. In fact Amazon hasn’t been overly friendly to its affiliates as of late, from cutting commissions, to terminating referral fees for search, and most recently eliminating credit to affiliates using url shorteners in general with Twitter specifically as a target.

Amazon is also at the epicenter of the affiliate tax nexus debate  playing out in legislatures across the country. It has even used affiliates as leverage by preemptively terminating affiliates in some states  in anticipation of new tax legislation.

Zappos meanwhile has enjoyed a fairly positive relationship with its affiliates. The question is if  Zappos will begin to mimic Amazon’s actions in the affiliate channel? Will Zappos leave CJ and run an internal affiliate program like Amazon currently does? How will this impact the Endless affiliate program which is also currently live on CJ?

Final Questions

As with any such blockbuster merger the playing field will change significantly upon completion. There are practical questions to be addressed. Will Endless remain in business or be absorbed? Will Endless become the high end product retailer and Zappos the low end retailer as mandated by their respective UIs? How will they coordinate differing plans and messaging?

Then there are slightly more existential questions. As people, Bezos is very different from Hsieh and in the same way the cultures of their two companies are very different. Amazon is not used to being as transparent as Zappos or, at times, as human. Which culture will survive? Will they be able to incorporate each other’s strengths or wallow under each others’ weaknesses? Management is a big part of this and for the short term Hsieh is staying. After a year under Amazon’s corporate coils will he leave for some other business where he can be “quirky” again?

The fallout will be interesting.

About Angel Djambazov

Born in Bulgaria, Angel Djambazov has spent his professional career in the fields of journalism and online marketing. In his journalistic career he worked as an editor on several newspapers and was the founding Editor-in-Chief of Wyoming Homes and Living Magazine. Later his career path led to online marketing where while working at OnlineShoes he earned the Affiliate Manager of the Year (2006) award at the Affiliate Summit, and In-house Manager of the Year (2006) award by ABestWeb.

For four years Angel served as OPM for Jones Soda for which he won his second Affiliate Manger of the Year (2009) award at Affiliate Summit.

Currently Angel serves as OPM for KEEN Footwear and MedicalRecords.com. His former clients include: Dell, Real Networks, Jones Soda, Intelius, Graphicly, Chrome Bags, Onlineshoes.com, Vitamin Angels, The Safecig, and Bag Borrow or Steal.

Angel is the Editor-in-Chief and Co-Publisher for ReveNews.com and ReveNews.org.

Angel lives north of Seattle, spending his free time reading up on obscure scientific references made by his wife MGX, while keeping up with a horde of cats and a library of books.

You can find Angel on Twitter @djambazov.

4 Responses to Endless Two-Step: Real reason Amazon bought Zappos

  1. Scott Hazard says:

    OK, so I'm a little late to this party.

    As long as we're speculating, here is my two cents worth.

    Fortunately, Zappos has created such volume very quickly that they can call most shoe manufacturers, have them send them the whole Fall line (in massive size depth), sell through it, then either send it back or have the manufacturer absorb the markdowns to clean the line at the end of the season. This is referred to in retail as having inventory on wheels. The retailer has no exposure to markdowns. I can't confirm this, but I would be you that in most cases, Zappos only pays for the shoes they sold at the end of the season, so they have nothing invested in these shoes. As I see it, that is they only way they have made any money at all. This is the biggest advantage to doing large volume with a given brand of shoes. You can negotiate such a deal with the manufacturer.

    Closeouts are another huge benefit of volume. If Brand Z is closing out a clog in 3 months, or New Balance closing out a shoe mid season like they are so famous for doing, these manufacturers will offer their entire inventory of the item to Zappos at closeout prices. They buy them then mark them down just enough to be a little less than everyone else and sell them until it is announced that the shoe is closed out, then they send them to 6pm and sell them at half price and still make decent margins on those shoes.

    Early on, Nick Swinmurn hired some very smart and saavy shoe buyers away from big department stores (Macy's maybe, I forget). He soon gave them 400 Million in volume as a negotiating tool. I really think the buying advantages that Zappos has (over Mom and Pop shoe stores, or even over several department stores) is the key to what modest profitability they have maintained.

    I think Hseih and his culture were bad for Zappos. He is no doubt a master promoter, but I really think there were avenues Zappos could have gone down that would secure profitability for them down the road, like manufacturing their own brand(s). With the reach they have, they could use their ability to create a buzz around a product where they control all facets and could make great margin and offer a superb product. I believe Swinmurn went down that path with apparel. Not sure how it worked out for him.

  2. Wade Tonkin says:

    Great insight from both of you guys. I hadn't seen the article on Amazon reversing commissions on shortened URL's – makes promoting them with Twitter pretty much impossible and certainly not elegant.

    This makes for a great "wait and see" item for 2010

  3. Scott Hazard says:

    And today Endless announces they are cutting commissions by 20%. Now that they have their rival under their own roof, they can now set the tone.

  4. […] stay in business?” But stay they have. Zappos started turning a profit in 2006 and reported $1 billion in sales in 2008. Now acquired by Amazon and offering loads more than shoes, the folks at Zappos know how to find […]