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Choosing the Best Amazon Business Model for your Brand
Since the birth of e-commerce almost 30 years ago, customers have been steadily increasing their spending online. The U.S. e-commerce market hit nearly $600 billion in 2021 and accounted for roughly 20 percent of total retail sales. The undisputed leader in the e-commerce game is Amazon, which accounted for 43 percent of the total U.S. e-commerce market. With continued growth on the horizon, it is more important than ever for brands to understand how Amazon works and how a brand should capitalize on its Amazon opportunities.
Amazon accounts for more than 40 percent of e-commerce sales.
The evolution of the Amazon marketplace
Long ago, product manufacturers wanted to distribute their products across the country. These manufacturers would make their products, then sell them at a wholesale cost to retailers, who would then market them to customers in their geographic market. This partnership between product manufacturers and retail stores flourished for hundreds of years.
When Amazon began as a bookseller, it became an “internet retailer” where they would buy books at wholesale prices, sell them at retail prices, and pocket the difference. This business model is commonly referred to as a first-party relationship or 1P.
From 2005-2010, Amazon looked to expand beyond selling just books and realized the fastest way to offer more selection was to let third parties sell directly to customers via the Amazon platform, similar to what occurs on eBay. This third-party marketplace is known as 3P.
Since launching a 3P market on Amazon, it has become a vibrant and thriving destination for shoppers, with the majority of product revenue and sales going through the 3P side of sales rather than being supplied by Amazon directly. It is now widely reported that the 3P marketplace accounts for between 60 and 70 percent of all sales on the Amazon platform. Essentially, Amazon is now both the operator of the marketplace with millions of sellers and also the largest seller on its own platform.
In addition to contributing to Amazon’s growth, the decision to offer a 3P sales channel meant that brands could start to decide how they wanted to approach the market.
The three Amazon business models
Today, Amazon businesses can choose from three different sales models depending on their resources and goals. Each model has unique advantages and disadvantages that are important for a brand to understand.
Businesses have three ways to utilize Amazon to sell their products.
1P Vendor Central model
In the 1P Vendor Central Model, a brand sells its product directly to Amazon at wholesale prices. Amazon then lists the product for sale as Amazon and sells it to the end consumer. However, this model is an invite-only program and is usually limited to larger brands with $10M or more in revenue on the Amazon marketplace. When it comes to smaller brands, the vendor model is unlikely to be a realistic option.
For eligible businesses, the 1P option has some attractive advantages:
- It’s easy to understand. Since it’s similar to any other relationship between a vendor and retailer, a brand does not need to have any internal Amazon expertise.
- It’s Purchase Order-based. The brand receives large purchase orders from Amazon, which pays for the inventory.
- As a retailer, Amazon will often accept lower profitability than a 3P seller, as they compete with Walmart and other retailers on price.
But, there are disadvantages of operating within a 1P model:
- By selling to a retail middleman, a brand is giving up margin. 1P is often far less profitable for premium quality brands
- Amazon provides little guidance. The platform does not assist in your overall strategy, brand positioning, merchandising, or provide technical support. Amazon simply buys the products.
- Amazon is very aggressive at negotiating lower costs from their 1P suppliers by tacking on co-op advertising fees, return fees and chargebacks. Negotiating with the company is notoriously difficult.
- Amazon does not always follow Minimum Advertised Pricing (MAP) guidelines and may sell products for less than a supplier expects.
With this set of pros and cons, the 1P model is often a good fit for low-priced and highly competitive Consumer Packaged Goods (CPG). It can also work well for heavy products with high shipping costs, brands that sell through many distribution channels, and brands that do not attempt to enforce a MAP program.
More expensive products with high margins and brands that want significant control over the customer experience should probably not pursue a 1P arrangement with Amazon. In addition, businesses that are invested in enforcing their MAP agreements should also consider alternatives.
Tide laundry detergent is one example of a 1P product on Amazon.
Retailer-based 3P model
In the retailer-based 3P model, rather than selling to Amazon, a brand will sell its products to one or multiple other retailers, who will then list and sell the product to shoppers on the Amazon platform. The retailer-based 3P model is evolving away from retailers who simply buy and sell products and toward an “exclusive retail” model where retailers provide added services on Amazon, such as advertising, content and strategy, in return for being the exclusive seller of the product on Amazon.
It’s essential for a brand to realize that under this model, the retailer still needs to make a profit on the difference between the price they buy the product for and the price they sell it for after fees. If there is not enough margin in the product for the retailer to also make money, they will not be willing to purchase or provide services on a listing.
The advantages of a retailer-based 3P model include:
- Like 1P, it’s a relatively simple relationship to manage since the brand does not need to have any internal Amazon expertise.
- It is also a Purchase Order based fulfillment process.
- A Retailer-based 3P model can be a viable option for smaller brands that are not invited to participate in a 1P relationship with Amazon.
- Finding an exclusive retailer will often result in strategy, content, and advertising services for the products on Amazon.
Among the disadvantages to consider with this model:
- By selling to a retail intermediary, a brand is giving up margin. The retailers must make money between the wholesale price the brand sells the product for and the retail price consumers pay to Amazon. This margin could otherwise be going into the brand’s pocket.
- Retailers do not care about the brand experience as much as most brands. Therefore their primary goal is to increase profits without concern for the brand’s other objectives.
The brands that find the retailer-based 3P Model most attractive will be those that are too small to become eligible for a 1P partnership but would otherwise be interested in that model. Inventory management and order fulfillment will be similar, and an exclusive collaboration can result in marketing advantages for Amazon listings. Again, brands with high margins or that want to maintain a direct connection with customers should pursue other options.
Tile, Inc. is one of many brands using the Retailer-based 3P Model to sell its products.
Consumer-direct 3P model
In the consumer-direct 3P model, a brand sells its product directly to the end customer through an Amazon Seller Central account. By avoiding a retailer, brands can realize increased profitability, gain more control over the customer experience, and enjoy increased visibility into data and sales trends.
Brands that sell directly in this way would typically add a clause to any retailer agreements prohibiting the product from being sold on Amazon by other distributors. Finding success with this type of 3P model can require an experienced team that understands Amazon optimization.
Consumer-direct 3P advantages include:
- Profitability increases by maximizing margins and avoiding retailer costs
- Enjoy improved control of branding and the customer experience on Amazon
- Businesses have more access to data, customers, and information
- Customers can feel more comfortable when purchasing directly from brand
Disadvantages of Consumer-direct 3P model include:
- Many brands do not have the internal skills or resources to manage selling on Amazon
- It could potentially be viewed as competition for other retail partners
- A brand may face more risk by having to own inventory until it is sold to the end consumer
In most cases, brands with experience selling directly to consumers and with high-margin products can benefit from opting for this model. These companies can use the valuable data to refine their strategy and will maintain control over their customer-facing interactions. Businesses without appropriate margins or the resources to dedicate to Amazon optimization will not be well-served by a Consumer-direct 3P model.
Hanz de Fuko utilized a Consumer-direct 3P Model. Notice the brand name is the same as the seller’s name.
Amazon business model comparison chart
The chart below offers an overview of the impact that each model can have on various aspects of a business and which entity manages those responsibilities. A definition of the areas covered is also provided below.
Brand Profitability – For most brands, cutting out the retailer go-betweens will lead to improved profitability. This causes a direct sales strategy to be the most profitable on an individual SKU level.
Inventory Owner – When selling to a retailer (either Amazon or another 3P), the retailer purchases and owns the inventory. When selling direct, the brand will continue to own the merchandise until it is sold.
Inventory Management – It is crucial to have the correct amount of inventory in Amazon warehouses. Too much stock means you will face high storage fees. Not enough means you run out and lose sales. Amazon and other retailers will place purchase orders for inventory to be sent into Amazon warehouses in those models. For brand-direct sales, the brands need to track inventory levels and send in replenishment orders to their fulfillment warehouses.
Listing Control – A brand’s listings need to be high quality to drive conversion rates. In the two retailer models, this content is usually managed by Amazon or the retailer and may not be to the same quality level as a brand would do.
Brand Strategy – Who is driving the overall brand strategy on Amazon? Amazon does not provide these services, so using a 1P model often yields no comprehensive plan. Some 3P retailers will provide these services in their agreements. However, brands would have complete control over this if selling direct.
Advertising – Amazon Sponsored Ads are an important part of launching and growing a brand on Amazon. While Vendor Central offers some advertising control, pricing is not among the aspects you can determine independently.
Customer Service – Customer service is often a way for a brand to differentiate itself. Who is doing the customer service for the brand on Amazon? Frequently, brands are best prepared themselves to manage their own customer service.
Prime-shipping Eligible? – All models are eligible to take advantage of Prime shipping on the Amazon platform.
Seller Awareness – Customers like to buy from retailers they recognize. This yields higher conversion rates. When buying on Amazon, customers prefer to buy either from Amazon or the brand directly. It lowers the conversion rate when they must purchase from a retailer they don’t recognize.
MAP compliance – Minimum Advertised Prices (MAP) are an agreement between a brand and its retailers to keep product prices above a certain level when marketing products to the end consumer. As a retailer, Amazon does not always follow MAP policies, and the company can make it difficult for brands to enforce these policies.
How a business model can impact profitability
For many brands, one of the critical advantages of moving to the Direct 3P model is a dramatic increase in profitability. However, this profitability improvement depends on the price point and margin for most brands. The tables below provide three examples that demonstrate how profitability can fluctuate depending on the model used.
A $100 product, weighing 1 pound, sold at a $50 wholesale cost (50 percent margin)
This is an example of a high price point product with healthy margins. Using a direct 3P strategy, the brand would realize $80 per unit sold rather than $50 per unit sold using retailers. This $30-per-unit increase in profitability is a primary reason many brands are moving to a direct 3P strategy.
A $20 product, weighing 1 pound, Sold at a $12 wholesale cost (40 percent margin)
This is an example of a mid-price-point product with average margins. The profitability across the three brands is equal due to the lower price point and high shipping cost (25 percent) as a portion of the product’s total price.
A $10 product, weighing 1 pound, sold at a $5 wholesale cost
The Amazon 3P model works best for high price point products where shipping costs are a low percentage of the sales price. Usually, this means products need to sell for above $15 for 3P to be profitable. In this case, using a 3P model for a low-price-point product is not sustainable. The brand would either need to sell 1P to Amazon or increase its retail sales price to offset shipping.
Where Amify sees Amazon sales heading
E-commerce is continuing to evolve. As brands continue to compete in a larger and more competitive environment, we feel it is more important than ever for brands to control their own destiny on the Amazon platform.
Specifically, Amazon is evolving from a retailer for brands into an extension of a brand’s website. Brands need to meet the customer where the customer wants to purchase, and the customer expects an excellent experience from the brand. This is difficult to achieve when a retailer sits between the brand and the end customer. We expect the long-term trend will be for brands to sell directly on Amazon to increase margin, control their brand, manage the customer experience, and have better access to data.
Switching business models
Fortunately, brands have the ability to control their Amazon channel and choose which model is best for them in this fast-changing industry. But, brands need to understand the necessary steps and have realistic expectations when switching from a retailer-based model to direct sales. When planning this switch, it is critical that your product listings, brand stores, and overall demand on Amazon stay constant, if possible. There are several steps you can take to navigate a smooth transition.
Understand current dealer agreements
A brand needs to understand existing vendor agreements and when they end. Amazon 1P vendor agreements often have a precise end date, while other agreements can usually be changed as needed.
Brands should also update their deal agreements to explicitly prohibit retailers from selling on Amazon and spell out clear consequences if a retailer continues to sell. When a brand decides to move to a direct model, it’s vital that sales go to the brand, not a retailer that is no longer needed.
Create a seller account and build inventory
In order to sell direct, a brand needs to have an Amazon seller account that they control. This can easily be created in Amazon Seller Central. They should also consider building inventory for the expected sales utilizing Amazon’s Fulfillment by Amazon (FBA) services for the most efficient approach.
Prepare for a ramp-up of sales
When a brand switches to a direct model, the previous retailers will likely still have inventory in stock. This inventory may take several weeks or even months to sell through. As this existing inventory sells through, the brand should experience an increase in sales on their account until all inventory from other sellers is sold through and it begins to level off.
Amify is your best partner for direct sales on Amazon
Amify’s clients enjoy a long-term partner with more than a decade of experience helping premium brands achieve their Amazon goals. If a consumer-direct 3P sales model awaits your business, you want to have industry-leading expertise on your side. Trust our results-oriented approach to Amazon growth and up-to-the-minute platform knowledge to outperform the competition and unlock your product’s full potential. Contact us today to learn more.
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