Updated: Apr 25, 2019
If you haven't read our other business model explorations, you can do so here:
The last couple weeks, we've been delving into business models and how they can be a little tricky. This week, we'll look at how the internet plays a role.
There are all sorts of internet business models including advertising, affiliate marketing, lead generation and much more but this week, we're talking specifically about marketplaces.
E-commerce has taken the world by storm. Bricks and mortar stores have seen steep declines in sales, strip malls are closing at record rates, and bankruptcies in the retail space have picked up. It's clear that businesses must adapt to the times and have an e-commerce presence.
While physical retail has struggled, online marketplaces like Amazon have seen rapid growth. To make a clear distinction, marketplaces engage in e-commerce, but not every company that sells through the internet is a marketplace. Nike.com is not a marketplace. Whereas, eBay is.
The key difference is the integration of third parties. Third parties are just other businesses besides the main company and the consumer. For example, Nike would be a third party on Amazon.
Some people might think all e-commerce is the same, but there are two main ways it's handled that can be illustrated nicely with marketplaces.
The first, is first-party or 1P sales.
And the second, is third-party or 3P sales.
Amazon's retail business involves both whereas eBay only operates a 3P marketplace.
Let's break it down a little more.
1P means the company who runs the marketplace holds physical inventory. This is where Amazon would buy products from manufacturers or wholesalers, store them in a big warehouse and then ship them to customers. Amazon would profit just like a retailer, from the difference between what it could buy and sell products for. But Amazon also makes their own products like the Echo so this would fall under 1P as well.
3P means the company who runs the marketplace is just a virtual storefront for another company's products. This is where Nike would sell shoes to you and me through Amazon. Here, Amazon would profit from taking a fixed percentage of the selling price.
You might ask, well, why doesn't Nike just sell shoes on their own website?
To Sell on Amazon or not to Sell on Amazon?
And the answer is a little more complex than it seems on the surface. First off, Nike does do that. It's called Nike.com.
But second, Amazon's brand and scale force Nike into a corner.
Nike has long struggled with resellers on Amazon. They buy up a bunch of Nike products and then sell them on Amazon, hoping to make a razor-thin profit. But these resellers have been a nuisance to Nike. For one, there is a greater chance items are counterfeited and second, Nike has no control over how its brand is displayed. To combat this, in June of 2017, Nike decided to open an official storefront on Amazon.
The goal was two-fold. By caving in, Nike hoped more traffic would be driven to them through Amazon's huge customer base. Further, Nike hoped building a relationship with Amazon would incentivize the marketplace to limit the number of resellers.
What has transpired in the last year, hasn't been so easy on Nike though.
Apparently, Nike sales have been lackluster on Amazon. Surprisingly, when the official storefront opened, it actually wasn't the first option that would pop up when customers typed "Nike" into the search bar. The big resellers would show up first because they have a longer history and more customer reviews. So essentially, Nike was and still is fighting against, well…itself. It's a cache-22 for Nike but it reveals the true power of a marketplace. Amazon doesn't need Nike since it has the resellers. And Nike can't really sue the resellers unless there are counterfeits. All the while, Amazon remains in the position of power.
To go direct-to-consumers, brands must think seriously about how to navigate the situation. Should they spend liberally to draw in customers to their own sites? Submit to Amazon? Sue resellers? Or all of the above? It's a tricky balance to figure out, even for the best brands in the world.
What's interesting is how this affects the supply chain. If Nike begins selling through Amazon as a distribution center, what does it actually do? Manufacturing is off-shored, direct-to-consumer is covered, so it's almost like a wholesaler of sorts. It would be responsible for design and marketing. That's its bread and butter but it is strange to think of Nike, one of the world's most powerful brands as a wholesaler that focuses on marketing rather than a shoe titan that controls the whole supply chain.
While this was a rather long tangent on the specifics of brands dealing with Amazon, it reveals the intricacies of marketplaces and the power they can have. To illustrate this using a different context, imagine Hilton or Marriott listing on AirBnb because that was where all the demand was. That's exactly what's happening. If AirBnb bought night-stays at the Marriott and then re-sold them to buyers, that would be 1P sales. If buyers could purchase night-stays from the Marriott through AirBnb, that would be 3P. These two concepts, 1P or first-party and 3P or third-party are crucial to understanding marketplaces.
But there are some marketplaces that only support third-party sellers. For instance, eBay doesn't actually carry any inventory. It is only a web interface to connect buyers and sellers. This decreases its risk since all the risk falls on the sellers. However, eBay has less control of how its own brand is represented. For example, since third-party sellers are responsible for shipping and customer service, a few bad experiences could drive customers from eBay to Amazon real fast. Just like with anything, there trade-offs to each decision.
I would be remiss not to specify what holds these marketplaces together. Why, it's the internet of course. The closest thing to a marketplace pre-internet was a literal marketplace where groceries were sold. Stores like Walmart and Safeway have generic brands they make while primarily carrying third-party items and then marking them up. But, this is still considered 1P sales since they hold inventory.
Because of the internet, marketplaces can scale infinitely. Scale just means getting bigger very quickly. When Amazon first started out, it only sold books. But the cost between listing 5 books and 50,000 wasn't that different. Versus, Borders, who had to create additional floor space and hire more employees. This why the internet is so powerful; marginal costs for adding each product are negligible. Bricks and mortar stores have a hard time competing with that. Just in case you forgot, Borders was a bookstore. RIP.
The internet has changed the retail landscape. The rise of marketplaces like Amazon have created a meritocracy based on transparency and competition. As consumers, this makes us happy, but poses a challenge for brands such as Nike. After all, demand is king.