AMAZON & GOOGLE IN WHOLESALE DISTRIBUTION

Distribution & Wholesale

1/2013

AMAZON & GOOGLE IN WHOLESALE DISTRIBUTION

OVERBLOWN HYPE OR GAME-CHANGERS?

"By the time customers call you today, they have now already done the majority of the research.

They want the easiest way to accomplish the task ? That's where the market is going.

We are trying to get ahead and create the customer experience of the future."

? CEO, $BN DISTRIBUTION COMPANY

Over the past fifteen years or so, the emergence of online players like Amazon and Expedia has transformed many B2C sectors, from books and music, to electronics and travel. With US e-commerce sales of goods at some $210 BN+ in 2012 and Amazon alone accounting for $35 BN sales in the US and over $60 BN worldwide, it is hard to argue that Amazon does not now represent a formidable competitor in those areas where it chooses to focus.

What then to make of Amazon's entry into B2B Distribution with AmazonSupply in April 2012, or Google's beta-test of Google Shopping for Suppliers launched in January 2013?

To what extent do these represent early moves of disruptive game-changers, or will they turn out to be limited incursions in a set of complex sectors where local presence, technical knowledge, and personal customer relationships will always win?

Copyright ? 2013 Oliver Wyman

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WHAT WE HEAR AND SEE

In our discussions with more than 25 CEOs of Billion Dollar distribution businesses in recent months we have heard a broad range of views. Around a third are skeptical that e-commerce will have a major impact on their business: often because their product is too difficult for a new entrant like Amazon to warehouse and ship, and sometimes because of value added services that they feel cannot be provided except through a direct local relationship. This view is reinforced in some cases by work their businesses have done to provide online ordering platforms that have seen limited uptake.

EXHIBIT 1: YOUNGER PROCUREMENT BUYERS ? THE FUTURE OF THE B2B CUSTOMER BASE ? ARE FAR MORE LIKELY TO USE ONLINE PLATFORMS THAN THEIR OLDER COUNTERPARTS

Respondents by age making B2B purchases online1

Other CEOs take a different view. In some cases they are already competing head-to-head with AmazonSupply in certain categories. Many are keenly aware of how customer behavior is changing in influencing sales. To quote one: "By the time customers call you today, they have now already done the majority of the research. They want the easiest way to accomplish the task ? that's where the market is going. We are trying to get ahead and create the customer experience of the future." Within this group, of those CEOs intending to build greater barriers to online competitors, about half feel they are on the right path, while half are struggling.

Such concerns are underpinned by some interesting facts:

? In B2C, in 2012, US sales that were influenced by online research, at $1,200 BN, already account for around 6x the sales transacted online

? In B2B, 45% of professional buyers have already purchased from AmazonSupply. Additionally, 85% of buyers state they will always buy a lower cost option online, despite loyalty to their current supplier

? 90% of younger procurement buyers (aged 18?35) make B2B purchases online, compared to only 29% of older procurement buyers (age 60 and over)

(See Exhibit 1)

29% AGE 60+

45% AGE 46 60

68%

It is also worth bearing in mind that Amazon in particular has a track record of taking a long view in establishing a competitive position. In 1997 Jeff Bezos stated, "It's all about the long term... We may make decisions and weigh tradeoffs differently than some companies". More recently he was quoted as saying, "Percentage margins are not one of the things we are seeking to optimize..." Amazon's history of always seeking to have the most competitive price in the market by applying advanced trading algorithms to `real time' competitor price data is well known.

AGE 36 45

90%

AGE 18?35

Copyright ? 2013 Oliver Wyman

NOTES 1. 2013 State of B2B Procurement, Acquity Group

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HYPE OR THREAT?

If you cut through the hype, we believe that there is a steady and inevitable online and multi-channel transformation underway. As with most things in business, it's pretty simple: it starts with customers and their needs. Customers increasingly value quick, simple, effective ways of interacting to get the products and services they need, as well as new value-added services that were not possible previously. As one CEO put it, "Our customers have already been trained by Amazon [in B2C] on what good looks like. That's what we have to compete with."

We believe this multi-channel shift will eventually affect nearly every type of product in B2B distribution. Some sectors though are likely to feel the competitive impact much more quickly and acutely than others. Sectors characterized by small, high value, low weight, easy to handle and ship SKUs that are readily specified and do not require specific physical services to deliver, are much more amenable to an Amazon entry. Unsurprising then that AmazonSupply has launched with an industrial parts offer ? a category which meets all of the above criteria ? rather than, say, industrial chemicals, which fails most of the above tests (see Exhibit 2).

EXHIBIT 2: SOME CATEGORIES ARE MORE IMMEDIATELY PRONE THAN OTHERS TO A NEW ONLINE ENTRANT

Productdriven

Intrinsic `Shipability' Handling Requirements

Technical Guidance

Customer Product Selection driven

Value-Added Services

Chemical

? Much lower value, heavy, bulky product

? Requiring local supply chain density

? Often requires specialist equipment /

handling / certification

? Numerous products require technical

guidance and support

? Typical customer buys a small number

of predictable products ? enabling local SKU counts of 100s ? 1000s only

? Diluting, blending, cleaning, etc. are

widespread and require physical presence

Not an obvious place to start

Industrial parts + Typically high value, light, smaller product

? Easy to ship via common carrier

+ Straightforward

+ Many products easily `bought to

specification'

+ Customers can buy across many 1000s

of SKUs

+ Real time availability, tracking,

inventory management, etc. can often be executed remotely

Online platform & remote DCs wellsuited to meet many customer needs

Copyright ? 2013 Oliver Wyman

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It would be a mistake, though, to think that the threat from AmazonSupply or others is `binary' in nature. The question is not whether AmazonSupply will be a threat, rather it is which customers, purchase occasions, and categories will be attacked first. Consider the lesson from the mass merchant retail clubs. In a number of categories Amazon already has a comparable or broader range than the established club stores such as Costco. In addition, Amazon's Subscribe & Save service that delivers frequently purchased high value items such as razor blades and diapers automatically every month or so (unless the customer pro-actively updates or skips the order) is already `hollowing out' shoppers baskets at the clubs and reducing trip frequency.

The question is not whether AmazonSupply will be a threat, rather it is which customers, purchase occasions,

There is a ready read-across to `non-core' categories such as personal protective equipment in industrial gas distribution or non-food items in food-service. While the core business may not be at threat, such adjacent categories can often drive around 20?30% of dollar gross margin. That's a lot to have to make up in other `core' and often lower margin categories. Such customer unbundling also acts to undermine `full service' customer relationships.

and categories will be attacked first.

The key battle is one of consideration rate, i.e. for what percentage of customers are you the first place they will go (whether physically or online) when the customer thinks about purchasing a product in a specific category? In B2C of course, Amazon has already comprehensively won the consideration rate battle in many categories through its aggressively low prices, huge range, consistent meeting of fulfillment promises and `no quibble' returns. So much so that many customers now never check prices or range anywhere else.

As one looks ahead, compared to most traditional `off-line' distributors, AmazonSupply by our reckoning starts with an SG&A cost advantage of some 20% or more to its scale and lack of local operations and field sales; as well as a business model built on operating margins (currently ................
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