Amazon and a Pricing Power Conspiracy Theory

Friday, October 19, 2018

Introduction and a Disclaimer

I like listening to conspiracy theories as much as the next guy - and the next guy seems to really like them, considering that the show Ancient Aliens enjoys higher ratings than CNN's prime-time reporting. Nevertheless, there's an activity that I enjoy even more than listening to crazy conspiracy theories: creating them.

Today, I present one of my own. It involves a participant looking for a big score, a bloodbath involving a chainsaw, and allegations of questionable behavior.

No, I'm not talking about the opening act of Scarface. I'm talking about Amazon and its attempts to dominate the competition.

First a disclaimer: I have no solid evidence that my theory is true. In fact, it probably isn't. Nevertheless, the facts on the ground are lining up so perfectly that the theory should not be ignored.

It Has to Do with Commingling

One of the primary concepts in my book Premium is that consumers prefer to feel safe when making their purchases. That is, if customers believe that an offer might not be on the up and up, shoppers will either avoid making purchases or, at the very least, demand some serious price reductions to compensate for the risk of disappointment.

I've been obsessed with Amazon's practice of commingling the inventories of its suppliers for quite some time. I first wrote about it half a year ago, but it has been a topic of conversation for years.

Most vendors only sell products that they source directly from trusted suppliers. As a result, shoppers know that whatever they buy is likely to be the real McCoy. They might not like what they receive, but they won't doubt its authenticity.

Amazon operates a little differently. The company sells products that it sources, but also allows third parties to sell items that they have sourced independent of Amazon's primary auspices. In the end, the products acquired by Amazon and by the various third party sellers are put into the same inventory systems and commingled.

Whether a shopper on Amazon.com selects a product "sold by Amazon" or one "sold by Example, LLC," he has no means of determining whether the chosen product has been sourced from a trustworthy supply chain. The vendor he selects may have acted honorably and sent genuine products to Amazon's warehouses for distribution, but, because of commingling, its customers could very well receive knockoffs. Sure, Amazon has a pretty good reputation for offering refunds to unhappy shoppers, but sometimes buyers don't realize that the products they receive are counterfeit in the first place. Instead, they may simply come to believe that the counterfeits are genuine, yet simply inferior goods, produced by manufacturers that are worthy of negative reviews, bad-mouthing, and public boycotts.

Commingling Isn't All Bad

That is not to say that commingling is without benefits. When defending the practice, analysts usually focus on variations of the following:

I think that there may be a fourth purpose that, for some reason, no one seems willing to discuss in public.

Word is getting out that commingling can, at times, harm consumers as well as manufacturers. The Los Angeles Times recently detailed the case of the creator of an innovative charging cable who has seen his firm's reputation torn to shreds as buyers became increasingly disappointed by the many knockoffs bearing his company's logo. Although his products are tough enough to stand up to an electric chainsaw, the counterfeits bearing his company's name can not.

The Conspiracy Theory

Now we arrive at the conspiracy theory: Has Amazon's leadership decided that instead of stamping out the sale of counterfeits by third-party sellers, it should be actively working to increase them?

On its face, the hypothesis appears ridiculous. Why would the world's largest retailer attempt to destroy the confidence of its shoppers on its own platform, especially when Amazon has been stating for years that it has been working to eliminate the presence of counterfeit goods?

As we all know, rules that apply to small businesses can often be ignored by dominant players - and Amazon is certainly a dominant player.

If Amazon can convince customers that it is not directly responsible for the presence of counterfeits, it has the potential to profit greatly and increase barriers to competition. I once suggested that certification agencies were earning profits by solving problems of their own creation; Amazon might be following suit.

Amazon owns what is effectively the only online shopping website for many customers. Yes, shoppers have a choice of many online stores, but Amazon is top of mind - by a long shot. As a result, the firm is in an excellent position to introduce a secondary sales channel that offers increased certainty with respect to the credibility of its product descriptions. Items sold within the more trustworthy channel would instantly command a premium price because of the decrease in risk. This trade-off between increased certainty that a product is genuine and its ability to command a high price isn't just my pet theory. It has been demonstrated again and again, most famously by the high prices commanded by American baby formulas after the Chinese milk scandal of 2008.

The most obvious, and easy to implement, means for Amazon to guarantee that a product is genuine would be to market it under Amazon's own name. Amazon already sells many dozens of goods under its own private labels. It wouldn't take much to add an Amazon logo and prevent other suppliers from offering said products from secondary sources.

Jeff Bezos is famous for saying your margin is my opportunity, but it might be time to revise the quote to "your lack of trust from consumers is my opportunity."

Unlike most vendors, such as the previously mentioned charging cord manufacturer, Amazon's private labels would need not fear knockoffs trading on their good names. Amazon could simply disallow other vendors from selling their products on Amazon's marketplace - and who could fault the company for a policy like that? Amazon would be able to state with certainty that any other firm claiming to offer genuine Amazon products is clearly making a dishonest claim and acting in bad faith.

Over time, consumers would naturally change their buying habits to favor Amazon's trustworthy private labels. The safety offered by the non-commingled supply chains would simply be far too compelling a benefit for shoppers to ignore. The resulting increase in customer loyalty toward Amazon's brands would lead to increased margins for Amazon, and a customer base that, once trained to purchase Amazon's own products, would be hesitant to switch to substitutes or to purchase goods from other retailers who are unable to stock Amazon's proprietary products.

Conclusion

Would such a move be ethical? Probably not. Would it be legal? I'm no lawyer, but the entire strategy relies upon Amazon's efforts to increase the number of untrustworthy third-party sellers on its platform, in order to improve the relative safety and security shoppers will feel when buying Amazon-labeled products. Traditionally, people have believed that increased competition is always a sign of a healthy marketplace, rather than a monopolistic abuse of power. In this case, economic theory might prove otherwise.

Like all great conspiracy theories, it's impossible to say whether it's true, whether it's simply the result of a number of independent coincidences, or whether it's merely the ravings of a lunatic with far too much idle time on his hands. That said, if I disappear tomorrow - my readers will be looking at you, Mr. Bezos.