Supply Chain Management Practices In Amazon

PROJECT REPORT

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Abstract

The aim of this project is to analyze the supply chain management practices existing in Amazon,

changes in the supply chain management Amazon has adopted since its inception and looking

into if there are chances of improving the practices of supply chain management to have a better

impact on its business. It further illustrates how Amazon made a debut in the online digital

products marketing and how it sets its strategies for supply chain managements of digital goods.

The report also highlights the key alliances of Amazon to maintain its inventories. The report

further highlights the key results due to excellent inventory management system and key reasons

behind it. A separate strategy on how Amazon can further improve its supply chain management

practices has been proposed in this project.

Introduction

Amazon was launched by its founder Jeffrey Bezos after he realized online trading is peaking up

very faster and there is an immense opportunity to harness the profit of current trend of people’

inclination towards online shopping. Though Amazon was initially launched as an online book

store yet it became popular for other products being offered online. Amazon was launched in

1995 and since its inception the website has performed remarkably even in tough business

environment throughout years of its operation in the industry. Time and again Amazon has been

listed among top websites in internet retailing and e-commerce.

The company has its headquarters in Seattle, Washington, United States with its customer’s

service centers in about fourteen countries spread across the world. Since 1998 it has done many

acquisitions and latest one is IVONA software, GoodRead, Liquavista. The company has many

software development centers situated in North America, Europe, Asia and Africa.

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Amazon’s popularity among its customers is attributed to its finest customer services and this has

been possible only because of its exemplary inventory management and its decision of

distributing its inventory management to various distributors.

Brief Introduction of Amazon’s Inventory Management Evolution

For any company inventory management is one of the key factors to its success. The way a

company handles its inventory management decides if it can pursue its short and long term

objectives or not.

Amazon is taken as one of the best organization to have its well defined inventory management

practices and it has evolved over time. While stating the company founder of the company

Jeffrey Bezos had laid three principles on which he would be running the company in online

business market. The three principles decided by him were: offering customers product at lower

prices, targeting a relatively bigger market and offering customers a wide range of choices.

To meet its objective of lower price offer to customers the first priority of Amazon was to reduce

the inventory cost and in this regard Amazon decided not to open any store or warehouse.

However Amazon started managing its inventory by having its own warehouses keeping in mind

to make the process time efficient and cut the cost as much as possible. This was quite

contradictory in the sense that the company has decided not to open any inventory but it started

managing its own inventory. Though for Bezos it was quite difficult to decide to go for

managing its own warehouses because it was completely opposite of what he had decided in the

beginning. But he realized that if customers’ satisfaction as to be achieved he will have to go for

having warehouses.

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Value Proposition By Amazon

To sustain and excel in the market Amazon proposed a fourfold values for its online venture

which included convenience to the customers, wide range of selection, lower prices to customers

and excellent customer support services. To meet its goal of all four value propositions Amazon

took steps in an effective manner. To ensure convenience to the customers Amazon operated the

business 24 x 7 with all time customer support. Further to enhance the customer satisfaction it

collected the feedback from its buyers, offered the facility of writing product reviews and many

more. Amazon made an inventory which had millions of product available and from wide range.

Below figure illustrates the Amazon’s customer fulfillment network:

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Amazon’s Strategies of Inventory Management

During the year 1999 Amazon was having a total of ten warehouses out of which six were added

in the year 1999 itself to increase the capacity of warehouses from 300,000 square fit to five

million square feet. Building warehouses on such a large scale was a challenge for Amazon as

each warehouse cost $50 million approx. To meet the cost of making warehouses on such a large

scale Amazon issued bonds worth $2 billion.

To ensure the minimum return rate Amazon decided to order any product from its warehouses

only when customers have finally decided to buy the product and this strategy proved quite

helpful for Amazon to keep return rate minimum. Attaining minimum return rate was quite

important in the view that at that time most of the segments of internet retail were witnessing a

huge percentage of return rates.

Another important step taken by Amazon in the direction of inventory management was

assurance of product availability to its customers. During off season of 1999 Amazon tried to

stock each and every product that customers were willing to buy and this way Amazon made it

sure that customers did not get disappointed due to unavailability of the product with the

company. This logic of Amazon is considered as one of the most vital step towards customer

satisfaction as assurance of product availability in time influences the customers’ loyalty to a

greater extent.

Figure 1. Below illustrates the data of the COGS (Cost of Goods Sold), inventory, and total

inventory turnover, days to sell and total sales. This figure reflects the inventory management

ratios of Amazon during different years.

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Fig1. Source: OS Financial Trading System, 2011

When during 1999 Amazon expanded its own warehouses COGS increased remarkably to 1349

and even sales increased up to 1640 which was even more than 250%. However due to its

inventory expansion the inventory turnover declined sharply and during 1999 it came down to

6.12 and days to sell its inventory had gone up to 59.69 in comparison of 22.61 during the

previous years.

Hence due to the expansion in the warehouses and inventory Amazon had to face a significant

deterioration in the working capital however Amazon worked out on this to rectify and

subsequently it covered up.

Hence throughout the years from its inception to now Amazon has been evolving in context of its

supply chain management. Through establishing a number of warehouses, making a stock of

millions of items, managing its own inventory it can be concluded that Amazon has

acknowledged the following responsiveness throughout its operation:

To have a stock of huge items to avoid disappointment of its customers

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Executing and delivering the order in as lesser time as possible

To offer excellent and unmatchable customer support services

To offer customers a wide range of items through its inventory

To manage uncertainty in supply due to various factors

Amazon’s Inventory Outsourcing

Once Amazon has proved its mettle in customer oriented services and assured satisfaction to its

customers Amazon realized the need of expanding its warehouses and inventories to meet the

demand of ever growing number of customers while maintaining the same level of standard.

However Amazon realized that by doing so it may need to invest huge money which may further

cause capital shortage. This will also put pressure on Amazon to increase the price of services to

the customer and hence its own value of providing products at lower cost to the customers would

get contradicted. However Amazon was sure about shoot in its customer base and it needed a

way out to manage the growing demand of inventory and warehouses. Amazon at this point of

time realized it has core competency in internet retail and e-commerce rather than inventory

management. Hence Amazon decided to outsources its inventory.

However many analyst doubted that increasing the capacity of its inventory on a speculation

basis may prove to be a deadlock for Amazon. Keeping this in mind Amazon responded to the

situation and Amazon during 1999-2000 decided to reduce inventory to reduce the risk of

demand uncertainty and it realized that in place of expanding the inventory it would be better to

increase the range and of inventory with different options of items. The steps taken by Amazon

during this period may be summarized as follows:

Reducing the number of inventory on the basis of demand uncertainty.

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At the same time increasing the range of products in its inventory and warehouses.

Purchasing the items from its manufacturer rather than distributors to ensure low price to

customers and still having a good profit.

Automation through software to decide which particular inventory should supply to a

customer’s demand.

Drop Shipping Model of Amazon

Drop shipping model refers to a technique of supply chain management where the actual retailer

does not have the stock of the item or product to be purchased by the customer but the actual

retailer transfers the order placed by the customer to the manufacturer or a wholesaler of the

product whom the actual retailer has already have an agreement over the profit sharing and

commission. In general the actual retailer only enlists or displays the items available with

different manufactures or wholesaler or in some cases it provides the catalogue of the items or

products available with the manufacturer the actual retailer has tied up with.

Fig2. Drop Shipping Model Cycle of delivery

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During 2001 Amazon decided to follow drop shipping model of supply chain management and it

would be outsourcing its inventory through this model. Though Amazon did realize the huge risk

lying behind the drop shipping model yet it had taken this risk to outsource its inventory. But

providing superior customer services to its loyal customer was still in the mind of Amazon.

After Amazon’s decision to bring drop shipping model in place for its supply chain management

it had gone for various steps like defining its policy with the organization participating with it to

ship the items ordered by the customers, making sure that they comply with the policy of

Amazon for fullest customer satisfactions and quality delivery in time.

In this direction Amazon got into a deal with various dealers and wholesalers whom Amazon

perceived would be coming up to the expectation. One of such deals made by Amazon was with

Ingram Micro. Ingram Micro became one among the largest wholesale dealer of electronic

products and providing logistic services to Amazon.

The best part which Amazon practiced in this regard was it always partnered with organization

having the excellent performance in the field of supply chain management services at that time

and this made it possible for Amazon to keep the customers up-to their expectations and Amazon

sustained the loyalty of the customers. In this way Amazon managed well to keep up the

previous profit level and also reduce the inventory holding charges remarkably.

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Source: Amazon.com Q4 2010 transcript

Above figure illustrates one of the examples on how Amazon tried to in-sourcing the value chain

throughout. As we can observe in the above figure that Amazon bought CreateSpace which is a

print-on-demand company which Amazon intended to in-source cover design, copyediting, press

release creation etc services of the company. Having agreement and business relations with print

on demand and digital storage the effective inventory costs for digital goods was negligible and

Amazon further proved its mettle in cutting the inventory costs. After this Amazon now tried to

add more and more distribution channels or fulfillment centers to make distribution system

smoother and more promising to the customers. At the 3rd stage of in-sourcing the value chain

Amazon tried to keep the direct contact with customers and always owned the customer’s

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account directly. At the 4th stage i.e delivery stage Amazon tried to keep delivery charges in its

own hand and it used the means of delivery like bicycles couriers. At this stage Amazon tried to

keep its own network for delivery of goods to the customers to assure maximum satisfaction to

its customers.

Digital Goods & Amazon’s Supply Chain Strategies

Amazon has a track record of always exploring new business models in the market after

assessment of the market situations and predicting the future needs of the common people.

Realizing the fact that online digital goods market is going to peak in coming years Amazon

embarked with well planned strategies.

The fact that Amazon realized at the point of time was:

The printed book sale which contributes to Amazon’s sale considerably is going to

shrink by 2015 as much as by 4.7%

By 2015 the market of ebook is expected to grow by as much as 300% which is

remarkably a shift in people’ choice of reading.

As per the expectations US customers are going to spend more on online music rather

than recorded music and this may be a good opportunity to enter the market of digital

and online music.

Amazon has already realized that online subscription for music and online streaming

services has been peaking up and its services like DVD sale, recorded track sale was

taking a plunge remarkably.

Hence assessing the forthcoming market of digital world Amazon acted cleverly in this direction

and made a debut in it. The best part of it was Amazon tried to set up its supply management

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strategies in a very organized manner with minimization of inventory management costs. The

strategy which Amazon acquired to assure delivery to the customers was a three step model as

shown below:

Source: www.smartinsights.com (Amazon’s Case Study, 2012)

Hence Amazon made a value chain for digital products sale. As in this domain the numbers of

intermediates were fewer it made Amazon to take up a large share. In this way Amazon which

had made business relationship with various content producers in digital business market, it

could sale more and more services.

As far as inventory for digital products was concerned Amazon could make a large cut over here

as it followed the strategy of giving orders to digital vendors only on demand, storing products

digitally of-course was costless. This could further made possible for Amazon to increase the

profit margin and investing lesser in inventory management. One of the key principles of

Amazon was to keep the shopping experience of customers smoother. The sale of digital

products made it easier for Amazon to keep it customers happy as there was no need of shipping

the goods physically.

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Remarkable Results of Amazon’s Inventory Management Practices

Amazon could first record its profit of $5 million in the 4th quarter of the financial year

2001. This was a remarkable achievement by Amazon in the sense it was in deficit of

approx $2.86 billion in the seven years of its launch.

Amazon recorded a commendable sales figure due to its practices of excellent supply

chain management and inventory management. Amazon recoded a sale of $ 1.1 billion

merely in Q4 of the financial years of 2001.

Overall recorded sale in the financial year of 2001 was $3.12 billion.

During the financial year of 2002 the recorded sale was 3.93 billion.

Insight into Key Reasons behind Above Remarkable Results

Undoubtedly Amazon has made an excellent chain of supply management right from picking of

the products to delivery of the product to its customer and also taking return the products from

customers in case of complains of damaged products or mismatch of delivery. The key reasons

behind the excellent sales, turnover and profit margins may be enlisted as follows:

(1) Excellent Inventory management system and chain supply management system.

(2) Quality strategic alliances by Amazon with various vendors, manufactures, suppliers

directly.

(3) Huge cost cutting on inventory management system and avoiding redundant stocks as

much as possible.

(4) Having direct accounts of customers even if products are being sold through 3r party.

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