Why Amazon Bet (Almost) A Billion On Certainty

Amazon announced last week that it would spend $800 million to make one-day shipping the default for Prime members. Much of the coverage was about the hit to Q2 profits from the additional investments in logistics, warehousing and inventory management required to cut the current default shipping option in half.

Yet, there’s an insight here that goes well beyond the number of dollars Amazon will invest, and how well the company may manage investor and analyst expectations in light of revised Q2 guidance.

The question is how much should businesses invest to create certainty for their stakeholders: In Amazon’s case, for its best, most loyal customers (and those they wish to attract).

And how much are consumers willing to pay to get that certainty? For Prime members, $119 a year, it turns out.

And the businesses that create that certainty will gain the competitive advantage.

In Amazon’s case, that takes the form of holding 50 percent of all eCommerce spend and more than 6 percent – and growing – of all retail consumer spend. And a Prime customer who spends $1,400 each year, more than twice that of non-Prime shoppers.

Certainty as a Competitive Advantage

Humans hate uncertainty – so much so that scientists who study the human brain observe that people will do whatever it takes to avoid it.

For instance.

In one such study, people were given an option to either get an electric shock right away or take a chance that they might get shocked (or not) at some future point.

You guessed it. Most opted to get the shock right away. (Would you?)

It’s also why more than 90 percent of criminal cases never go to trial, instead ending with some sort of plea arrangement, even if the defendant claims his or her innocence. Certainty, with some amount of pain right now, is preferred to the uncertainty of being judged by a jury of one’s peers, even if the outcome could be better later.

Okay, you might say, they are probably criminals – but almost all civil cases also get settled before a judge or jury decides. Just like Apple v. Qualcomm did, before the lawyers had even finished their opening remarks.

That fear of uncertainty is why so many people choose the devil they know, but why others are driven to try the one they don’t know, in hopes of flipping that certainty switch.

Take Uber.

Sure, payments is a huge part of the Uber experience, but Uber ignited because it eliminated the uncertainty of getting a taxi – and became a reliable way to get to and from a destination on time. Hailing a taxi or trying to schedule one was a crapshoot – and still is. Integrating payments into the experience made Uber both certain and friction-free.

The need for creating certainty is why QSRs are hopping on the mobile order-ahead bandwagon. Standing in line waiting to order a sandwich or salad creates uncertainty. Ordering ahead and managing pickup (or delivery) gives the consumer a way to create both predictability and assurance – on their terms. And there’s the added bonus of higher order values – sometimes even 15 to 20 percent higher – for those establishments.

The uncertainty over how and where to use digital wallets in the physical store is the reason many of the “Pays” fell flat – and continue to struggle now, four years later. And it’s why plastic cards still rule at the physical point of sale, even though there are more contactless POS terminals than ever before. Plastic cards and the card rails are reliable and certain, at the physical store as well as online. Consumers stick to what they know will deliver a predictable outcome.

Speaking of online, uncertainty over shopping online is what gave birth to PayPal in 1998.

Then, buying and selling online was a sea of uncertainty. Sellers never knew if they’d actually get those checks consumers said they put in the mail when they placed their orders on eBay. Buyers never knew whether they would actually get what they bought. PayPal created certainty by getting sellers paid while making sure buyers got their stuff, while keeping buyers’ bank accounts and payment credentials secure and private. Today, consumers know that paying online using PayPal means a less friction-filled checkout experience, especially on mobile devices.

Certainty as Retail’s Disruptor

Amazon introduced Prime and free two-day shipping in 2005, when buying online was still a fraction of a fraction of a fraction of all retail sales.

Back then – two years before the iPhone would change the dynamics of shopping, when today’s 27-year-olds were just turning 13 and online was still two words – shopping online was pretty miserable, even on a good day.

Websites were slow and hard to navigate. Without mobile devices, online shopping was mostly done while on PCs at home or at the office, further limiting the time and opportunities to shop. Since most purchases weren’t made on the web, retailers didn’t feel pressured to feature a lot of products on their sites. Loading online shopping carts and checking out was time-consuming, tedious and hit-or-miss.

If a consumer was committed enough to power through all of those frictions, there was the uncertainty at the end of the chain about when the ordered items would arrive. Shipping wasn’t free and delivery was far from assured. It could be seven days, 10 days or two weeks, depending. Retailers offered a window, but never a guarantee – so consumers never knew. Sooner or later, things just showed up … but not always.

The only way to guarantee that a consumer would receive an item when they needed it was to go to the retailer’s store, buy it and take it home.

In 2005, Amazon’s promise of two-day shipping in exchange for spending $79 bucked that trend by introducing the certainty of delivery and giving consumers more options to shop at their convenience. That got the Amazon eCommerce flywheel rolling, at the same time Prime membership got off the ground.

Slowly, to start.

It would take until 2014 – nine years after the Prime membership debut – for Amazon to confirm that it had more than 20 million Prime members. Those members could buy more than 30 million products – roughly 8 percent of all the site’s products – from its marketplace, and have them delivered free within two days.

That same year, the average number of days to deliver an order placed online from any other retailer was 8.3 days – and delivery wasn’t free.

Two years later, by 2016, Amazon’s Prime membership had more than tripled to 63 million members, who could order nearly 42 millionproducts with guaranteed free, two-day shipping. That included half a million SKUs from marketplace sellers who wanted exposure to big-spending Prime members.

That same year, delivery from other e-tailers averaged 5.1 days. And it still wasn’t free.

By the end of 2018, Amazon confirmed more than 100 million Prime members, and more than 564 million products in its U.S. marketplace (more than three billion worldwide). Data related to how many of those items were eligible for Prime membership aren’t on any public site that I would find, but in the past it has hovered between 8 and 11 percent.

If past is prologue, last year Prime members could order more than 62 million products, with guaranteed two-day free shipping, for $119 a year. Today, that membership includes access to other services including Prime Video and Music.

Depending on whose stats you like and believe, today roughly 15 to 20 percent of shopping is done online. The Census says 10 percent, but you know how we feel about their estimates. Delivery from those non-Amazon merchants remains a mixed bag.

Some sites offer free shipping based on a minimum purchase requirement, with delivery in a three- to five-day window. Most of the time, that’s closer to five rather than three days. And it’s still a window – not a guarantee.

One- or two-day delivery is available, of course, but it comes at a pricey premium. To fill the void, retailers have embraced buy online and pick up in store. That works well when the items ordered are available to pick up in that store on that day.

But that’s not always the case – and creates its own uncertainty loop for consumers.

During the 2018 holiday season, I was amused to find lots of stories about the merchants offering free, two-day shipping. One article proudly listed 25 of them. Many of those merchants sold things that could also be purchased on Amazon.

Amazon reported that its holiday 2018 broke all records, with a billion items shipped to Prime members and “tens of millions” of new Prime signups. Traditional retail, for the most part, reported a mixed bag of results, with some of the biggest players seeing same-store sales flat or up slightly. The Macy’s CEO told analysts that the holiday season did not meet their expectations even though their profits were up.

The Cost of Delivering – or not Delivering – Certainty

Businesses today are spending tens of billions of dollars to create certainty.

In 2018, more than nine billion dollars of venture capital money was invested in startups using AI to improve certainty across a range of use cases. Everything from improving the odds that the right job candidates will be matched with the right employers to helping ensure that consumers’ problems will be handled to their satisfaction by the right call center workflows – even down to the inflection of their voice.

It’s been reported that Google and Amazon spend two or three times that much every year on R&D, which includes the application of AI and machine learning to more precisely match brands with consumers and improve the reliability of virtual assistants when it comes to answering questions or completing transactions.

And lest you think consumers don’t use virtual assistants to buy things, Alexa skills were reported to have sold 10 million items over the 2018 holiday period. And our last How We Will Pay study showed that of the more than 28 percent of consumers who own voice-activated speakers, more than a quarter used them to make a purchase during the seven-day period in which they reported their buying behaviors.

The cost of fraud and the impact of false positives on customer relationships has driven banks and FinTechs to open their checkbooks, too. They are collectively investing billions of dollars in AI and machine learning to create certainty about who’s showing up in their digital channels to open new accounts or check out online, while improving conversions and keeping the fraudsters at bay. They’re also using AI and machine learning to fine-tune their credit and risk models, so that consumers and businesses seeking access to credit have a more certain outcome, even if that outcome does not involve extending credit.

Goldman Sachs estimates that Brexit has cost the U.K. roughly ￡600 million a week, amounting to 2.5 percent of its GDP. Part of that loss stems from people not knowing what’s going to happen – or when it will happen. Banks, in the face of that uncertainty, have already moved more than $1 trillion of capital out of the country.

In the absence of certainty, consumers and businesses have shown their willingness to pay to get it.

In the B2B payments world, the uncertainty over when good funds will post to a supplier’s account has kept innovation at an impasse. It’s why, when asked, all suppliers say they’d love to be paid faster, but they’d love even more to know when good funds will be available for them to spend. That lack of certainty – and the supplier trade credit deficit it creates – is why many suppliers are willing to pay something to get that assurance, as well as the positive cash flow impact that comes with it.

We also see consumers willing to pay for certainty when it’s offered as an option. For a small fee, they can get instant access to money sent via P2P rails. When needed, they will also spend more to get money to someone instantly, too. The assurance of boarding an airplane first to snag scarce overhead luggage space is why consumers stick with a favorite airline or consolidate spend on co-branded airline cards.

When Amazon Prime was first introduced, people were floored by the notion that consumers would actually pay outright to belong to a loyalty program. Why, they said, would anyone pay Amazon money just so they could shop with them?

It turns out that 100 million people do just that – and not because they want to be part of Amazon’s loyalty club.

They’re paying (and I bet you are, too) $119 a year to get certainty: to know that the products they order will be delivered within two days, without a doubt. And soon, that will shrink to one day.

Certainty’s Next Chapter

Steve Jobs was famously quoted as saying that it makes no sense to ask consumers what they want, since they don’t really know. And that is very true.

What consumers – and businesses – do know really well is where they lack certainty, where it’s hard to make a decision because the options are not clear, where things look ambiguous and cloudy. And they know for sure that they really don’t like not knowing for sure.

Smart business and VCs know that consumers – and business buyers – make choices to get clarity and certainty.

And when they it solves their problem, they’ll even pay to get it.

Amazon isn’t spending $800 million to cut the default shipping option in half. It’s investing in creating the next 100 million Prime members – and the certainty that comes along with it, for the company and for those Prime members.

Amazon knows the value of certainty for consumers, and how it has already helped them build a massive business. So, they are doubling down.

Innovators, investors and every business should take heed: Certainty pays, for sure.