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Amazon.com: Behind the Kiva Systems Acquisition

April 13th, 2012

Amazon logoWith a stroke of the pen, or more likely the click of a mouse, Amazon.com CEO Jeff Bezos approved the second largest acquisition in the company’s history, when it announced last week that it will buy privately-held Kiva Systems of North Reading Massachusetts for $775 million. Kiva’s orange-colored robots have become the rage among ecommerce companies that are looking to reduce labor costs and collapse the time between a website order and shipment.

Kiva Systems, which opened a new 160,000 square foot facility in May of 2011, had risen to about $100 million in annual revenue, and an unknown level of profitability. As a venture-backed start-up that had undergone a management shakeup two years ago, Kiva Systems, we surmise, had been positioning itself for an IPO, as evidenced by the hiring of a high profile CFO last year. That a bird in the hand may well be worth two in the bush certainly explains the motivation of Kiva’s owners to sell the company.

The same, however, cannot be said of Amazon.com, whose motivation to buy Kiva Systems is less obvious.

Amazon’s acquisitions of recent years, including Audible, Zappos, and Quidsi, the parent of Diapers.com, added new products to sell over its websites. Kiva Systems, on the other hand, makes robots that help retail and ecommerce companies manage their warehouse operations. To be sure, Amazon.com has invested heavily in website development and other technology infrastructure since its inception, and Kiva certainly fits into Amazon’s strategy to add millions of square feet of fulfillment center capacity each year around the world.

And yet, if Amazon.com was already a Kiva Systems customer—and presumably had the ability to purchase tens of millions of dollars of robots over the next several years—why would it pay eight times revenue when there is no evidence to suggest that Amazon has ever paid more than three times revenue—and often substantially less—for any company it has acquired in recent memory?

Theories abound. Could it have been that Kiva gave Amazon a glimpse into its future product plans, which in turn led it to believe that such technology in the hands of its competition would reduce its competitive advantage? Or could it have been a logistics automation vendor that lured Amazon into a bidding war for Kiva?

After reflecting on these questions, we conclude that Amazon.com bought Kiva for four reasons:

  1. The desire to secure access to a future flow of robots, ahead of its competition;
  2. The ability to drive Kiva’s software development efforts in Amazon’s direction;
  3. The preference to customize Kiva’s robots for its proprietary warehouse operations;
  4. The need to keep Kiva out of the hands of the public market, and potentially an alternative suitor who may have wanted to take the company’s robots and planning in a different direction.

Background

Against all odds, Kiva Systems founder Mick Mountz built a substantial enterprise, selling orange colored robots capable of performing incredible feats of industrial strength and cunning. As a replacement for conveyor belts, and human beings wandering miles of warehouse space, Kiva’s robots are able to locate and lift loads of several thousand pounds, moving palettes over a warehouse floor, even in conditions of poor lighting, and ventilation. The labor cost reduction stemming from the elimination of workers who walk several miles each day to retrieve goods from remote parts of the warehouse is a key benefit cited by Kiva’s customers. As the fulfillment center becomes the physical store, and the website a cash register for the retailer, Kiva has become an integral part of many ecommerce vendors’ fulfillment efforts.

Another benefit is making the most obscure and infrequently ordered products as accessible as the most popular items, a key differentiator for an ecommerce site versus a physical store, and one of the many reasons that Amazon.com has been so successful against its brick and mortar competitors.

Just as brick and mortar retailers were keen to stock up on inventory management and replenishment systems in the 80s and 90s for fear of getting pushed out of business by Wal-Mart, so have the country’s leading retailers and ecommerce sites been stocking up on Kiva Robots for fear of being upended or obliterated by Amazon.

Kiva’s Many eCommerce Customers

Known Kiva customers—all of whom compete with Amazon.com in some way, shape, or form—include Staples, the Gap, and Drugstore.com (now owned by Walgreens) which chose Kiva for help in fulfilling orders drawing from a catalog of 50,000 unique non-prescription drugs and health oriented consumer items. Kiva evidently also assists in things like inventory control, forward replenishment, as well as classic pick, pack and ship. Accumen Brands, the Fayetteville Arkansas ecommerce leader that runs trailsedge.com, toughweld.com, scrubshopper.com, and babyhabit.com, was able to install and get Kiva up and running in its 400,000 square foot warehouse in 14 weeks.

Dillards, the multi-channel US retailing giant with annual sales exceeding $6 billion, and 294 sore locations and 13 clearance centers across 29 states also utilizes Kiva, as does Timberland, Dickies, Fisher Price, Under Armour, Crate & Barrel, Toys R Us, Office Depot, SaksFifth Avenue, and Dansko, the footwear maker that ships its shoes to over 2,500 US and international locations. The Gilt Groupe found that it could process orders from website customer click to fulfillment in as little as 15 minutes. Even Follett Corp. the venerable 150 year-old, privately held purveyor of, among other things “pre-owned” textbooks for college students, has been using Kiva for order fulfillment through its stores and website.

To make things easier for retailers, Kiva announced a robot rental program in June of 2011, designed to help ecommerce fulfillment centers handle peak demand during the holiday season, thus easing the burden to purchase a basic system, which is estimated to be in the vicinity of $5 million or so.

Amazon’s Rising Fulfillment Costs

In each of the last two years fulfillment expense—excluding stock-based compensation—has outstripped revenue growth at Amazon.com. Though each of Amazon.com’s operating expense line items, which include marketing, technology and content, and general and admin, have all risen in excess of sales growth, fulfillment expense may be the most labor intensive of Amazon’s operations, and likely susceptible to further automation.

Fulfillment costs in 2011 were $4.4 billion. Assuming that Amazon can shave as much as 10 percent from its fulfillment expenses annually, the acquisition may pay for itself in as little as two years—not to mention the incremental revenue Amazon can generate from selling robots to its competitors, as well as other industries. The ability to avoid additional labor costs during peak shopping seasons, by deploying more or smarter robots, is a benefit that Amazon will reap as well.

In the mean time, Amazon shows now sign of letting up on fulfillment center expansion as it opened 17 new fulfillment centers in 2011, bringing the total to 69 world-wide. This year, it plans to open another 17.

Amazon.com as eCommerce Sphinx

Amazon has stated that it intends to continue to conduct business with Kiva’s customers, most of whom are dyed in the wool competitors. At first glance this might appear to be preposterous. However, when one considers that Amazon licenses elastic cloud computing resources to Netflix even as it competes head to head against it in online movie rentals, and that Amazon sells books that it publishes under its own imprint— alongside books from Random House and virtually every other book publisher—as well as new and used books from their party merchants, one begins to get a sense of how large and intertwined with its competitors are Amazon’s operations.

The extent to which Amazon’s ecommerce competitors will continue to buy robots from a wholly owned subsidiary of Amazon is unclear. The acquisition may provide the opportunity for other robot companies to fill the void. These include privately-held Seegrid, a robotic technology company based in Pittsburgh, whose solution is working at Cabela’s.

Fear of Kiva Falling into the Wrong Hands

An unanswered question that lingers in our mind is why Amazon.com paid eight times revenue for Kiva, when a Kiva IPO certainly would have valued the company at a much lower EV-to-sales multiple. While Wal-Mart has publicly claimed that it was not interested in buying Kiva, we find it hard to believe that there were not other companies who may have been approached by Kiva’s private equity owners, and who may have placed a bid for the company, given the success of its customers, its unique technology, and the large opportunity for robot sales into ecommerce and other industries.

Conclusion

The desire to achieve cost reduction and faster order fulfillment times only partially explains Amazon’s desire to buy Kiva. More likely, there are four other reasons: the desire to secure access to a future flow of robots ahead of its competitors; the ability to drive Kiva’s software development efforts in Amazon’s direction; the preference to customize Kiva’s robots for its proprietary warehouse operations, and finally the necessity to keep Kiva out of the hands of another suitor that may have wanted to point the company’s orange robots in a new direction.

Amazon.com: Torrid Growth Continues

February 1st, 2012

Amazon logoAmazon’s torrid growth in electronics and general merchandise has prompted a major expansion in infrastructure to support its operations. The company now has 69 fulfillment centers around the world, having added 17 this year. Amazon plans to add 17 more in 2012. Amazon.com’s headcount now exceeds 50,000 people, having grown over 60 percent over the prior year, and it has begun to feel the strain of its warehouse and fulfillment operations.

Amazon also continues to invest heavily in cap ex related to its data center expansion, which is required to support the growing number of companies that tap into its web services. Starting with packages that offer five gigabytes of storage for free on a monthly basis, companies ranging from venture-backed start-ups to global corporations and government agencies can purchase computer and storage power on a per use basis, rather than make large capital outlays for computer servers, storage racks, and networking gear. AWS already has several hundred thousand customers across the globe in more than 180 countries. We expect the business to grow in excess of 50 percent compounded annually, though like its other businesses, Amazon does not report on its margin contribution.

Amazon recently launched a frontal assault on Apple in order to lay claim to its unfair share of the emerging computer tablet category. The Kindle Fire, a $199 color Amazon branded tablet, may have sold more than five million units in the most recent quarter, and we think that Amazon.com will confidently lay claim to the number two position in computer tablets within the next few months. The Kindle Fire enables Amazon to sell more of everything digital that it already sells, including video on demand, online game and music services, ebooks, audio books, pictures, and data and backup storage.

Amazon’s video on demand service, for example, allows access to over 100,000 movies and television show episodes s on a pay-per-view basis. Most can be rented for a price which ranges from $1.99 per television episode, to $2.99 per movie. Amazon also offers 13,000 movie and TV shows free for members of Amazon Prime, the company’s $79 per year service which provides unlimited two-day free shipping services. The Kindle Fire also fits well into Amazon’s Cloud Drive strategy, as it already offers 5 gigabytes of free storage for videos, games, music and other data.

It may be hard to believe that electronics and general merchandise now comprises more than 60 percent of Amazon.com’s quarterly sales, up from about 40 percent three years ago. From its humble roots as an online bookstore, Amazon.com now serves over 160 million active customers around the world. Traditionalists will be happy to note that despite rapid growth in electronic books, physical books, that is, hardcover and paperbacks grew by double digits in the most recent quarter.

Google Vs. Amazon.com: Episode 8

December 6th, 2011

google vs. amazon.com internet equity researchInvestors long accustomed to thinking of Google as the leader in online search and Amazon.com as the king of commerce may be surprised to learn of the growing rivalry–some might say hostility— between the two companies. Only last week The Wall Street Journal suggested that Google may be speaking with brick and mortar retailers about a one day shipping service that would up the ante on Amazon’s two day free shipping service, which it provides to its most elite customers. If the report is true, one would surmise that Google could only have had the intent of taking Amazon off guard, in advance of the critical holiday shopping season.

Given the vast no man’s land which defines the border between ecommerce and online search, one may ask where the seeds of this now bitter rivalry were sewn.

We would speculate that it began with Google’s bold online book initiative, in which it sought to scan the world’s out of copyright book collection ensconced in the bowels of the nation’s great universities, including the University of Michigan. With the intent of making hard to find texts available online for the first time, Google’s ostensibly altruistic effort, lauded by researchers, became the object of scorn among the world’s publishers and authors who resented Google’s efforts to corner the market on out-of-print, and out-of-copyright books, without due consideration to paying author royalties.

Amazon.com, no doubt looking to fend off a challenge to its position as the world’s dominant online book reseller—which, by the way includes used, out of print, and out of copyright books—saw it as an obvious threat to its franchise. Thus, it joined forces with Microsoft and others to fend off the Google challenge.

To make a long story short, a period of détente began to emerge between Google and Amazon.com when Google sensibly abandoned or at least temporarily suspended its book initiative. Amazon.com, in keeping with its sophisticated yet sphinx-like approach to ecommerce (see Amazon.com: ecommerce Sphinx), began to sell Google’s internet PC on its website. Amazon.com, in a gesture of rapprochement, selected Android as the operating system for its new tablet, the Kindle Fire.

Dissatisfied with the pace at which the rest of the world was adopting Android, Google suddenly, in our opinion, lost patience with the pack of Android licensees, and purchased, out of left field, Motorola’s Mobility unit, whose Xoom tablet places it in direct competition with not only Apple, but Amazon.com.

Thus, the ante has been upped in the tablet wars, with Amazon.com’s Kindle Fire an increasingly sure bet to become the number two tablet in the next 12-18 months. This probability may have been realized only recently by the Googlers, and serves to explain—or at least better understand—its controversial decision to acquire Motorola’s phone and tablet group.