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Coping With The Amazon Factor In Private Equity

Coping With The Amazon Factor In Private Equity

Four key inquiries can help private equity firms assess the "Amazon factor" in due diligence.

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Coping With The Amazon Factor In Private Equity

This article originally appeared on Forbes.com.

For investors and corporate leaders in an ever-increasing number of industries, Amazon.com resembles nothing so much as The Blob—the alien antihero in the classic 1958 movie with the tagline “It eats you alive!” Amazon already controls roughly 40% of the US e-commerce market and is on track to own 50% by 2021. That implies that the Seattle-based retail disrupter will capture around 70% of all e-commerce growth over the next five years.

But that’s hardly the end of it. Extending into business-to-business (B2B) commerce and distribution, cloud services, media and hardware, the Amazon ecosystem now covers a huge part of the economy. The double-digit monthly percentage growth of its Amazon Business commercial distribution unit shows how hard it’s pushing. Whether Amazon’s sprawl presents a threat or an opportunity for a given company depends on the context. For consumer products companies looking for quick online distribution to a mass audience, the Amazon platform might be a game changer. The same could be said for B2B companies looking to build cloud services without having to make noncore investments in server infrastructure. The threats, on the other hand, are obvious. Amazon achieves this growth by offering the world’s largest selection, lowering the cost of goods and fulfillment, and providing a best-in-class customer experience. Add in an incredibly nimble organization, and Amazon seems able to disrupt businesses at will.

As we discuss in Bain & Company’s recently released Global Private Equity Report 2018, Amazon’s rise presents unique challenges for PE investors. It has become a factor in the due diligence of almost any target asset across the industrial, consumer and retail sectors. In more and more cases, underwriting future value means, at least in part, assessing the “Amazon factor”—good or bad. Firms need a systematic approach for understanding what Amazon is likely to do in a given sector, product category or business and how a company stacks up against the potential threat or opportunity.

The good news: Advanced analytics, combined with deep pools of customer and market data, allows firms to measure impacts and opportunities as never before. The process begins with some relatively straightforward questions. In the retail sphere, for instance, top firms start with four key inquiries:

Where are the target company’s product categories on the e-commerce penetration curve?

The e-commerce freight train is bearing down on all sectors, but it’s important to distinguish between those that have already felt its full impact and those that are feeling it now. An e-commerce penetration curve shows where a category’s sales growth is coming from (online vs. in store) and where the trend is headed.

Predicting future penetration takes into account factors like online pricing, customers’ ability to find what they are looking for in stores, and how easy it is to deliver or return goods. The landscape is always shifting, as retailers constantly innovate to lift the constraints on e-commerce adoption and improve their omnichannel experiences. Knowledge of the major players in each category is critical. What investments are they making to shift sales online or increase in-store purchases? How is Amazon likely to play its hand?

Does the target have a compelling assortment at a good value?

Among Amazon’s great strengths is the ability to offer the widest possible assortment at great prices. Factor in free two-day shipping through an Amazon Prime membership, and the advantage can be overwhelming. Whether a target company can compete often depends on whether it can offer customers a unique set of products at a good value. Assessing how the company’s brand and product offering overlap with Amazon’s is critical to understanding how vulnerable its sales are.

The task can be daunting. For any retailer, the number of SKUs can easily run into the many thousands. Matching these one by one against Amazon and other direct competitors can be a massive effort. The challenge in due diligence is to compare items based on an array of data points, such as price, Prime participation, availability of two-day shipping and whether the item is a third-party product fulfilled by Amazon. Even if there is substantial product overlap with Amazon, however, it isn’t game over. A retailer with a well-curated assortment may still be the customer’s first choice. Consumers of baby products, for example, may opt for a retailer that offers a wide selection of high-quality goods deemed safe, chemical-free and nonallergenic because they trust that retailer’s specialized knowledge and experience.

Does the target have a differentiated and valued customer experience?

Amazon’s customer experience is hardly flashy, but it clearly delivers on the things that matter most to customers. Bain’s 2017 Advocacy in US Retail study, conducted in collaboration with ROI Consultancy Services, looked at the Net Promoter Score® (NPS®), a measure of customer advocacy and satisfaction, across top retailers. The study revealed that Amazon has the highest Net Promoter Score among top retailers for many categories, including home products, consumer electronics and sports equipment. Even in women’s clothing, where Amazon has its lowest NPS, it remains among the top 50% of retailers.

Companies can fight back with a more compelling customer experience, as long as it presents a discernible and defensible advantage. The retailers that are having the most success offer services Amazon can’t match—a uniform retailer featuring high-quality tailoring services, for instance, or a retailer offering an omnichannel customer experience that seamlessly blends a full suite of digital features with the advantages of a physical store.

Does the target have a reliable way to drive traffic?

Approximately half of all consumers start their online searches for goods at Amazon. That can be an instant advantage for companies that sell through the online retail giant. For others, it presents a major challenge. Investors need to know where search traffic starts for each category a target company plays in and how the company plans to boost its visibility. Amazon itself is very good at ensuring that its offerings rise to the top of Google searches when it enters a category. But there are highly effective search optimization tools and strategies that companies can use to fight back.

Retailers can also develop an advantage with aggressive strategies to drive people into brick-and-mortar locations. Beauty retailers, for instance, attract foot traffic by offering free consultations and tutorials in person. The key is to analyze traffic holistically to understand how a target generates traffic and whether it will be able to sustain its current flow of customers over time.

The issue of defensibility is at the heart of all four of these questions. If a target company has developed an advantage, how likely is it to persist? Can others (Amazon included) simply replicate it? Context matters a lot. Even if the picture doesn’t look great for a target in the face of Amazon, it might look better than it does for competitors, presenting an opportunity to gain share that others lose. When it comes to due diligence—and crafting a value-creation plan—the mere presence of Amazon isn’t a deal breaker. But to measure risk or opportunity, it is increasingly critical to underwrite with full confidence what that presence means for a company’s future performance.

Aaron Cheris, a Bain & Company partner based in San Francisco, leads the firm's Retail practice in the Americas. Monisha De La Rocha is a partner with Bain's Retail practice and is based in New York. Suzanne Tager, a Bain partner based in New York, is the senior director of the Retail and Consumer Products practices in the Americas.

Net Promoter Score® and NPS® are registered trademarks of Bain & Company, Inc., Fred Reichheld and Satmetrix Systems, Inc.

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