Adventures in (Thinking About) Selling on Amazon

Your margin is my opportunity

Amazon relies on a large network of independent third-party sellers to procure goods for Amazon’s marketplace. This third-party selling platform is vast, and generates something close to half a trillion dollars’ worth of sales every year for its various merchants. (Amazon is a merchant on its own marketplace, so this figure includes revenue for products that Amazon sells directly.)

Given the size of this market, there are a number of different ways for third-party sellers to generate revenue. There is also a lot of competition.

A few months ago, I started looking into the possibility of selling on Amazon as a third party. I ultimately decided not to do it, for reasons that are beyond the scope of this post. However, I thought I’d share what I learned about the various ways in which third-party sellers make money on Amazon, in order that someone reading this for the first time can better understand how Amazon sources a lot of the products that consumers buy.

This post is not intended to be a “how to”. Rather, it’s a high level overview of different business models. And, due to the sheer size of the marketplace, there may be a few models that I have not included here, or some complexities that I have elided.

On to the models.

Private label

This is a model in which someone invents a new product, sources a manufacturer for it, and sells the product under their own brand name. Maybe you have made an improvement on an existing product, like, say, a water bottle, and find a manufacturer who can manufacturer your design. You can patent it, contract with the manufacturer to manufacturer your new and improved water bottle, and market and sell it on Amazon.

Of course, just because you can do this means that other people can, too. Just because you improved Water Bottle Version 1.0 with your 2.0 model doesn’t mean someone else can’t come along and create Version 3.0. So, with private label, you need to continually improve your product and/or create new products, or lose out to competitors (including, potentially, Amazon itself) who create better and less expensive versions of what you had originally improved.

In theory, if you can sustain this model, it allows for the largest margins. However, as Bezos is fond of saying, your margin is his opportunity. Amazon has created a whole category of Amazon Basics products, which essentially are Amazon’s version of commoditized private label products. Given Amazon’s vast balance sheet, it can contract with manufacturers at a much lower cost than can any private label company. As ever: your margin is my opportunity.

Wholesale —> Retail

Third-party sellers on Amazon are selling retail through Amazon’s marketplace. Just as any number of bricks-and-mortar retailers have to source product from manufacturers or distributors, so, too, some third-party sellers on Amazon rely on contracts from manufactures, which allow these third-party sellers to buy directly from the manufacturer and sell the manufacturer’s product on Amazon.

This seems like a clean and simple business model. However, Amazon has increasingly struck partnerships with manufacturers/brand owners, which allow those manufacturers to sell directly on Amazon, thus cutting out retailers who rely on wholesale pricing. Again: your margin is my opportunity.

Retail Arbitrage

Arbitrage occurs when you can buy something at one price in one marketplace and sell it at a higher price in another marketplace. In the financial markets, true arbitrage opportunities are fleeting and rare, due in part to financial markets’ liquidity and efficiency.

In the context of selling on Amazon, this means finding sales on popular consumer products (say toothpaste) at major retailers (say Walmart), and pocketing the spread (after Amazon fees) between the price at which you buy the toothpaste and the price at which you sell the toothpaste.

So, for example, if you go to Walmart and notice that they’re having a sale of 50% off Crest toothpaste, maybe you buy a few dozen tubes, bring them home, package them up, ship them to an Amazon fulfillment center, and profit from the spread.

The advantage to this model is that it requires very little capital up front. The disadvantage is that there are no barriers to entry, and you’re competing with many thousands of other retail arbitrageurs who are trying to profit off the same spread. In financial parlance, this means that the arbitrage opportunity is “arbitraged away.” Thus you need to spend a lot of time finding new products for which an arbitrage opportunity exists. There is little scalability here, and little repeatability.

Many people do not realize that in the United States the US Supreme Court has recognized the right of people to resell products which they lawfully acquired. It is under the rubric of this decision that an Amazon third-party reseller can acquire product at Walmart (or any other store) and resell it via Amazon, without infringing on the brand owner’s rights.

This having been said, Amazon may at some point decide that they don’t want these kinds of resales to happen on their platform, and there is nothing that prohibits them from making such a decision. In fact, Amazon’s decision to strike partnerships with brand owners to allow brands to sell directly on Amazon suggests that Amazon is mainly interested in having established companies sell product on its web site.

Your margin is my opportunity.

Online Arbitrage

Where retail arbitrage requires that you go to a physical store to source product to sell on Amazon, online arbitrage only requires that you visit ecommerce web sites to find arbitrage opportunities. In theory this requires even less capital than does retail arbitrage. For example, you don’t need a car or gas, and you don’t incur wear and tear on your car in the service of your business.

Again, however, due to low barriers to entry, there are thousands of people competing with you, which requires that you constantly source new products. As with retail arbitrage, the US Supreme Court has recognized your right to resell products you’ve lawfully acquired; however, again, there is nothing stopping Amazon from deciding that it doesn’t want resellers to sell on its web site.

Your margin is my opportunity.