Why Amazon Demands Multi-Channel Performance Pricing

Why Amazon Demands Multi-Channel Performance Pricing (MCPP)

Amazon’s status as a company driven largely by economical concerns is now widely recognised. The effect of this on its own revenue performance is felt by manufacturers and distributors when Amazon ceases to order a product on account of so-called “CRaP-Out” status. CRaP stands for “Cannot Realize Any Profit” and effectively means that end users can only obtain an item from Amazon Marketplace distributors from thereonin. The reason for the occurrence of a CRaP-Out status is typically a lack of pricing strategy on the part the respective manufacturer/distributor. In order to better understand the precise background, it is first necessary to understand the differences between the two different business models operated by Amazon on its online marketplace: “Amazon Vendor” and “Amazon Marketplace”.

• Amazon Vendor: In this business model, Amazon functions as the seller to the end user. Accordingly, Amazon purchases the goods from manufacturers and/or other distributors beforehand and sells them for as much profit as possible on their own account. From the perspective of the manufacturer/distributor, Amazon is essentially a “classic” B2B customer.
• Amazon Marketplace: In contrast to the vendor model, it is not Amazon that functions as the seller, but rather the respective marketplace distributor (for example, a manufacturer or  wholesaler). In this case, Amazon merely provides the online marketplace infrastructure (and, where required, additional services against a fee, such as the logistics service Fulfillment by Amazon). From the perspective of the manufacturer/distributor, Amazon is a direct sales channel.

Which of the two business models makes most sense – or whether it might be worthwhile to operate the two in parallel – depends on a manufacturer or distributor’s respective Amazon strategy. Regardless of which of the business models is chosen, it is important to understand that pricing – that is, deciding what prices to charge Amazon in the vendor model or what prices to charge consumers in the vendor model – has a significant influence in both cases. As previously mentioned, Amazon is a company driven largely by economical concerns and, accordingly, prioritises the goal of profit maximisation in their deployment of these business models. This means that from Amazon’s perspective, the trading margin that can be earned in the vendor model stands in direct competition with the sales commission that can be earned in the marketplace model. As can be seen from Figure 1, the minimum trading margin earned by Amazon in the vendor model typically lies at around 20% of the net online streetprice (OSP) – that is, the price for which the product is sold to the end consumer minus VAT. It is comprised of three components: frontend, backend and marketing fees (see Figure 1).

Figure 1: Price & margin system for the Amazon vendor business model

If Amazon’s trading margin is below approximately 20% of the net online streetprice, Amazon sets the status of the respective item to “CRaP-out” and ceases to order the item from the manufacturer/distributor, eliminating revenue generated by the vendor model.

The reason for the minimum trading margin of 20% (of net OSP) is that in the marketplace model, Amazon generates at margin of approx. 18% (of net OSP) from the marketplace fee alone (see Figure 2).  Since Amazon also then generates margins via other services – e.g. the logistics service Fulfillment by Amazon, or marketing expenses from marketplace players – the marketplace model is preferable to the vendor model in such cases and is implemented by means of the above-mentioned CRaP-out status.

In light of all this, the topic of pricing strategy is a highly relevant one, since the CRaP-out risk must always be borne in mind when determining prices for the Amazon vendor model. To this end, current market prices (online streetprices) are retrieved by means of comprehensive price crawling to enable a corresponding price corridor for Amazon negotiations to be ascertained.

For a holistic pricing strategy, however, considerations must go significantly further: to earn the Amazon Buy Box (items in the Buy Box tend to be the ones that are purchased by customers), marketplace providers frequently set prices below the Amazon vendor price level. As such, they are a driver for the erosion of online streetprices and ultimately increase the CRaP-out risk. From a manufacturer’s perspective, it can be noted that wholesalers frequently distribute products via the Amazon marketplace due to the fact that the purchase conditions governing their relationship with manufacturers leave sufficient room for a trading margin to be generated through resale on Amazon. A tried-and-tested concept offering solutions for the pricing challenges described above comes in the form of a systematic multi-channel performance pricing (MCPP) strategy with a market data and performance-oriented conditions model. This involves defining a cross-channel pricing strategy that avoids such margin-damaging distortions and damage to a brand through price erosion.

Our experience has shown that a multi-channel performance pricing (MCPP) strategy is essential, particularly for the successful pursuit of business on and with Amazon.