The Everything Store: Jeff Bezos and the Age of Amazon (43 page)

Still, as Wilke says, some of the companies that disavow selling on Amazon ultimately return, irresistibly drawn to its 200 million active customers and brisk sales. Amazon’s own employees have compared third-party selling on the site to heroin addiction—sellers get a sudden euphoric rush and a lingering high as sales explode, then progress to addiction and self-destruction when Amazon starts gutting the sellers’ margins and undercutting them on price. Sellers “know they should not be taking the heroin, but they cannot stop taking the heroin,” says Kerry Morris, the former Amazon buyer. “They push and bitch and complain and threaten until they finally see they have to cut themselves off.”

Wüsthof, the German knife maker, had its relapse in 2009, after
an intensive courtship by Amazon that included promises of obedience in regard to the manufacturer’s suggested price. The company reallocated product to the online retailer, but the earlier pattern repeated itself; for example, Wüsthof’s gourmet twelve-piece knife set, with a MAP of $199, showed up on the site at $179. René Arnold, the CFO, was overwhelmed with complaints from his other retail partners, whose prices remained 10 percent higher. These small shop owners either lost sales to Amazon or were forced by their customers to match Amazon’s price. In their angry calls to Arnold, they threatened to lower their retail prices as well, and now it was easy for Arnold and his colleagues to envision a day when all these retailers would start demanding lower wholesale prices on Wüsthof knives, cutting into the company’s profit margins. The economics of its traditional-manufacturing operation in Germany would no longer make sense.

When Arnold complained, his counterpart at Amazon, a merchandising manager named Kevin Bates, responded that the company was merely finding and matching lower prices on the Web and in its third-party Marketplace. Arnold argued that many of those sellers were not authorized retailers and urged Amazon not to match them. Bates said that he was required to—Amazon always matched the lowest price.

Arnold was frustrated. He was monitoring Amazon’s third-party Marketplace and tracking several unfamiliar low-priced sellers, including one called Great Deals Now Online. This mysterious entity always seemed to have Wüsthof knives for sale, yet Arnold had no idea who they were, and Amazon provided no way to contact them. “He might know someone who has gotten a hold of surplus product, or he might have someone working at Bed, Bath and Beyond stealing from the distribution center,” says Arnold. “Customers would never give their credit card to this guy, but because he’s on the Amazon platform, they figure he’s clean, he must be good.” Arnold felt that Amazon’s own Marketplace was enabling the destructive discounting that its retail business was using as an excuse to undercut MAP.

In 2011, Wüsthof decided, again, to end its relationship with Amazon. To help explain to his bosses why Wüsthof was cutting off one of its best sales channels, René Arnold requested a meeting with Amazon and brought Harald Wüsthof over from Germany. Wüsthof, in his mid-forties with wavy, white hair and an avuncular smile, has quite possibly never in his life been photographed without a sharp blade in his hands.

The meeting, at Amazon’s offices in Seattle, was tense. Kevin Bates was joined by his boss Dan Joy, a director of hard-line categories like kitchen and dining. Bates and Joy seemed genuinely surprised to hear that Wüsthof was walking away and vowed to acquire Wüsthof knives through the gray market. They also threatened the company, as Arnold recalls, saying that every time a customer searched on Amazon for the Wüsthof brand, Amazon would show advertisements for competitors like J. A. Henckels, another knife company based in Solingen, and Victorinox, maker of Swiss army knives.

Wüsthof and Arnold were shocked by the fierceness of Amazon’s stance and held firm on their decision to withdraw. “Anyone can sell more Wüsthof at half the price. It’s easy,” Arnold says. “But if you start selling at the lower price, maybe you have a heyday for a few years, but within two or three years you drive a two-hundred-year-old family business into a wall. We had to protect our brand. That was the main decision point. So we pulled out.”

At a kitchen-and-bath trade show in Chicago the following spring, Arnold was surprised to receive an outpouring of support from sympathetic vendors who were also tussling with Amazon over issues like MAPs and mysterious third-party sellers. Meanwhile, Amazon followed through on its threats to show ads for Wüsthof rivals. In mid-2012, an enterprising Amazon buyer somehow managed to get someone at Wüsthof headquarters in Germany to ship him a large crate of knives meant to go to Dubai. That supply lasted about six weeks.

By the end of 2012, an Amazon merchandising representative began courting Wüsthof once more, begging the company to
reconsider. The knife maker declined. But here’s the kicker: Customers can still find a decent selection of Wüsthof knives on Amazon from a handful of third-party sellers and even from Amazon itself. In 2010, Amazon started a unit called Warehouse Deals. The unit buys refurbished and used products and sells them in the Amazon Marketplace and on the Web at Warehousedeals.com. The goal of the project, according to an executive who worked on it, is to become the largest liquidator on the planet. These products are often advertised as “good as new”—a package of diapers with a tear in the shrink wrap, for example—and Amazon is not required to sell them at MAP.

As of this writing, Warehouse Deals has a selection of more than sixty Wüsthof products at steep discounts. Third-party merchants, mostly other authorized Wüsthof retailers, also sell their knives on Amazon, often through Fulfillment by Amazon, which allows the products to qualify for Prime shipping. So even when partners flee, the groundwork that Amazon has laid ensures that the hallowed shelves of the everything store are never completely bare.

* * *

Back in the anxious years after the dot-com bust, when Wüsthof was still happily selling its knives on Amazon.com, Jeff Bezos was tracking a firm he viewed as a potentially dangerous new rival: Netflix. At the time, Amazon was making a little extra money by inserting paper advertisements into its delivery boxes, and Bezos himself received a package that contained a flyer for the DVD-rental firm. He brought the flyer into a meeting and said irritably of the managers running the advertising program, “Is it easy for them to ruin the company or do they have to work at it?”

Bezos was clearly nervous about Netflix’s gathering momentum. With its recognizable red envelopes and late-fee-slaying DVD-by-mail program, it was forging a bond with customers and a strong brand in movies, a key media category. Bezos’s lieutenants met with CEO Reed Hastings several times during Netflix’s formative years but they always reported back that Hastings was “painfully uninterested” in selling, according to one Amazon business-development
exec. Hastings himself says that Amazon was never truly serious about an acquisition of Netflix because “the basic operating rhythms” of the DVD-rental space, which required multiple small fulfillment centers to send discs out and then receive them back, were so different from Amazon’s core retail business. “It made no sense for them to be an aggressive bidder because it didn’t really leverage their strengths,” he says.

Like everyone else, Amazon executives knew that the days of selling and shipping physical DVDs were numbered, but they wanted to be prepared and well positioned for whatever came next. So Amazon opened DVD-rental services in the United Kingdom and Germany, with the idea that it would learn the rental business and establish its brand in markets that Netflix had not yet entered. But local companies were ahead there too, and the cost to acquire new customers was higher than Amazon had anticipated. In February 2008, Amazon seemingly waved the white flag of surrender, selling those divisions to a larger competitor, Lovefilm, in exchange for about $90 million in stock and a 32 percent ownership position in the European firm. Jeff Blackburn says that by then Amazon suspected there was little future for the rental model and that “we sold them the DVD business because they seemed to be overvaluing it.”

Lovefilm was a kind of Frankenstein corporate creation, the combination of numerous Netflix clones that had gradually merged with one other and come to control a majority of the British and German rental market. As a result, it had many shareholders (including several prominent venture-capital firms), a large board of directors, and plenty of conflicting internal opinions about its strategic moves. Amazon became the largest shareholder after the deal and later consolidated its grip on the startup when another investor, the European venture-capital firm Arts Alliance, sold the company a 10 percent stake. Greg Greeley, the former finance executive who was running Amazon’s European operation, joined the Lovefilm board. As it is wont to do, Amazon watched from the sidelines, learned, and patiently waited for an opening.

By early 2009, the home-video market was inexorably tilting
toward streaming movies online and away from sending discs in the mail. Like Netflix, Lovefilm planned to transition to video on demand. It had arranged streaming deals with movie studios like Warner Brothers and put access to its catalog on devices like Sony’s PlayStation 3. But the company needed additional capital to execute such a shift in its business, so that year it hired the investment bank Jefferies and started entertaining acquisition and investment offers.

While private equity firms like Silver Lake Partners expressed interest, Google was the most prominent bidder for Lovefilm. The search giant’s executive team was developing a plan over the summer of 2009 to acquire both Lovefilm and Netflix and add a significant new focus that was unrelated to its core advertising business. Nikesh Arora and David Lawee, business-development executives at Google, had several meetings with people at both companies that year and produced a preliminary letter of Google’s intent to buy Lovefilm for two hundred million pounds (about three hundred million dollars), according to three people with knowledge of the offer. But these efforts ultimately fizzled; there was opposition from Google’s YouTube division and fear that the company might be able to acquire one streaming-video business but not the other.

That left Lovefilm still in need of additional capital. So over the summer of 2010, the company’s executives decided to pursue an initial public offering. Then Amazon decided it wanted to buy Lovefilm, and everything changed.

Amazon had watched the explosion in popularity of Internet-connected Blu-ray players and video-game consoles in its own electronics store and knew it had to get off the sidelines. Its incipient streaming service, Amazon Video on Demand, was the successor to an overly complicated video download store called Amazon Unbox, which required users to download entire movies to their PCs or TiVo set-top boxes before they could start watching. The streaming service (which did not require downloads) was showing early promise but the company still lagged behind Apple and Hulu in the online-video market. Buying Lovefilm would give it a beachhead in Europe. “They went from having a financial interest, where they
thought they might make a financial return on their investment, to a strategic interest,” says Dharmash Mistry, a former partner at the London venture-capital firm Balderton Capital and a Lovefilm board member. “They wanted to own the asset.”

Now the Lovefilm board members would witness the same ruthless tactics observed by the founders of Zappos and Quidsi. Amazon pointed out, quite sensibly, that Lovefilm needed to invest hundreds of millions to acquire content and hold off deep-pocketed rivals like the massive cable conglomerate BSkyB and, when it finally entered the European market, Netflix. Amazon also argued that Lovefilm needed to invest in its long-term prospects and should not spend time and money gussying itself up for the conservative public markets in Europe, which would want to see profits before an IPO. The best path forward was for Lovefilm to sell itself to Amazon. It was more Bezos-style expedient conviction—the arguments had the advantage of being completely rational while also serving Amazon’s own strategic interests.

In the midst of this debate, Amazon found a technical way to prevent a Lovefilm IPO. If the company was going to free up stock to sell to the public, it needed to amend its own bylaws, or articles of association—and as the largest shareholder, Amazon could block this change. It effectively had a veto over an IPO, and Amazon made it clear that it was not going to authorize or publicly endorse the move, according to multiple board members and people close to the company. This was an enormous problem. Potential investors were likely to balk if the company’s biggest shareholder was not visibly showing its support for the offering.

Lovefilm executives had several meetings with attorneys to try to find a way to extricate themselves from the situation. They also attempted to entice other potential acquirers, hoping to spark a bidding war, but without success. Everyone saw that Amazon was squatting over the asset.

Though Lovefilm was a prestigious European company with a strong brand and solid momentum, Amazon offered an opening bid
of a hundred and fifty million pounds, the very bottom of Lovefilm’s price range. With no alternatives, Lovefilm started negotiating. In the protracted discussions that followed, Amazon characteristically argued every point, such as compensation packages for management and the timing of escrow payments. Lovefilm’s attorneys were astonished at the intractable positions taken by Amazon’s negotiators. The talks lasted more than seven months, and the acquisition was finally announced in January 2011. Amazon ended up paying close to two hundred million pounds, or about three hundred million dollars—roughly the same amount Google had offered despite the fact that Lovefilm had expanded its subscriber base and its digital catalog of movies in the intervening year and a half.

Amazon now had a strong foothold in the European video market just as it unveiled its most serious play for the living room. A month after it announced the purchase of Lovefilm, the company introduced a video-streaming service for Amazon Prime in the United States. Members of the two-day shipping service could watch for free a selection of movies and television shows, a catalog that would grow steadily over the next few years as Amazon inked deals with content providers such as CBS, NBC Universal, Viacom, and the pay-TV channel Epix.