Amazon recently made the news by publicly announcing that it is targeting hard to sell items, so called Can’t Realize a Profit (CRaP) for removal from its all-powerful sales channel. Such items are believed to be those that have a low revenue for the cost to ship. Essentially, the shipping costs outdoes the contribution margin of the item. That sounds easy and makes sense. However, Amazon and its sellers will soon find that removing CRaP and even identifying CRaP is not so easy.
The challenge facing Amazon and its sellers reminds me of a problem I was assigned by a professor once in a class. He asked us to calculate the cost a grocery store incurred in selling one package of chewing gum. Indeed, the revenue of the one pack of chewing gum did not even justify the labor needed to check out the customer at the register or even the HVAC costs of the people involved in touching the gum package, if we assigned labor and all costs using activity based accounting rules. Stocking, store space, and especially management overhead dwarfed the opportunity offered by chewing gum. Still, the store sold hundreds of thousands of dollars of chewing gum each year. Chewing gum is an excellent example of a marginal revenue opportunity. It is rarely the reason a person comes into the sore, but it offers attractive revenue when other costs are considered fixed. Accountants can have field day with what is fixed and what is activity-based. In my mind, fixed costs can’t be turned off. Removing the chewing gum did not reduce management overhead or property taxes on real estate of the building. Those should be treated as fixed costs for the business to overcome. If everything is assigned activity-based costs, surely you end up with less profit, even if profit per item goes up, as marginal products and their revenue are left on the table.
Any item that makes it into an Amazon warehouse should rationally incur some costs associated with the facility. There is need for special analysis here. A small item that stays in the warehouse only a short time, rationally, should be allocated the smallest warehouse cost. A large item that rarely sells and stays there a long time, should be charged more “rent.” In this, a little wisdom from Aldi is appropriate. Aldi and Trader Joe’s select products using a metric like turns x revenue per square foot. They want to move items quickly, even if the revenue is low. It works the same way at Amazon. Warehouses are just like stores. The real estate is valuable and an item should not take up a lot of space. With such a metric, the chewing gum starts to look very attractive at the store. Amazon should consider a metric that involves the residence time of the item and the consumption of space (or volume) at the warehousing to achieve a fair cost for warehousing. If bottled water moves quickly, it might not be such a bad product.
Shipping costs are easier to identify, especially at Amazon. The product goes into a box and has a direct and assignable shipping costs. The problem is not just the product, but the Amazon model. If each item is sent via UPS on non-regular delivery, then yes, there are products with very high costs per margin. However, assume, there is a regular, weekly, or otherwise low cost delivery mechanism. This is how Amazon can delivery lower revenue items for a profit. Shipping costs are a real challenge, as the Amazon Dash Button promised the ability to order things like water detergent not by the bulk, but by smaller regular quantities. The idea is great. It is that the current Amazon shipping model does not support that. Let me also say, with gas prices low, any struggles in shipping will only get worse when gas prices get higher. Amazon might consider something like a post office model. Delivery is made to a neighborhood on some schedule. In doing so, the costs begin to appear fixed and not marginal, so bulky items can more easily be shipped.
More is Better…Not Always
Retailers like Costco figured this out, kinda. If an item has low margin, sell 5 gallons as the minimum order. It increased the profit per transaction. The metric to optimize was profit per transaction. 7-11 did it with the Big Gulp and Double Big Gulp. However, not everyone wants or needs a Double Big Gulp or a pallet of pasta to last 5 years. Part of the value of a store is that it allows a customer to buy just want they want.
Beware of Synergy
I understand why Amazon might want to raise the price on low margin, high weight or bulky items, like bottled water, kitty litter, potting soil, and paper towels. However, if I can’t buy bottled water online, my next best option is Costco. And, I, like most Americans, have never bought just one item at Costco. In such a decision to remove CRaP, Amazon will be pushing customers to competitors. It might feel right at the product level, but is it right at the customer level? What else will I buy at Costco that I would have bought at Amazon?
Department Store Model
From the early days of Sears and Montgomery Ward’s, the big question has always been, what does the department store need to carry to bring in more people? More departments attract more people and add more marginal revenue (hopefully at trivial cost of labor and expense). What additions are worthwhile? Sears seemed to have everything from photography sessions to car repair. It is hard to say these were highly synergistic. Indeed, it was a grasp to extract more revenue from its highly attractive real estate. Amazon should think of its online channel with the same mindset. What is the next best offer to make to a customer? Marginal revenue can be hard to evaluate on its own, because it might not overcome allocated fixed costs. However, in the totality of operations, it is attractive.
Advice for Amazon Sellers
Don’t look like CRaP. Cut packaging weight. Can you use plastics or disposable containers over glass? Consider drop shipping or delivery through retail outlets. Maybe Amazon warehousing is not the best channel for your bulky item. Here in Chicago, the Chicago Tribune newspaper once offered Icelandic water delivery – great way to leverage an existing delivery network to sell a bulky item.
Recognize the synergistic impact of your item and know the velocity of sale of your item. Analysis of an items should consider these aspect, not just size and shipping.
The “best” thing to sell is a small sized, low weight, high margin item, say, a piece of jewelry. It is also very helpful that the item sells quickly and therefore spends little time in the warehouse. The “worst” thing to sell is a low-priced, bulky, heavy item that rarely sells and requires lots of warehouse space and labor. Consider the vast space in between. Suppliers will want to shrink and cut the weight of their products. Amazon is caught between a store and a shipping firm. Which one is it? Maybe some items are best picked up a the local Whole Foods or delivered at a special fee from the local Whole Foods. Amazon will want to move some items to pantry boxes, or a new model for lower cost delivery.
Managing CRaP at Amazon will require a constant and dynamic approach to considering customer behavior, shipping costs, energy costs, and labor.
I found this random CRaP bag on Amazon. Buy it before Amazon gets rid of more CRaP!
Professor Walker provides keynote talks, seminars presentations, executive training programs, and executive briefings.
About Russell Walker, Ph.D.
Professor Russell Walker helps companies develop strategies to manage risk and harness value through analytics and Big Data. He is Clinical Professor of Managerial Economics and Decision Sciences at the Kellogg School of Management of Northwestern University. He has worked with many professional sports teams and leading marketing organizations through the Analytical Consulting Lab, an experiential class that he founded and leads at Kellogg.
His most recent and award-winning book, From Big Data to Big Profits: Success with Data and Analytics is published by Oxford University Press (2015), which explores how firms can best monetize Big Data through digital strategies. He is the author of the text Winning with Risk Management (World Scientific Publishing, 2013), which examines the principles and practice of risk management through business case studies.
7-11, activity based accounting, Aldi, Amazon, Costco, costs, CRaP, Dash Button, department store, energy costs, featured, fixed costs, Grocery Store, gum, HVAC, labor cost, marginal revenue, Montgomery Ward, profit, Real Estate, Retail, Sears, Shipp, shipping costs, Trader Joe's, warehousing, Whole Foods