Vertically integrated e-commerce is a business model we focus on at IP. These are companies that aim to move up or down the value chain to control more of the customer experience. This includes moving backwards into controlling product supply or forwards to manage logistics and delivery. Vertical integration drives greater control over the customer experience and the company’s own unit economics. In turn, this offers attractive opportunities for long-term organic growth and can build a durable moat.
Over the last five years, our research on these models has focused on understanding when and how vertical integration can build a better customer experience and deeper moat. We also explore when it doesn’t work, potential improvement in order economics, and the scalability relative to incumbent retail models. This research roundup curates some of our work on the topic and explains why we’ve covered specific angles:
Amazon is arguably the pioneer of the vertically-integrated e-commerce model. It has created a superior customer experience at favourable economics.
The most challenging and expensive integration move is to own the last-mile delivery to the customer. In Q4 22, Jassy reported that Amazon had “built out a transportation network roughly the size of UPS in a couple of years'’. A core angle of our Amazon research has been to understand the structural differences in AMZN’s delivery network design and performance relative to incumbent third-party carriers.
This analysis walks through how a parcel flows through AMZN network from inbound through FC’s to sortation centers and delivery stations to the end customer and the cost per parcel of each leg:
This interview provides context on the changes of Amazon’s fulfillment network over the last five years and how this has counterintuitively reduced unit delivery cost and increased speed:
So UPS does everything from a transportation perspective, and therefore the cost per package is going to be $8 to $9, as compared to a package that the post office might move, which might be, say, $3 or less. Why would the post office be so much less? Amazon is taking responsibility for all of the sortation process and getting that package directly to the post office back door. All the heavy lifting has been done by the time the package arrives at the post office, and the post office's job is really just that last mile delivery component. Maybe Amazon is paying them somewhere around $2.75, $3, or something in that range, for that part. Then when you look at the cost structure of Amazon doing that same work through the Amazon logistics umbrella, they have to not only move it to the sortation center, sort it, touch it, move it again to a delivery station, sort it, touch it and also do the last mile delivery.
This interview with the Former leader of Fedex Express explores a key difference in the design of AMZN’s network compared to incumbent carriers: multi-wave dispatch. This is the process of how inventory is received and dispatched throughout the middle and last-mile facilities in the network:
[Fedex’s] current network design really only has – in terms of the pick-up and delivery components that are based out of stations – one wave of drivers leaving. The building design is such that the trucks back into the building, against the belt; there is a sort that goes on for about two and a half hours in the morning. There is probably an earlier sort for First Overnight, where there are a small number of departures. But the majority of the volume, whether it’s committed for 10:30 in the morning or end of business day, it’s all sorted and loaded onto those FedEx Express courier vans that morning. Then that building sits idle for most of the day, until the pick-ups come back in and then the process starts again. - Former Fedex EVP
We curate our learnings on why multi-wave dispatch may be a critical variable in Amazon’s speed and scale advantage over incumbents in this piece:
We also spent months deconstructing Amazon’s P&L to understand the true underlying earning power of the retail business. Although Amazon splits AWS and Retail revenue, it combines some cost line items and groups exploratory projects such as Kuiper within Retail. This interview with a Former Finance Director at Amazon provides a lens into how Amazon builds its group P&L:
If you include ads in the core consumer business, you are unable to assess the health of the business, at its fundamentals. When you think about the core ecommerce, because the fulfilment network and those investments are so massive, there is a relentless focus on optimizing the opex/capex outlays associated with those operations. That includes those fulfilment centers, the staffing of those centers and the ultimate operation of the site, as a core business. Since operating income, from the consumer business, is largely attributed to advertising – it drives an outsized proportion of operating income – and the S-team is largely looking at that business, in terms of its operating income, if you include the advertising numbers in the core consumer business, it entirely obfuscates how that business is operating independently of the advertising. You look at third-party sales and fulfilment to consumers; how profitable is that? Look at third party and fulfilment to consumers; how profitable is that? - Former Finance Manager at Amazon
We walk through our approach to decouple the retail P&L from the Group, how to split each cost line between Retail and AWS, and how to account for projects such as Kuiper.
This helped us understand Amazon's historical e-commerce gross and contribution margins including and excluding Ads and Prime.
We curate all our work into this research that walks through an approach to decouple Retail from Amazon's consolidated accounts. It also ties in with our work above exploring the potential reduction in variable shipping cost per unit as more volume is insourced.
We also break down Amazon’s advertising business between endemic (sellers advertising products) and non-endemic (non-Amazon sellers advertising through Prime and other Amazon-owned properties):
What I see in various roles I've been in recently is that, actually, people are beginning to accept that this cookie data stuff is moving on. The reason retail media and Amazon and those types of businesses are growing, is because their data is first party data. What Google is, and Meta is – to a great extent – is a guess at first party data. It's not real first party data. - Former Director at Amazon Advertising
We curate all our Amazon Retail work in an IP learning journey covering:
Behind Amazon, Carvana seems to be a vertically-integrated retailer who has created a superior customer experience at favourable economics. This interview is a helpful introduction to the used car ecosystem and how inventory flows from OEMs or lessors through franchise dealers to customers and back into to used car market.
Leased cars are sold by a franchised dealer. They are not financed but leased and there is a whole separate ecosystem in place to handle those off lease units. That off lease vehicle has a deadline. When you lease that car, you are signing up via contract with the manufacturer to only put a certain number of miles on it. There is a penalty if you do more. You typically sign a 24, 36 or 48 month lease term and you know there is a deadline on that car. Generally speaking, while some consumers buy their car off lease, most of the time they have leased a car because they want another new car at the end of their lease term. That leased vehicle comes back into the OEM franchised network as a known quantity. By that I mean, you know, generally, how many miles are going to be on it. You know the condition of the car because it has been maintained at the franchised dealer as part of the leasing contract. That is the third point; you know the residual value of that car and when that car comes back to the grounding dealer – and grounding dealer is a term that simply means where the leased vehicle is turned in – they have a right of first refusal. The dealer can look at that vehicle and say, yes this is a really good used car, I can sell this in a heartbeat. It has low mileage, was well-maintained and is accident free. The person had no kids or dogs, and did not smoke. That is a cream puff and grounding dealers will cherry pick those off lease units. There are also incentives offered by OEMs, to dealer franchised networks, to pick up those off leased cars. - Former Vice President at KAR Global
Similar to our Amazon piece above, this interview with a Former Director of an Inspection Centre at CVNA walks step-by-step through the inspection process:
The biggest factors are age and mileage, not whether it's an auction or consumer car. Some people think that a consumer car takes longer, but generally, a car bought directly from a consumer tends to be older and have more miles. This is because you can focus on what you're buying at an auction and tend to buy later model cars with lower mileage. So, when you collect the data, it might show that it costs less and cars get through the system faster when bought from an auction. However, it's not necessarily a difference between an auction and a consumer car, it's the year and mileage. - Former Associate Director of Inspection Centers at Carvana
This interview explores in more detail how Carvana plans to improve the inspection process speed and cost post-ADESA acquisition:
From the point of purchase to the point of being ready for the website, it was probably closer to 18 to 20 days. As you probably know, with all the media attention it has received, you have to be very careful about when you have the title. Legally, from the point of purchase, they have 30 days to supply it. So, you could have the car completed well before that, but it still just sits until the title is there before you can put it on the website. There are a few different ways to measure cycle time. One is when Carvana is photo complete and ready for the website. From a reconditioning standpoint, you have no control over whether the title is there or not. So that's where Carvana's cycle time calculation ends. - Former Associate Director of Inspection Centers at Carvana
We also spent time aiming to understand Carvana’s prime and subprime loan underwriting process and economics. In the auto retail business, dealers, lenders, and investors collaborate to originate loans so consumers can purchase cars. In an indirect finance model, the most common in the industry, dealers outsource the origination of the loan to external lenders like Santander, Exeter, or Westlake who take on the risk of underwriting the loan. Dealers earn most of their margin from selling the vehicle and ancillaries and either pay or receive a fee from the lender to make the economics work for both parties.
The lender typically earns the largest profit in the value chain because they are taking the most risk underwriting the loan. Investors earn a risk-adjusted return determined by traditional credit drivers (rates, spreads, duration, etc).
CVNA's model is different in that it is vertically integrated; it acts as the auto dealer that buys and sells the vehicle and the lender that originates the loan. These loans are then securitised and sold to ABS investors.
This research explores how Carvana’s loan underwriting business is unique and how drives of gain-on-loan sale:
We also conducted a post-mortem on why Vroom went bankrupt:
We were good for prime customers, but not for subprime ones. So, you need to have a financing product for them. Also, we're buying these vehicles virtually sight unseen, using a lot of data. The risk increases once you start dealing with cars older than three years, due to potential reconditioning needs and pricing surprises. The challenge is to get the pricing right. If we buy a car in Seattle and ship it to our local reconditioning center, and then discover issues that we didn't account for in our pricing algorithms - and the customer wasn't aware of something like frame damage - we're stuck with it. Even though we technically have the right to send it back, we never did that because it wasn't cost-effective. If we find a problem during reconditioning, we might decide it's not a retail-grade vehicle and send it to auction, which can impact our margin. So there's risk there. - Former Senior Director at Vroom
Over the last decade, Wayfair has built out ~19m sqft of warehousing facilities and offers end-to-end logistics to furniture suppliers. Its CastleGate Logistics offering consolidates inventory in Asia, organises ocean freight, and stores product in Wayfair warehouses to offer 2-day shipping across the US to customers.
Unlike Amazon and Carvana, this is a layer of vertical integration that aims to improve the customer experience without directly owning inventory. The more inventory that Wayfair warehouses in its CastleGate network, the higher the product availability, faster the delivery times, and higher the conversion rate. The company believes owning the supply chain is one of the most important drivers of repeat buying, a metric that is fundamental to Wayfair’s unit economics.
This value chain breakdown aims to understand the value of Wayfair’s logistics infrastructure. It walks through each step of shipping a 20ft container of large, bulky items from Ho Chi Minh to New Jersey within CastleGate compared to a traditional drop shipping network.
Over the last five years, the adoption of CastleGate seems to have stalled. We hosted a survey of furniture suppliers to understand the attractiveness of CattleGate relative to other sales distribution models. The survey aims to understand more about how and why suppliers may or may not use CastleGate’s warehousing and logistics service.
This survey focuses on two core questions:
We also explored how IKEAs moving omni-channel. E-commerce as a percentage of sales grow to over 25% post-covid.
We walk through how IKEA is using its stores to deliver product and the long-term strategic advantages of moving from brick-to-omnichannel compared to Wayfair moving online-to-omnichannel.
We curate all our work on Wayfair in this IP Company Learning Journey covering:
Much has been written about Shein’s rapid growth: its $20bn in sales, the $100bn valuation, its mysterious founders, the daily launch of thousands of SKUs at rock bottom prices, and, of course, the sustainability issues. But there isn’t much explaining how the business really works.
How does Shein place orders and receive goods from Chinese suppliers? How does sampling work? How and where does it source fabric? Quality control processes? Order economics?
We’ve spent hours with Former Shein Managers and current suppliers to walk through the process of yarn to finished goods to understand how Shein’s supply chain really works. This piece of research is interesting for anyone studying or operating in e-commerce and retail. This also isn’t just about fashion; it’s insight into a new type of supply chain. Shein has redesigned the retail supply chain to be demand-focused, not supply-focused like traditional retail. To an extent, the core principles are potentially category agnostic. And the core tenets of Shein’s supply chain philosophy can be deployed in a sustainable manner.
We also compare SHEINs supply chain with Zara’s supplier relationships, merchandising and buying team structure, and overall speed and unit costs sourcing from Turkey vs Asia.
Finally, this interview with a Former CEO at Aldi explores the challenges of online grocery:
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