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Amazon's Game Changer

by Matt Miller | Published November 26, 2012 at 9:05 AM

Amazon.com Inc. sells just about everything, and lots of it. The world's largest online goods purveyor punched in sales last year of more than $48 billion, led by the company's own Kindle e-book reader.

Kiva Systems makes industrial robots. Think of a bright orange version of Rosie the Robot from "The Jetsons," minus the apron, the head and the obnoxious voice. Kiva droids scurry around warehouses, grab specially designed, goods-laden trays and motor back to awaiting packers, ready to fulfill and ship orders.

An odd coupling?

When Amazon announced in March 2012 that it was buying Kiva Systems for $775 million in cash, the transaction initially met with a mixed reception. A few equities analysts groused that the retailer was paying a lot of money for the loss-making, decade-old company, rather than just purchasing the robots themselves as needed.

"It's not obvious that Amazon needed to buy the cow when it could just purchase the milk," wrote one analyst.

Those who follow logistics, that multi-trillion-dollar, multi-faceted industry dealing with the movement of goods, have a very different take on the deal:

"It's a tremendous move for Amazon," said Jeffrey Unger, the chief executive of G2 Capital Advisors LLC, an investment bank advisory that specializes in logistics. "Amazon is becoming the model that others are looking at."

Leaders of The Daily Deal voted Amazon the winner in the consumer discretionary category of Most Admired Corporate Dealmakers. The e-commerce behemoth beat out Yum! Brands, with KFC, Taco Bell and Pizza Hut, and VF Inc., home to a diversified stable of apparel, including Wrangler, Vans, Timberland and JanSport.

That voting reflects a five-year period, during which Amazon has acquired almost 30 companies. Those acquisitions have tended to be smaller technology companies that enhance consumer shopping or Web-based retailers that broaden product offerings. Most are too small to require value disclosure.

The biggest acquisition came in July 2009, when Amazon paid $1.23 billion for Zappos, the leading online purveyor of footwear. Kiva represents Amazon's second-largest deal.

What drives Amazon "is the desire to enhance the consumer experience, whether it's shipping or product availability or price," said Kerry Rice, a senior Internet analyst with Needham & Co. "They make acquisitions to further that strategy."

For example, Amazon bought two technology companies late last year for undisclosed sums. Yap Inc. develops speech-to-text technology. Quorus allows friends, through social media, to weigh in on buying decisions. Both have obvious online shopping applications. Kindle developers may take advantage of the Yap technology as well.

Amazon has, to be sure, made a few investment missteps. In late 2010, the company paid $175 million for a 34% stake in Livingsocial.com, a Groupon-like daily deals site. Since then, Livingsocial has lost hundreds of millions of dollars and has suffered alongside its bigger competitor as consumer buzz has worn off and investor ardor has subsided.

Seattle-based Amazon declined to make Peter Krawiec, vice president worldwide corporate development, available to speak. A spokesman explained that the company prefers to keep a low profile around its M&A team and strategy.

The Kiva acquisition, meanwhile, fits into a consumer-centric approach, Rice believed. Yet, say others, it also reflects a shifting emphasis that is critical to the company's future.

It's potentially "a game changer," said investment banker Alexsander Stewart, a managing director with Stifel Nicolaus Weisel's transportation and logistics team, when asked about the Kiva deal.

Over the past decade, Amazon has moved from strictly retail to both selling goods and then executing the orders, for itself and for third parties. "Amazon, as much as people like to think of it as an e-commerce provider, is becoming a direct-to-consumer fulfillment company," Unger said.

That requires huge investments in, for lack of a better word, infrastructure. Kiva Systems aids in that change with powerful technology that accelerates fulfillment and cuts physical order completion time by as much as half. That makes warehousing and delivery, areas in which Amazon already excels, more cost effective.

"Amazon wants to control all facets of the supply chain," said Jason Bass, who co-heads Harris Williams & Co.'s transportation and logistics group.

Kiva turns traditional fulfillment -- sometimes known colloquially as pick, pack and ship -- on its head. Instead of pickers wandering warehouses in search of items, the humans position themselves at workstations and let the robots do the darting and dashing. The robots grab not the goods, but stackable trays containing the goods. All that removes the need for permanent, steel racks and conveyor belts, the mainstay of warehouses for the past half-century.

Kiva, Unger said, introduces "disruptive technology" into that process.

Excelling at fulfillment is essential because retailing, even without costly storefront real estate, operates with razor-thin margins. Amazon's operating margin is a scant 1.17%, which is lower than competitors, said Leslie Hand, research director at IDC Retail Insights. But Amazon has a high return on equity, Hand continued. This comes, she said "from an efficient use of assets and very low investments in inventory compared to other retailers."

Logistics analysts see the Kiva acquisition in tandem with Amazon's current, multibillion-dollar warehouse construction program. This represents a reversal of the move a decade back when Amazon built a few, mammoth, centralized fulfillment centers. Now, Amazon is building smaller warehouses throughout the United States. (Small is relative. A new facility can stretch over one million square feet, cost more than $100 million and employ more than 1,000 workers.)

All this is aimed at the Holy Grail for Amazon and competing retailers: same-day delivery.

"Amazon as a fulfillment center is in a unique position," said Hand, who follows retail supply chain companies. With the acquisition of Kiva, "they become the model for fast, unit-level picking."

While poles apart in emphasis, Amazon's acquisitions of Kiva and Zappos are linked in applicability. Zappos is one of the first operations to employ Kiva robots on a large-scale basis. In effect, Zappos provided proof of concept for Amazon.com.

Some analysts believe Amazon acquired Kiva to insure someone else, such as uber-retailer Wal-Mart Stores Inc., didn't. Debate about whether the acquisition represents a defensive move has been replaced by how proprietary Amazon will be: Will Amazon prevent retail competitors from buying Kiva robots? There's no consensus. Amazon has denied that it plans to shut off sales to others, and Kiva continues to sell to third parties. However, as Unger points out, "despite what they publicly say, [Amazon's] own utilization is probably going to absorb the vast majority of what's coming out of Kiva's production capabilities for the foreseeable future."

What is apparent is that Kiva's success has excited those developing and producing next-generation industrial robots and spurred the venture capital necessary to sustain that development. In the U.S., that community is based largely around Greater Boston, where Kiva operates from the small town of North Reading, Mass.

Whether the Kiva deal signifies a change in Amazon's overall acquisition strategy is a matter of some debate. Rice, for one, believes Amazon.com may still use acquisitions to add to specific niche offerings to its e-commerce menu. One possibility, the analyst suggested, is in luxury goods.

Speculation these days is trained on geographic expansion as well. In mid-October, rumors surfaced that Amazon was in talks to acquire the Brazilian bookseller and publisher Saraiva SA Livreiros Editores. Saraiva said in a securities filing that there was nothing material to report on a deal but that it was open to opportunities.

Amazon has turned to acquisitions in the past to further its international reach. Notably, Amazon invested in the European online film rental operation, Lovefilm International Ltd., in 2008. It bought out other shareholders in early 2011, a deal that valued the company at $320 million.

Those following the company agree on this: The company will continue to invest in technology aimed, in Hand's words, at "serving the customer better and at a lower cost of operations."

Said Unger: "They've created, arguably, the most sophisticated direct-to-consumer channel in the world. That will be something that will be incredibly difficult to disrupt in the future."

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