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Amazon's Most Overlooked Competitive Advantage


Image source: Amazon.

A lot of investors look at Amazon.com (NASDAQ: AMZN) and they see a company with unparalleled distribution capabilities or a market-leading cloud computing service. What I see, however, is the place people go to shop online.

While that might sound completely obvious, it's an advantage that's hard for competitors to overcome. Fifty-five percent of American online shoppers begin their product search on Amazon.com, according to a recent survey from BloomReach. I'm willing to bet a large percentage of shoppers end their product search on Amazon as well.

That influx of shoppers leads to more product creators and merchants wanting to get their products on the virtual shelves of Amazon so that their items show up in shoppers' product searches. That inimitable shopper behavior is at the core of one of Amazon's three pillars: its Fulfilled by Amazon program.

Can't be beat

Amazon is rapidly building out warehouses and distribution centers. Last quarter, it opened 18 new warehouses, and it's already opened five more this quarter. But even at this breakneck pace, it's competing with retailers that already have significant real estate footprints like Wal-Mart (NYSE: WMT) and Target (NYSE: TGT). Both have taken steps to utilize their stores' footprints more effectively for fulfilling online orders.

Where Target and Wal-Mart can't compete with Amazon is in driving traffic to their websites. Wal-Mart went out and bought Jet.com because it's been able to rack up significant interest in a short amount of time. Target has succumbed to offering loss-leading promotions like free shipping on all items during the holiday season to drive traffic. Meanwhile, Amazon increased its threshold for free shipping, a luxury afforded by its ability to attract shoppers.

A virtuous cycle

With the amount of traffic Amazon attracts, third-party merchants and manufacturers want to get their products on Amazon. Amazon has cultivated a huge marketplace with third-party merchants and presents it all seamlessly to its visitors. Many customers don't even know that about half the items sold on Amazon.com come from third-party merchants and are simply fulfilled by Amazon.

The Fulfilled by Amazon (FBA) program is one of the three pillars of Amazon's business, according to its management. (The other two are Amazon Web Services and Prime.) FBA allows merchants to send inventory to Amazon's warehouses, and Amazon takes care of sending individual shipments to customers. In return, it takes a fee. The program has been the main driver of Amazon's warehouse expansion efforts.

But as more and more merchants come to Amazon, more and more shoppers are able to find items that fit exactly what they're looking for at the price they want to pay. That, in turn, drives more merchants to the platform, because that's where all the shoppers are going. This virtuous cycle is what allows Amazon to continue growing its sales at a faster pace than Wal-Mart of Target, despite a significantly larger base.

About $0.20 of every $1 Amazon brings in from its North American marketplace comes from FBA merchants, according to estimates from R.W. Baird analysts. That number will continue to grow as more merchants come to the marketplace.

While Wal-Mart and other big-box retailers offer a marketplace for third-party merchants online, none offer the supply of shoppers that Amazon has. Growing an active shopper base is significantly more difficult than building out the infrastructure needed to store and ship all the items those shoppers are purchasing. That makes Amazon's shopper base one of its biggest, most obvious, but oft-overlooked competitive advantages.

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Adam Levy owns shares of Amazon.com. The Motley Fool owns shares of and recommends Amazon.com. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.