Well, hi everyone. Well, we are ready to progress further in our understanding of channel strategy, and today, we're kicking off a new section, Part 2 of answering the question of, what our route to market should be? We have said that the first step is to ask, how do our customers want to buy? We said that was the demand side of the channel strategy equation. But now the question to ask is, what channel activities do we need? We'll be answering this question over the next few sessions, starting first with the concept of channel functions, so stay tuned. Channel functions are the activities and processes that must occur in order to produce the channel benefits the customers demand. Now at one level, you can think of the channel system as a benefit delivery mechanism, as not just the firm. The functions and flows and the machinery by which those benefits are created and delivered. Remember the first day of class, we said that channel members provide value added functions and processes to products. These are activities that the channel captain or producers don't want to do such as movements of products, educate customers, or customize solutions for them. The functions are of huge economic importance because they are monetizable. Intermediaries make huge chunks of change simply for performing functions that other firms do not want to do. One of the most pervasive functions that you'll often hear about is something called ''Pick, Pack, and Ship.'' Here's short video about it. Heinz ketchup, Beats headphones, the bagel biter original [inaudible] bagel slicers, every product sold by Amazon starts it's journey the same way in assimilable loading dock of a massive loading center. Inside, an army of workers unload the boxes and scan each item. While there's automation everywhere, this is largely a job performed by people, not robots. A team of workers could store or stash the items, well, anywhere, no rhyme or reason. Products are stored in the first empty space, it makes for unusual bedfellows, Hello Kitty, next of vans sneakers, and Alpine speakers. The location is all tracked by complex software, and as soon as something is sold, another worker, a picker, gets a notification on a wireless device, almost like a GPS. The everything kids, giant books of jokes, riddles and brain teasers is picked from the shelf, and sent packing. Software selects just the right box, even cutting off just enough tape to seal the box. Finished orders are stamped and labeled on a fast moving conveyer belt, and they zip down a complicated series of slides, routing the box to the right truck where another set of workers packs the truck in an impossible tedious like task, squeezing in as many boxes as possible before this truck heads to its destination. Store, Pick, Pack and Ship, an incredible architecture, the likes of which business has never seen before. Now, there are endless forms of channel functions, and of course, when you talk about them within your firm, you need to be specific about what they are. It's also important to realize that flows and functions may occur at multiple levels of the channel system. They might be aggregated together or dis-aggregated, and they can reside either outside the firm, although occasionally, they are vertically integrated and done by the supplier firm itself or the channel captain. The question for you now is, what firm collects more channel functions and flows than anyone else? The answer is Amazon. They're mastered understanding how the translate channel benefits into vital functions that are valued. Here's some examples. Consider consumer packaged goods, how many of you were aware that just a few years ago, the purchase of household staples such as paper towels and other products, trash bags and cleaners, represented only two percent of online sales. But that two percent was worth $16 billion, and it grew by about 25 percent per year, and it's now, well, over $32 billion annually. Well, in order to accommodate this, one of the things that Amazon did was to set up shop in Procter and Gamble warehouses. Each day, P&G would load palettes and pass them to Amazon inside a small fenced-off area. Amazon employees would then package, label, and ship the items directly to the people who ordered them. Well, this little approach that Amazon is quietly doing with a number of key suppliers as it tries to capture the next big frontier of household goods through Internet sales. In this situation, P&G is performing the functions of holding it owning inventory, but Amazon is executing important functions such as merchandising, and the pick, pack, and ship into packages that contain the product variety and the assortments the customers want to purchase. This is how they've been able to offer programs such as their new Prime Pantry offering. Check this out. Sometimes it's hard to keep up with everyday life. Keeping your home and pantry stocked can be difficult. Some things in life are more important. Introducing Prime Pantry, a new way to shop on Amazon. Purchase everyday essentials in everyday sizes from the convenience of your home. Shopping at Prime Pantry is easy, select items and fill your box with everyday essentials in everyday sizes. Save time, save money, and never miss a beat. Now you can imagine that Amazon's competition is not really crazy about their cozy arrangement with P&G. But this is a valuable strategic partnership. You might ruffle feathers, but you both make a bunch more money than you would have alone. Another thing that Amazon did was to partner with the United States Postal Service in order to create seven-day delivery. We might not be aware of this, but the United States Postal Service has always been capable of seven-day delivery. Personnel were always employed to do so and the resources were in place. But since no one ever asked them to do this, they didn't. So when Amazon discovered that they could, then Amazon offered the Postal Service a deal. Now, why does this matter to Amazon? Because it turns out that prime customers buy two times more than the customers who opt for free shipping. In other words, prime customers are a goldmine. Now think about what this arrangement does. By taking over Sunday deliveries for Amazon, the United States Postal Service now enables customers in select markets to get their products faster. By holding the inventory, Amazon is able to reduce it's storage costs for items shipped on Sunday and of course, they are the beneficiaries of being able to be the first to advertise this new delivery offering. Here's another example. Do you realize that the largest bulk of Amazon's income is not produced by its retailing activities. Instead, it comes from their Cloud hosting activities. Now that's a function holding the CIA's data and not have anyone else who was willing to pay for it has become their top source of revenue. It's a channel function. Now all of this raises an interesting question of what is Amazon? Is it a global infrastructure firm? Is it a retailer, a distributor, a shipper? Do you know the sales of third-party goods on its site are greater than sales of its own goods? In fact, since Amazon's marginal costs to servicing sales are small and they use existing infrastructure, their margins are higher than on sales of its own goods. So as Amazon claims more third party sellers, customers, and sales, it creates leverage over shippers like the United States Postal Service, and UPS, and FedEx. So you see this is why I call Amazon, a master at collecting and monetizing channel functions. From the inside, Amazon doesn't see what it does is a channel function strategy. Culturally, it is a VC hotbed. Employees pitch and defend novel ideas and innovation and those that hold up to their due diligence are given millions of dollars and a time frame in which to do it. That's their strategy from the inside. But I wanted you to notice how whether knowingly or not, channel dynamics, that is the organization and management of functions and flows are what is essentially driving Amazon's activities. which in turn drives its enormous valuation in its revenues. Wait, let me do that again. They understand that channel benefits are being created and that these should be monetized. This is why analysts have also concluded the following, that Amazon is in a race to embed itself into the fabric of worldwide commerce in a way that would make it indispensable to everyone's shopping habits and to do so before its rivals wise up to its plan. So don't be fooled by people who say stupid things like, "Will they ever make money?" They make tons of money. They just pour it back into R&D.
