Amazon’s pricing a trap for buyers and sellers

By Rana Foroohar for The Financial Times

As Amazon heads for a $1-trillion valuation, the company usually speaks softly and carries a big stick. CEO Jeff Bezos, the world’s richest man, has remained mostly silent as Donald Trump has accused his company of everything from tax evasion to gutting the US postal service.

But criticism from progressives such as Bernie Sanders is another story. Last week, Sanders said too many of the company’s workers are on public assistance, and he plans to introduce legislation to make big companies such as Amazon pay for offloading the cost of low wages to the state.

Amazon fired back in a blog post, saying the Vermont senator’s comments were “misleading”, and it encouraged employees to share their stories with him.

They should, because it would help open up the black box that is the online retailer.

The company is approaching the first anniversary of its HQ2 search, a highly publicised but opaque bake-off between cities seeking to host its second corporate headquarters. (Seattle, home to the first, cannot accommodate more growth, in part because housing prices have risen so much.)

Amazon says it plans to pick a city on the basis of metrics including the quality of infrastructure, human capital and transport. Yet it has rejected many cities that score well in such areas and required officials to sign nondisclosure agreements about the details of their bids.

The current short list seems to be heavy on locations with high-ranking US senators and those that included billions of dollars in tax credits and other subsidies in their bids.

Meanwhile, Amazon recently secured a very unusual procurement deal with American local governments. It will purchase all the office and classroom supplies for 1 500 public agencies, but will not have to guarantee them fixed prices for the goods. The purchasing will be done through “dynamic pricing”, in which the final charges depend on bids put forward by suppliers on Amazon’s platform.

It is a stunning corporate ju-jitsu, given that the whole point of a bulk purchasing contract is to guarantee the public sector competitive prices by bundling together demand.

While Amazon claims to offer discounts, a study conducted by the nonprofit Institute for Local Self-Reliance concluded that one California school district would have paid 10%-12% more if it had bought from Amazon. And cities that want to keep on using existing suppliers must move that business to Amazon.

This adds up to three things. First, companies such as Amazon, which can leverage data and the network effect to not only play in the market but become the market, are like the house in a Las Vegas casino. They always win.

Communities that offer subsidies to lure big headquarters may see positive headlines and short-term gains but the end result is almost always negative. One recent study found that 70% of such subsidies fall into the category of property tax breaks and job creation tax credits. The big companies pay less for their real estate, but human capital is undermined, because property taxes often fund schools in the US.

State and city business subsidies have tripled since the 1990s, which leads to a snowball effect — employers that demand skilled workers and good infrastructure are degrading the tax base that creates them.

Amazon’s HQ2 competition is taking place at a time when states are less prepared for an economic downturn than they have been in years: it is the wrong moment for local leaders to starve their tax coffers to enrich such a wealthy company.

Second, I see parallels in Amazon’s behaviour to the lending practices of some financial groups before the 2008 crash. They used dynamic pricing, in the form of variable rate subprime mortgage loans, and exploited huge information asymmetries in their sale of mortgage-backed securities and complex debt deals to unwary investors including cities such as Detroit.
Amazon, for its part, has vastly more market data than the suppliers and public sector purchasers it plans to link.

Indeed, I see more and more parallels between online groups and large financial institutions. They each sit in the centre of an hourglass of information and commerce, taking a cut of whatever passes through. Like a big investment bank, Amazon can both make a market and participate in it.

Such companies need systemic regulation to prevent them from unfairly capitalising on those advantages. Senator Mark Warner’s recent white paper on platform technology regulation points to “diseconomies of scale — negative externalities borne by users and society as a result of the size of these platforms”. The comparison reminds me of the moral hazard problem posed by the “too big to fail” banks.

Finally, Amazon’s behaviour suggests that its leaders are living in a cognitive bubble. The company will inevitably reach a deal with a desperate politician in one of the HQ2 bid cities. But old local political machines are dying. There is no guarantee that the new generation of progressive candidates that look likely to win in November’s midterm elections will be as friendly to big business.

Amazon has a big stick. But the one wielded by populists in years ahead may be bigger.

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