Amazon's digital empire spreads offline

Sep 16, 2012 by Amy Martinez

Amazon.com built its business for the digital age, but it's crossing over to the bricks-and-mortar world.

From self-serve pickup stations in 7-Eleven stores to grocery- rolling through Seattle neighborhoods, Amazon is expanding its physical footprint to make shopping online quicker and easier - if no longer tax-free.

Much of this expansion, in fact, appears driven by the diminishing tax advantages of keeping that footprint small. For years, Amazon carefully managed its to avoid triggering state requirements that it charge customers sales taxes.

Now, as Congress considers legislation that could bring an end to tax-free sales on the Internet, Amazon is going offline for ways to hook customers.

Amazon plans new distribution centers in California, Texas, New Jersey and elsewhere to be closer to major markets and deliver items the same day they're ordered.

It also is trying out new services that bridge the gap between e-commerce and bricks-and-mortar retailing, such as in-store lockers so that customers have another place besides work or home to pick up packages.

The world's largest Internet retailer even is rumored to be considering opening a first-ever Amazon store to sell e-readers and .

"They're not quite a brick-and-click, but they're moving quickly in that direction," said Jonathan Johnson, president of Internet-only retailer Overstock.com, using a term to describe store chains that sell online.

Amazon's "business model has changed so that they have a physical presence in many more states than they used to."

Amazon has announced plans to open at least eight new U.S. distribution centers this year, adding to the 34 it operated at the end of 2011.

Analysts say it is laying the groundwork for a broad rollout of same-day delivery, a service it already offers in 10 major .

Amazon Tom Szkutak told analysts in a July earnings call that the company had not figured out how to do same-day delivery "on a broad scale economically." But he suggested the build-out of Amazon's distribution network had contributed to lower shipping costs and faster deliveries.

"We're getting closer to customers," Szkutak said. "We have a lot of opportunity to improve that over time."

Analysts say an expansion of same-day delivery would take away one of the few remaining advantages traditional stores enjoy over Amazon: instant gratification.

"People now expect instant gratification, as opposed to waiting several days for their item to arrive in the mail, and they don't want to pay Federal Express prices for it to come overnight," said Suresh Kotha, a business professor at the University of Washington.

Moving toward faster delivery also would offset the popularity of competing services that let customers buy online and pick up their purchases in stores, said Michael Harvey, chief operating officer for New York-based e-commerce solutions company CorraTech.

"If I'm working away in my office and I want something later that night, I could place my order on Amazon and have it waiting for me when I get home," Harvey said. "I don't need a retail store."

Same-day delivery raises the possibility that Amazon will become an even more formidable threat to traditional retailers. At the same time, though, its new locker pickup service suggests it sees a benefit in working with some bricks-and-mortar businesses.

The service, being tested in London, New York, Seattle, Silicon Valley and Washington, D.C., lets customers pick up orders at self-serve stations in 7-Eleven stores and other locations. Amazon pays a small monthly fee to cover utilities costs.

"It opens up some interesting collaboration possibilities between Amazon and physical retailers," Harvey said. "Certainly, 7-Eleven loves it because everyone who walks into one of its stores to pick up a package from Amazon is going to buy gum and a Slurpee."

But the main reason Amazon may be trying out in-store delivery is to solve the "last-mile problem," a reference to the final, costly leg of getting online orders into people's hands.

Amazon could entice customers to use the service by offering discounts or freebies, such as same-day delivery at no extra charge, Harvey said.

"It's much easier for Amazon to pull off same-day delivery if they're stuffing things into lockers rather than going up people's porches," he said.

Amazon's physical expansion comes as more states try to levy sales taxes on online purchases.

The company long has benefited from a 1992 U.S. Supreme Court ruling that exempts Internet retailers from collecting sales taxes in states where they lack a physical presence.

One reason Amazon started in Seattle 18 years ago is that founder and CEO Jeff Bezos did not want to tax online purchases in more populous states, such as New York or California.

Amazon later built distribution centers in less populous states and operated them under separate legal entities to avoid tax liability. But its days of doing that appear numbered.

Led by Wal-Mart, traditional retailers mounted a campaign last year to end what they call Amazon's tax loophole, saying it gives the Internet giant an unfair price advantage of 5 to 10 percent over local merchants. State and local governments also came to see taxing online sales as a necessary revenue stream in a tough economy.

By 2014, Amazon will be required to collect sales taxes in 13 states representing half of the U.S. population.

At the beginning of the month, Pennsylvania became the seventh state to make Amazon charge for taxes, after Texas. California, the nation's most populous state, will add its name to the list Saturday.

Amazon, long known to play it close to the vest, declined to make Paul Misener, its Washington, D.C.-based vice president for global public policy, available for an interview.

Instead, the company released a statement downplaying the effects of new tax requirements on its business, noting it already taxes online purchases in more than half of the places where it operates, including Europe.

"We are pleased to say we are thriving in those geographies because Amazon offers low prices, vast selection and fast delivery," it said.

The most noticeable downside of tax collection for Amazon likely will be lower sales of big-ticket items, such as TVs and appliances, said analyst Atul Bagga of Lazard Capital Markets.

In a recent survey, Bagga's firm found that a fifth of online shoppers who live in Texas plan to buy fewer big-ticket items from Amazon now that taxes are part of the equation. Still, he said, survey participants ranked "no sales tax" behind convenience, selection, customer service, and low prices and shipping fees as reasons to shop on Amazon.

He believes Amazon is better off moving past the tax issue to expand its distribution network. By making room for more products, he said, it can improve on its selection and delivery times.

Perhaps it's no wonder that Amazon has split with its Internet peers to urge Congress to help states collect sales taxes from online purchases.

On Aug. 1, Steve Bercu, co-owner of BookPeople, an independent bookstore in Austin, Texas, joined Amazon's Misener at a hearing of the U.S. Senate Commerce Committee to support the Marketplace Fairness Act. The legislation would allow states to impose tax-collection requirements on businesses that generate more than $500,000 a year through online sales, even if they lack a local physical presence.

"Somehow, it seems cool that we're on the same side," Bercu recalls telling Misener as they took their seats next to each other.

But others are skeptical about the company's reasons for supporting federal e-fairness legislation.

Sen. Jim DeMint, R-S.C., suggested that Amazon's real aim is to ensure that if it no longer can enjoy a tax advantage, Internet-only sellers such as eBay and Overstock can't either.

"When you had no physical presence in other states, you tended to support the status quo," he said to Misener. "Now that you're going to have to pay taxes in all of these states where you have a physical presence, you want to come back and tax other companies that don't."

While store chains and mom-and-pops applaud the taxing of online sales as only fair, some wonder if they'll regret the moment when Amazon felt freed up to get more physical.

"There's an ambition at work here to ultimately displace a lot of physical stores," said e-commerce analyst Sucharita Mulpuru of Forrester Research in Cambridge, Mass.

But merchants say that's a chance they're willing to take. No matter how big Amazon might get, they say, they're eager to compete on a level tax field.

"If they're doing it by the rules, that's capitalism. I can't argue with it," said Hut Landon, executive director of the Northern California Independent Booksellers Association.

"We don't consider we beat Amazon by any stretch," he said. "They just got to the point where distribution was more important to them."

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