(32 min) Before, the monopoly was in production, but now it is in ranking a huge supply.
Need a word for Power through Network Effects, even though there are alternatives
People would see and react if you were a monopoly that jacked up the price of oil, but if you are Google and Amazon, you could reduce someone’s ranking and only a minority will notice.
Antitrust was designed to deal with scarcity, but that makes current antitrust that deals with abundance worse.
(57 min) What’s good for the goose is good for the gander. If Silicon Valley wants net neutrality, they should be open to regulation too.
This episode surprised us; through a discussion of who is at fault in the latest series of new vs old-world spats, we realized that not only has the Internet fundamentally changed winners-and-losers, but also the very nature of economic competition and the type of regulation that is required.
The e-commerce giant overcame internal dissent from engineers and lawyers, people familiar with the move say
Amazon.comInc.AMZN -1.87% has adjusted its product-search system to more prominently feature listings that are more profitable for the company, said people who worked on the project—a move, contested internally, that could favor Amazon’s own brands.
Late last year, these people said, Amazon optimized the secret algorithm that ranks listings so that instead of showing customers mainly the most-relevant and best-selling listings when they search—as it had for more than a decade—the site also gives a boost to items that are more profitable for the company.
The adjustment, which the world’s biggest online retailer hasn’t publicized, followed a yearslong battle between executives who run Amazon’s retail businesses in Seattle andthe company’s search team, dubbed A9, in Palo Alto, Calif., which opposed the move, the people said.
Any tweak to Amazon’s search system has broad implications because the giant’s rankings can make or break a product. The site’s search bar is the most common way for U.S. shoppers to find items online, and most purchases stem from the first page of search results, according to marketing analytics firm Jumpshot.
Top Billing
When people search for products on Amazon*, nearly two-thirds of all product clicks come from the first page of results…
Row 1
2
3
4
5
6
7
8
First page
Other pages
0
20
40
60%
…so the proliferation of Amazon’s private-label products on the first page makes it more likely people choose those items.
Search for ‘men’s button down shirts’
Search for ‘paper towels’
Amazon private- label products
Sponsored content
*Based on a study in 2018 of anonymous consumer actions on mobile and desktop devices
Note: Product searches conducted Aug. 28
Source: Jumpshot
Angela Calderon/THE WALL STREET JOURNAL
The issue is particularly sensitive because the U.S. and the European Union are examining Amazon’s dual role—as marketplace operator and seller of its own branded products. An algorithm skewed toward profitability could steer customers toward thousands of Amazon’s in-house products that deliver higher profit margins than competing listings on the site.
Amazon’s lawyers rejected an initial proposal for how to add profit directly into the algorithm, saying it represented a change that could create trouble with antitrust regulators, one of the people familiar with the project said.
The Amazon search team’s view was that the profitability push violated the company’s principle of doing what is best for the customer, the people familiar with the project said. “This was definitely not a popular project,” said one. “The search engine should look for relevant items, not for more profitable items.”
Amazon CEO Jeff Bezos has propounded a ‘customer obsession’ mantra.PHOTO: JIM WATSON/AFP/GETTY IMAGES
Amazon said it has for many years considered long-term profitability and does look at the impact of it when deploying an algorithm. “We have not changed the criteria we use to rank search results to include profitability,” said Amazon spokeswoman Angie Newman in an emailed statement.
Amazon declined to say why A9 engineers considered the profitability emphasis to be a significant change to the algorithm, and it declined to discuss the inner workings of its algorithm or the internal discussions involving the algorithm, including the qualms of the company’s lawyers.
The change could alsoboost brand-name products or third-party listings on the site that might be more profitable than Amazon’s products. And the algorithm still also stresses longstanding metrics such as unit sales. The people who worked on the project said they didn’t know how much the change has helped Amazon’s own brands.
Amazon’s Ms. Newman said: “Amazon designs its shopping and discovery experience to feature the products customers will want, regardless of whether they are our own brands or products offered by our selling partners.”
Antitrust regulators for decades have focused on whether companies use market power to squeeze out competition. Amazon avoided scrutiny partly because its competitive marketplace of merchants drives down prices.
Profit Center
A majority of Amazon’s sales come from retail, but a majority of its operating profits come from its cloud-computing unit.
Retail, subscriptions,
advertising and services
Amazon Web
Services
Percentage of total sales
86.9%
13.1%
Retail sales and
commissions: 75%
Percentage of operating income
42.1%
57.9%
Note: First half of 2019; Amazon doesn’t break out operating income for retail.
Source: the company
Now, some lawmakers are calling for Washington to rethink antitrust law to account for big technology companies’ clout. In Amazon’s case, they say it can bend its dominant platform to favor its own products. Sen. Elizabeth Warren (D., Mass.) has argued Amazon stifles small businesses by unfairly promoting its private-label products and underpricing competitors. Amazon has disputed this claim.
Amazon says it operates in fiercely competitive markets, it represents less than 1% of global retail and its private-label business represents about 1% of its retail sales.
An account of Amazon’s search-system adjustment emerges from interviews with people familiar with the internal discussions, including some who worked on the project, as well as former executives familiar with Amazon’s private-label business.
SHARE YOUR THOUGHTS
When you search for products on Amazon, how should it determine what listings to show? Join the conversation below.
The A9 team—named for the “A” in “Algorithms” plus its nine other letters—controls the all-important search and ranking functions on Amazon’s site. Like other technology giants, Amazon keeps its algorithm a closely guarded secret, even internally, for competitive reasons and to prevent sellers from gaming the system.
Customers often believe that search algorithms are neutral and objective, and that results from their queries are the most relevant listings.
Executives from Amazon’s retail divisions have frequently pressured the engineers at A9 to surface their products higher in search results, people familiar with the discussions said. Amazon’s retail teams not only oversee its own branded products but also its wholesale vendors and vast marketplace of third-party sellers.
Amazon’s private-label team in particular had for several years asked A9 to juice sales of Amazon’s in-house products, some of these people said. The company sells over 10,000 products under its own brands, according to research firm Marketplace Pulse, ranging from everyday goods such as AmazonBasics batteries and Presto paper towels, to clothing such as Lark & Ro dresses.
Inside an Amazon fulfillment center.PHOTO: KRISZTIAN BOCSI/BLOOMBERG NEWS
Amazon’s private-label business, at about 1% of retail sales, would represent less than $2 billion in 2018. Investment firm SunTrust Robinson Humphrey estimates the private-label business will post $31 billion in sales by 2022, more than Macy’sInc. ’s annual revenue last year.
The private-label executives argued Amazon should promote its own items in search results, these people said. They pointed to grocery-store chains and drugstores that showcase their private-label products alongside national brands and promote them in-store.
One former Amazon search executive said: “We fought tooth and nail with those guys, because of course they wanted preferential treatment in search.”
For years, A9 had operated independently from the retail operations, reporting to its own CEO. But the search team, in Silicon Valley about a two-hour flight from Seattle, now reports to retail chief Doug Herrington and his boss Jeff Wilke —effectively leaving search to answer to retail.
After the Journal’s inquiries, Amazon took down its A9 website, which had stood for about a decade and a half. The site included the statement: “One of A9’s tenets is that relevance is in the eye of the customer and we strive to get the best results for our users.”
Mr. Herrington’s retail team lobbied for the adjustment to Amazon’s search algorithm that led to emphasizing profitability, some of the people familiar with the discussions said.
When a customer enters a search query for a product on Amazon, the system scours all listings for such an item and considers more than 100 variables—some Amazon engineers call them “features.” These variables might include shipping speed, how highly buyers have ranked product listings and recent sales volumes of specific listings. The algorithm weighs those variables while calculating which listings to present the customer and in which order.
Nate Sutton, an Amazon associate general counsel, at a House Judiciary Subcommittee hearing on antitrust in July.PHOTO: ANDREW HARRER/BLOOMBERG NEWS
The algorithm had long placed a priority on variables such as unit sales—a proxy for popularity—and search-term relevance, because they tend to predict customer satisfaction. A listing’s profitability to Amazon has never been one of these variables.
Profit metric
Amazon retail executives, especially those in its private-label business, wanted to add a new variable for what the company calls “contribution profit,” considered a better measure of a product’s profitability because it factors in non-fixed expenses such as shipping and advertising, leaving the amount left over to cover Amazon’s fixed costs, said people familiar with the discussion.
Amazon’s private-label products are designed to be more profitable than competing items, said people familiar with the business, because the company controls the manufacturing and distribution and cuts out intermediaries and marketing costs.
Amazon’s lawyers rejected the overt addition of contribution profit into the algorithm, pointing to a €2.42 billion fine ($2.7 billion at the time) that Alphabet Inc.’s Google received in 2017 from European regulators who found it used its search engine to stack the deck in favor of its comparison-shopping service, said one of the people familiar with the discussions. Google has appealed the fine and has made changes to Google Shopping in response to the European Commission’s order.
To assuage the lawyers’ concerns, Amazon executives looked at ways to account for profitability without adding it directly to the algorithm. They turned to the metrics Amazon uses to test the algorithm’s success in reaching certain business objectives, said the people who worked on the project.
When engineers test new variables in the algorithm, Amazon gauges the results against a handful of metrics. Among these metrics: unit sales of listings and the dollar value of orders for listings. Positive results for the metrics correlated with high customer satisfaction and helped determine the ranking of listings a search presented to the customer.
Now, engineers would need to consider another metric—improving profitability—said the people who worked on the project. Variables added to the algorithm would essentially become what one of these people called “proxies” for profit: The variables would correlate with improved profitability for Amazon, but an outside observer might not be able to tell that. The variables could also inherently be good for the customer.
Money Flow
Amazon commands more than one-third of U.S. retail dollars spent online.
Share of 2018 online retail sales
Amazon
36.5%
eBay
6.9%
Walmart
4.0%
Apple
3.9%
The Home Depot
1.6%
Source: eMarketer
For the algorithm to understand what was most profitable for Amazon, the engineers had to import data on contribution profit for all items sold, these people said. The laborious process meant extracting shipping information from Amazon warehouses to calculate contribution profit.
In an internal system called Weblab, A9 engineers tested proposed variables for the algorithm for weeks on a subset of Amazon shoppers and compared the impact on contribution profit, unit sales and a few other metrics against a control group, these people said. When comparing the results of the groups, profitability now appeared alongside other metrics on a display called the “dashboard.”
Amazon’s A9 team has since added new variables that have resulted in search results that scored higher on the profitability metric during testing, said a person involved in the effort, who declined to say what those new variables were. New variables would also have to improve Amazon’s other metrics, such as unit sales.
A review committee that approves all additions to the algorithm has sent engineers back if their proposed variable produces search results with a lower score on the profitability metric, this person said. “You are making an incentive system for engineers to build features that directly or indirectly improve profitability,” the person said. “And that’s not a good thing.”
An Amazon warehouse in Mexico in July.PHOTO: CARLOS JASSO/REUTERS
Amazon said it doesn’t automatically shelve improvements that aren’t profitable. It said, as an example, that it recently improved the discoverability of items that could be delivered the same day even though it hurt profitability.
Amazon’s Ms. Newman said: “When we test any new features, including search features, we look at a number of metrics, including long term profitability, to see how these new features impact the customer experience and our business as any rational store would, but we do not make decisions based on that one metric.”
In some ways, Amazon’s broader shift from showing relevant search results is noticeable on the site. Last summer, it changed the default sorting option—without publicizing the move—to “featured” after ranking the search results for years by “relevance,” according to a Journal analysis for this article of screenshots and postings by users online. Relevance is no longer an option in the small “sort by” drop-down button on the top right of the page.
Tokyo emerges as surprise international front-runner for world’s largest listing
Saudi Arabian Oil Co. is considering a plan to split the world’s largest IPO into two stages, debuting a portion of its shares on the Saudi stock exchange later this year, and following up with an international offering in 2020 or 2021, according to people familiar with the plans.
The company is leaning toward Tokyo as the venue for the second phase of its proposed plan, the advisers and officials said, as political uncertainty in the U.K. and China reduces the appeal of London and Hong Kong’s markets.
Saudi Arabia’s state oil giant, also known as Aramco, revived plans to sell 5% of its stock in an initial public offering earlier this monthaimed at funding Saudi Arabia’s efforts to diversify its economy beyond oil.
With earnings of $111 billion in 2018, Aramco is the world’s most profitable business, outstripping juggernauts such as Apple Inc. and Exxon Mobil Corp. But the company has seen many twists and turns on the road toward its IPO. Aramco and its advisers drew up for a potential listing in 2018, but the offering never materialized.
Everything from the fundraising amount, to the valuation of the company, to the venue for the listing, has been hotly debated, according to people involved in the discussions. The company had initially targeted raising $100 billion, but it remains unclear what the final number will be.
The outcry that followed the murder of Saudi journalistJamal Khashoggi last October also complicated plans to attract investors, according to people familiar with the matter.
According to one plan under consideration, the company could seek to raise as much as $50 billion in a domestic listing, one person said. Both domestic and international investors would have access to the stock in a domestic listing.
If Aramco and its advisers choose Tokyo as the setting for the international offering, it would be a disappointment for London and Hong Kong, which were initially seen as the most likely locations for the listing. Both locales were considered politically safer than the U.S., but are now less likely, the people said.
Saudi Crown Prince Mohammed bin Salman has pushed for an IPO in New York as a way to deepen Saudi ties with President Trump. But Aramco Chairman Khalid al-Falih has opposed the U.S. option over concerns that Saudi assets could be targeted by terrorism-related lawsuits. The Justice Against Sponsors of Terrorism Act, passed in 2016, allows terror victims’ families to sue foreign countries for compensation.
The company could invite antitrust litigation if it were to list there due to its membership in the Organization of the Petroleum Exporting Countries and the cartel’s efforts to control oil production and prices. Aramco identified the risk of such litigation in its bond-offering prospectus.
London, which has lobbied Saudi Arabia to host the IPO, was seen as a favorite when Prince Mohammed visited the U.K. last year. But the Aramco advisers and Saudi officials said they were increasingly concerned about the regulatory uncertainty that could arise from the U.K.’s plan to leave the European Union on Oct. 31.
On Wednesday, U.K. Prime Minister Boris Johnson moved to shut down Parliament for several weeks, a tactic aimed at preventing opposition lawmakers from blocking the U.K. from exiting the EU without a deal.
An Aramco adviser said leaving without an agreement increased the chances that the U.K. would align its legislation with the U.S.—including the terrorism laws that have been an impediment to a New York listing.
Meanwhile, Hong Kong has beenrattled by protesters who have fierce objections to a bill that would have allowed extradition of criminal suspects to China. The demonstrations have evolved into a broader pro-democracy movement and disrupted business and travel.
Aramco’s press office said the “company continues to engage with the shareholder on IPO readiness activities.” It “is ready and timing will depend on market conditions and be at a time of the shareholder’s choosing,” it said in an email comment.
The Saudi officials and Aramco advisers said no final decision has been made about where, or when, any listings would take place and all options remained open. Still, officials said they were leaning toward a listing on the Tokyo exchange.
A spokeswoman for the London Stock Exchange declined to comment. The Hong Kong bourse didn’t respond to a request for comment.
A spokesman at Japan Exchange Group Inc., which operates the Tokyo Stock Exchange, said Thursday, “there has been no change in the status [of a potential Aramco IPO] so far. But there has been no change in our attitude that we would like the company to come to the TSE.”
Japan Exchange Group’s Chief Executive Akira Kiyota has repeatedly expressed his eagerness to have Aramco listed in Tokyo. And in June, Saudi Arabia, which supplies about a third of Japan’s oil, mentioned “cooperation in the IPO of Aramco” in an outline for economic partnership with Japan.
The Tokyo exchange has attracted some of the world’s largest IPOs, including last year’s nearly $24 billion issue by SoftBank Group Corp’s mobile phone unit. It was the world’s second largest IPO after China’s Alibaba Group Holding Ltd. listing in 2014, and showed that the exchange can manage big debuts and serve a large pool of investors.
Aramco’s interest in pursuing a local listing emerged as the company has discussed with bankers the possibility of launching the IPO before the end of this year, and asked about the valuation Aramco might expect with a domestic-only offering, according to people familiar with the matter.
Prince Mohammed is looking to value Aramco at $2 trillion. Bankers and other Saudi officials say they believe a range of between $1.2 trillion and $1.5 trillion is more realistic.
The sale of a smaller amount through the domestic offering could bring Aramco closer to the crown prince’s goal by making it easier to ensure investors’ demand for the available shares exceeds supply, which would drive up the company’s ultimate valuation, some bankers suggested. In turn that valuation would set the floor for a subsequent listing on an international exchange in 2020.
Alternatively, Aramco could try to sell a stake to a so-called cornerstone investor such as a sovereign-wealth fund at the target valuation—ahead of the IPO, to establish a precedent, one banker said.
Cutting interest rates now could set the stage for a collapse in the financial markets.
To widespread applause in the markets and the news media, from conservatives and liberals alike, the Federal Reserve appears poised to cut interest rates for the first time since the global financial crisis a decade ago. Adjusted for inflation, the Fed’s benchmark rate is now just half a percent and the cost of borrowing has rarely been closer to free, but the clamor for more easy money keeps growing.
Everyone wants the recovery to last and more easy money seems like the obvious way to achieve that goal. With trade wars threatening the global economy, Federal Reserve officials say rate cuts are needed to keep the slowdown from spilling into the United States, and to prevent doggedly low inflation from sliding into outright deflation.
Few words are more dreaded among economists than “deflation.” For centuries, deflation was a common and mostly benign phenomenon, with prices falling because of technological innovations that lowered the cost of producing and distributing goods. But the widespread deflation of the 1930s and the more recent experience of Japan have given the word a uniquely bad name.
After Japan’s housing and stock market bubbles burst in the early 1990s, demand fell and prices started to decline, as heavily indebted consumers began to delay purchases of everything from TV sets to cars, waiting for prices to fall further. The economy slowed to a crawl. Hoping to jar consumers into spending again, the central bank pumped money into the economy, but to no avail. Critics said Japan took action too gradually, and so its economy remained stuck in a deflationary trap for years.
Many Western economies appeared to face a similar threat following the global financial crisis of 2008. Since then, led by the Fed, central banks have responded aggressively to every hint of a downturn, making money ever cheaper and more plentiful to try to juice growth.
Yet, in this expansion, the United States economy has grown at half the pace of the postwar recoveries. Inflation has failed to rise to the Fed’s target of a sustained 2 percent. Meanwhile, every new hint of easy money inspires fresh optimism in the financial markets, which have swollen to three times the size of the real economy.
In this environment, cutting rates could hasten exactly the outcome that the Fed is trying to avoid. By further driving up the prices of stocks, bonds and real estate, and encouraging risky borrowing, more easy money could set the stage for a collapse in the financial markets. And that could be followed by an economic downturn and falling prices — much as in Japan in the 1990s. The more expensive these financial assets become, the more precarious the situation, and the more difficult it will be to defuse without setting off a downturn.
The key lesson from Japan was that central banks can print all the money they want, but can’t dictate where it will go. Easy credit could not force over-indebted Japanese consumers to borrow and spend, and much of it ended up going to waste, financing “bridges to nowhere” and the rise of debt-laden “zombie companies” that still weigh on the economy.
Today, politicians on the right and left have come to embrace easy money, each camp for its own reasons, both ignoring the risks. President Trump has been pushing the Fed for a large rate cut to help him bring back the postwar miracle growth rates of 3 percent to 4 percent.
But much as in Japan two decades ago, an aging population and falling productivity have sapped the capacity of the American economy to sustain its previous pace. According to the Congressional Budget Office, the economy’s growth potential has fallen by half from its postwar average to less than 2 percent now. With the domestic economy already growing a bit above that pace, injecting more easy money into the engine won’t make it run much faster, particularly not after 10 years of trying.
At the same time, liberals like Bernie Sanders and Alexandria Ocasio-Cortez are turning to unconventional easy money theories as a way to pay for ambitious social programs. But they might want to take a closer look at who has benefited most after a decade of easy money: the wealthy, monopolies, corporate debtors. Not exactly liberal causes.
By fueling a record bull run in the financial markets, easy money is increasing inequality, since the wealthy own the bulk of stocks and bonds. Research also shows that very low interest rates have helped large corporations increase their dominance across United States industries, squeezing out small companies and start-ups. Once seen as a threat only in Japan,zombie firms — which don’t earn enough profit to cover their interest payments — have been rising in the United States, where they account for one in six publicly traded companies.
All these creatures of easy credit erode the economy’s long-term growth potential by undermining productivity, and raise the risk of a global recession emanating from debt-soaked financial and housing markets. A 2015 study of 17 major economies showed that before World War II, about one in four recessions followed a collapse in stock or home prices (or both). Since the war, that number has jumped to roughly two out of three, including the economic meltdowns in Japan after 1990, Asia after 1998 and the world after 2008.
Recessions tend to be longer and deeper when the preceding boom was fueled by borrowing, because after the boom goes bust, flattened debtors struggle for years to dig out from under their loans. And lately, easy money has been enabling debt binges all over the world, particularly in corporate sectors.
As the Fed prepares to announce a decision this week, growing bipartisan support for a rate cut is fraught with irony. Slashing rates to avoid deflation made sense in the crisis atmosphere of 2008, and cutting again may seem like a logical response to weakening global growth now. But with the price of borrowing already so low, more easy money will raise a more serious threat.
By further lifting stock and bond prices and encouraging people to take on more debt, lowering rates could set the stage for the kind of debt-fueled market collapse that has preceded the economic downturns of recent decades. Our economy is hooked on easy money — and it is a dangerous addiction.
