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The Hidden Metric That Allows Amazon to Dominate Online Retail

Adam Levy, The Motley Fool

It's been well publicized how much Amazon.com (NASDAQ: AMZN) dominates online retail traffic. About half of all online product searches in the United States begin on Amazon's website. Amazon took 54% of general merchandise online shopping traffic in the country during the first two months of 2018, according to a recent survey from SimilarWeb.

But traffic is just half the story.

Traffic in and of itself isn't worth much. All of those viewers have to turn into paying customers. And surprise surprise, Amazon leads the field in that regard as well.

Amazon is able to convert its visitors at nearly twice the rate of its biggest rival, Walmart (NYSE: WMT), and at more than 2.5 times the rate of Target (NYSE: TGT). Even Costco (NASDAQ: COST), which fosters more loyal shoppers through its warehouse membership, struggles to convert traffic at a rate even close to Amazon.com's.

Retailer

Conversion Rate

Amazon.com

8.3%

Costco.com

4.9%

Walmart.com

4.3%

Target.com

3.1%

Data source: SimilarWeb. Table source: Author.

That's a major advantage for Amazon in online retail, so it's worth understanding how Amazon drives such a high conversion rate -- and whether the competition can match it.

"Free" shipping plus product selection equal checkout

Amazon has figured out a way to charge customers for free shipping. Management calls it "Amazon Prime." Ever heard of it?

Some 90 million U.S. households pay for Amazon Prime, which includes unlimited 2-day shipping among other benefits. At the beginning of this year, Amazon announced it had 100 million Prime-eligible items on its marketplace. That combination of fast and "free" shipping and broad product selection makes it easy for customers to find exactly what they're looking for and not worry about hidden costs.

A line of Amazon boxes getting loaded onto an Amazon cargo plane.

Image source: Amazon.

Walmart introduced free 2-day shipping on orders over $35 at the beginning of 2017, but only a couple million items are eligible for the service. Likewise, Target recently introduced free 2-day shipping with no order minimums for its REDcard holders, but the offer only applies to "hundreds of thousands" of items.

A customer who sees a sticker price on the item page but realizes they'll have to pay more for shipping is more likely to abandon their shopping cart. The number of Prime-eligible items on Amazon means more people are adding items to their carts, and the "free" shipping makes it easy to convert those sales.

Can the competition catch Amazon?

Amazon's 90 million Prime members probably aren't going anywhere. When Walmart and others have tried to establish similar programs in the past, they failed. Costco has managed to build up a significant membership of 50 million households paying $60 or $120 per year, but that's largely used to subsidize its lower retail pricing, not for shipping expenses.

If a retailer is going to compete with Amazon's fast and free shipping selection, it's going to have to build out a fulfillment network like Amazon's without the benefit of an additional source of revenue. Efforts to use stores as a way to improve shipping speeds are limited by the fact that retail locations often carry the same limited inventory while overlapping each other geographically, creating a major inefficiency.

Walmart is best positioned after shuttering 63 Sam's Club locations earlier this year. The company will convert some of those into fulfillment centers.

Ultimately, though, competing retailers are limited by their inability to match the Fulfillment by Amazon (FBA) program. The majority of Amazon sales actually come from third-party merchants, but Amazon handles the storage and shipping for their products through its FBA program. Third-party merchants on Walmart.com, for example, are in charge of storing and shipping their own inventory, which can limit its appeal and raise overall prices for customers.

Fulfillment by Amazon is reinforced by the growth of Prime, which incentivizes merchants to make their products Prime eligible. FBA is the easiest way to do that. As such, Amazon's Prime-eligible product selection continues to grow while other retailers can only offer fast and free shipping on a small selection of products they sell themselves.

As long as that's the case, Amazon's conversion rate on its traffic will remain significantly higher than the competition. And very few competitors can offer anything similar.

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John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Adam Levy owns shares of Amazon. The Motley Fool owns shares of and recommends Amazon. The Motley Fool recommends Costco Wholesale. The Motley Fool has a disclosure policy.