How to compete with Amazon

Updated: Oct 24, 2013 3:30 PM UTC

FORTUNE -- I’ve had Amazon on my mind lately, partly because I’m reading Brad Stone’s interesting book, The Everything Store: Jeff Bezos and the Age of Amazon.

I’ve described in earlier blog posts how Amazon (amzn) is a brutal competitor for brick and mortar merchants due to their large and growing cost advantages and a maniacal commitment (at least most of the time) to having the lowest prices anywhere. (You can read more about it here.) These same drivers also make Amazon a heavyweight competitor for e-commerce companies.

Much attention has been paid to the concept of “show-rooming” at brick and mortar stores, where customers use their smartphones to compare the cost of a product on a physical store’s shelf against online competitors -- typically Amazon. But immediate cost-comparison is a fact of life, online or off. Amazon is a monster competitor to online merchants as well.

Amazon enjoys economies of scale far beyond their online competition, and they can use that power to offer hyper-aggressive prices and fast, cheap shipping. Here is a simple illustration of their scale, using data from Internet Retailer:

Amazon is larger than the next dozen largest e-tailers -- COMBINED! Its resulting scale advantages are staggering. And they aggressively re-invest the benefits of this scale into even lower prices and faster, cheaper shipping that in turn lead to growth and further scale advantages. When we consider an e-commerce investment at a16z, we always strive to carefully evaluate the risk of competition from Amazon. They’re not just a heavyweight -- they’re the heavyweight champion of the world.

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So how do you compete with Amazon? Here are some strategies that we’re seeing in the market from both offline and online retailers. Not all are mutually exclusive -- i.e., many companies deploy multiple strategies:

Sell differentiated products

Amazon’s sales skew heavily towards “hard-lines,” things like media, electronics, home and garden, and toys. Most best-selling hard-line products are produced by large manufacturers that market them heavily and distribute them broadly through multiple retail channels. They are essentially commodities, identified by a standardized Universal Product Code (aka, U.P.C.). An example is a Canon digital camera; once Canon’s ads convince you that you might want a Canon camera, you know you can shop for it pretty much anywhere. And for most commodities, price is the key differentiator. Consumers know that Amazon almost always has the lowest prices, along with free and fast shipping.

Many retailers try to “hit ‘em where they ain’t” and sell in categories where Amazon is less dominant. Soft-line is one choice. While Amazon is trying to build up this business, they have not achieved anywhere near the dominance that they have on the hard-line side. Online companies like NastyGal and Zappos (before their acquisition by Amazon) and offline companies like Nordstrom (jwn) and Neiman Marcus have successfully pursued soft-line strategies and have managed to weather competition from Amazon. Home improvement retailers also have a shot, as products that “I need today” or bulky, heavy items are less suited to online distribution.

A related strategy is to feature products from companies that typically are not distributed or searched for on Amazon. a16z has two investments in companies that primarily sell goods from design firms that lack extensive national distribution. Zulily does this in kids’ and moms’ apparel, and Fab does this in design. These designers lack broad awareness, so users do not typically find these products when searching on Amazon.

Develop your own products

Many retailers compete with Amazon by developing their own products. These products can be largely insulated from direct price comparison as they are proprietary and the producing company can elect not to have them sold by other online retailers. A number of the best performing offline chains pursue this strategy, including Lululemon (lulu) and Victoria’s Secret. Online retailers like Chloe & Isabel in jewelry, Julep in cosmetics, ShoeDazzle in women’s shoes, and Poppin in office goods are pursuing this strategy as well (note: Andreessen Horowitz is an investor in Julep and ShoeDazzle).

While it’s clearly much more work to design and source your own products, retailers that do are often rewarded with higher gross margins as they both cut out expensive middlemen and avoid head-to-head price competition.

Merchandise product differently, at its core, is a search engine for products. They are strongest when consumers know pretty much exactly what they are looking for, and many consumers use Amazon’s ubiquitous search box. Merchandising on Amazon is almost completely algorithmic -- things like “others searching for ‘x’ also looked at ‘y’ and ‘z.’” I know of very few folks who browse Amazon in the traditional merchandising sense of the word.

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A number of companies are trying to compete with Amazon by building a great browse experience, showing consumers a targeted assortment of attractively displayed products. Offline retailers have done this through beautiful window displays and in-store end caps. And a new breed of online merchants is doing this, too, although it’s often referred to as “curation.” Price is not typically top of mind when consumers make these impulse purchases.

Deploy alternative distribution strategies 

A number of online retailers are trying to put themselves directly in front of consumers before they think to consider searching for a product on Amazon. “Flash sales” companies like One Kings Lane and The Clymb send daily emails that display an assortment of goods at attractive prices. Other companies like Birch Box or Trunk Club use a subscription model that sends you a highly curated selection of products, typically on a monthly basis.

Leverage unique advantages

Compared to Amazon, brick and mortar retailers are at a disadvantage because of their higher real estate, labor, and inventory costs. But a number of merchants are trying to flip this disadvantage on its head and put their network of local stores to use. Wal-Mart has allowed consumers to pick up online orders at their local store on the day it was ordered. Last holiday season, the retail giant launched a test of same-day delivery for online orders from its stores in a number of cities. Both take advantage of Wal-Mart’s massive inventory in geographically spread out locations. And in a creative twist, the company is considering crowdsourcing its local, same-day delivery to Wal-Mart (wmt) customers, who would receive discounts on their shopping bill in exchange for their efforts. Alternatively, Williams-Sonoma has used both its store locations and catalogs to build its online business. They have been willing to cannibalize themselves, believing that someone else will do it if they don’t. Over 40% of its revenue now comes through the online channel.

It’s clear that e-commerce is highly advantaged vis-à-vis offline retail and will continue to grow. The more relevant question to consider is how e-commerce companies will compete with Amazon.

Amazon will always be able to pummel other e-tailers on price and probably on shipping as their scale advantages are virtually unassailable. Companies that hope to compete with Amazon successfully have to adopt different tactics. As when Cassius Clay (now Muhammad Ali) prepared to fight heavyweight champion Sonny Liston, they’re going to have to “float like a butterfly, sting like a bee.”

Jeff Jordan is a partner at Andreessen Horowitz and is on the boards of AirBnB, Belly, Fab, Circle, Crowdtilt, Lookout and Pinterest, as well as Wealthfront and Zoosk. Prior to a16z, Jeff was president and CEO of OpenTable, which he took public in 2009. Before OpenTable, Jeff was president of PayPal, and he was previously the SVP and general manager of eBay North America. Follow Jeff on Twitter @jeff_jordan and his blog.