The Truth About an FBA Business
A few months ago, there was a big guru launch for a product based on Fulfillment By Amazon (FBA). In this interview, we take an inside look at a real FBA business.
FBA is a method by which vendors ship products directly to an Amazon warehouse, have them listed in the Amazon marketplace and have Amazon do all the shipping and handling. True to form, the aforementioned guru launch presented this as a veritable golden goose. You’d be making untold thousands in no time, once you handed over the $4K that were being asked for the product.
At the time, I wrote an email to my subscribers about it and as a result, got to talking to Howard Lee Harkness, a reader who has some real-world experience with the FBA business model.
What follows is a cold shower to guru hype and a real look at the business model, for anyone interested in seriously pursuing it:
How Fulfillment by Amazon Works
Shane Melaugh: Can you tell me a bit about how you started with Amazon FBA and what you’re currently doing?
Howard Lee Harkness: My wife (Georgene) was the one who first got into FBA sales. It came about as a result of several other things we were doing.
Back around 2005-2007, my wife was an Ebay Powerseller, and she was even featured in a Kindle book written by a friend of hers. She got tired of working 50 or 60 hours a week earning about half minimum wage, and she pulled the plug. However, the fact that the Kindle book her friend wrote was still up on Amazon and still selling got us interested in Kindle publishing. Georgene then wrote several Kindle books on various topics, with mixed success.
The Kindle publishing efforts led to a couple of other things, including the purchase of Amazopia.com from Tristan Higbee, who had lost interest in the site. We decided to buy the site and take the plunge. The main thing we got from Amazopia was exposure to more Amazon-related ideas, since Georgene was spending quite a bit of time researching news about Amazon to curate for Amazopia.
The connections we made through the site led us to discovering the world of retail arbitrage and we got to know some people who’d been pursuing this business model for several years.
Next thing I knew, Georgene had invested about $800 in equipment and software to use for FBA sales.
Her initial idea was to round up a bunch of stuff we had around the house (mostly books) and sell those. Except for a few outstanding items, that really didn’t work all that well.
Following Chris Green‘s advice, Georgene then started “scouting” at various outlet merchants, looking for things that had a price low enough locally and high enough on Amazon to make us some money after the various fees. Amazingly, we were able to find quite a few items that fit into that criterion.
Now, we are doing about 50% “retail arbitrage” and 50% wholesaling.
SM: What does your FBA business look like today?
HLH: Our current operation is in a state of transition. I mentioned that, initially, Georgene started with getting rid of junk we had lying around the house. While there were some definite winners in that phase, we didn’t make much money that way. But it was a valuable learning process.
The next phase in the business was going to outlet and specialty stores and “scouting.” Scouting is the process of locating items that you can buy locally and sell for a profit through FBA.
We learned was that it was not worth our time to sell anything for less than approximately $15.A major lesson we learned was that it was not worth our time to sell anything for less than approximately $15, even if we could get it for practically nothing. Due to recent Amazon fee increases, this is now closer to $20. An item that we can buy for $100 and sell for $175 returns about $50 for roughly the same amount of work as a $2 item that we can sell for $10 (which returns about $1), so the lower-cost items are not time-effective.
That second phase was more profitable.
Now we are entering a third phase of our FBA business, which is a combination of retail arbitrage and wholesaling.
When we are “scouting” we are looking for items that are fairly expensive on Amazon — the more expensive, the better — and have good rank. In addition, the price difference has to be at least a factor of 3 for anything that sells for less than $30, and a factor of two for anything between that and about $100. Over that is a judgment call. Items meeting those criteria are difficult and time-consuming to find, but the payoff is much larger.
The other part of the combination, wholesaling, is similar to what is recommended by the $3500 system that you advised your readers not to buy (and I definitely agree with you about that). We have found some items that we can buy in bulk for about $10, and sell for $30. They have great rank, and sell quickly. However, as time goes on, we have found that some other folks have discovered the same item, and the price we can get is dropping.
In the wholesale portion of our business, we order items in bulk (usual minimum order is around $1000), and have them delivered directly to us.
The best possible item you can sell through FBA is something that is no longer in production, and sells at a significant premium. One of the problems with items that sell at a very high markup and are currently in production is that occasionally, Amazon decides to go into direct competition with FBA sellers on items that it perceives to be overpriced. Once Amazon does that, the price set by Amazon defines the most that any FBA seller will be able to get. Why? Because people trust Amazon more than they trust any other seller (though the “Fulfilled by Amazon” designation helps a lot!).
The best possible item you can sell through FBA is something that is no longer in production, and sells at a significant premium.For that reason, we always check to make sure Amazon is not currently selling any particular item before we buy it, or we are satisfied with selling it at Amazon’s price. We are still taking a risk, because Amazon could enter the market for any item that is in current production. When we can find a closeout on a discontinued, but popular, item, we can eliminate that particular risk. There may be other risks, though — like the underlying reason the product has been discontinued, for instance.
Discontinued, but popular, items are harder to find, but we have found a few.
We are currently scouting two or three days a week, and continuously looking for new wholesale items. We are getting a good enough return on the process that we can grow the business. It helps a lot that we have other sources of income; otherwise that would make growing the business much more difficult.
As the business grows, we are still learning and improving. I think it has the potential in the next 6 months to exceed our income from all other sources combined.
Our main goal at this point is to decrease the amount of time and effort it takes to process our merchandise. Georgene currently does most of the scouting, and nearly all of the bookkeeping, labeling, and packing. I spend some time looking for wholesale sources, and I help her carry stuff to the UPS pickup point.
There are folks we know who do only retail arbitrage, and work at that full time, who list (and sell) more merchandise every month than we have listed in total since we started last November. Those folks have to really enjoy scouting. There are others who do exclusively wholesale because they don’t enjoy scouting, who do just as well as the scouters. Some, like us, do some of both. None of the folks we know are doing private-label wholesaling (or at least, they aren’t talking about it).
SM: What does a typical scouting trip look like?
HLH: Here’s one we did last week: We went to a charity thrift store which occasionally gets new merchandise (clearance items, bankruptcy liquidations, and some corporate donations), where we spent about $100 on merchandise that we expect to eventually sell for about $350. Then we went to a chain discount store, where we found another $150 worth of merchandise that we expect to eventually sell for about $400. We then went to our local Wal-Mart, and found some clearance items for $10 that are currently selling for about $50 (only 3 of them were available). That’s sort of a typical day of scouting. The 3 stops took us about 2 hours. Some days are better, some are not as good.
SM: Most small businesses hit a “growth ceiling” at some point, where the business can’t be scaled up further unless some changes are made (e.g. hiring more staff). Are you facing such scaling problems in your business yet and do you have a plan for how to grow beyond that point?
HLH: We’ve already hit a few growth ceilings, and I anticipate more.
One of the first things we didn’t get quite right was that we were not paying enough attention to rank. We learned that it doesn’t really matter what kind of margins we are seeing if the item takes a long time to sell. Another I already mentioned is that we discovered that unless something sells for at least $20, it probably isn’t worth the time, even if all of the other criteria are met.
I think that we are close to hitting another growth ceiling on our scouting activities. Scouting takes a lot of time and effort, and even applying the lessons we’ve learned, I don’t currently see a way to expand our scouting significantly. We plan to continue scouting indefinitely, and occasionally we do uncover an item that gets a really good return. Our main frustration with scouting is that once you find a really profitable item, you usually only have access to a few of them.
On a good day, we may find enough high-margin & high-rank items to clear $500-$1000 profit (eventually), which is not a bad day’s income. We may average $200 or so, and I don’t see any obvious way to do better without changing something, so that’s a growth ceiling.
We know people in the community who are satisfied with this level. $200-$400/day is not a bad living. From our experience, you can get to that level in about 6 months if you have the required starting capital and are willing to put in the work needed.
Another ceiling we have encountered is due to the sheer number of different items we have listed in inventory. It takes time to re-analyze the market when something isn’t selling as well as expected, and doing that manually means that you can’t react to market changes in a timely manner. Georgene was spending enough time on this that it was impacting the time available for activities like scouting. Since there are people who maintain ten times as much inventory as we do, we knew we had to change something.
So, we recently bought and installed a software tool in our system which helps us do better analysis of the market and allows us to apply more intelligent re-pricing as the situation changes. This tool increased our sales to the point that our online inventory is actually shrinking! There was a bit of a learning curve on the software: It took a few round trips of repricing to make sure that the tool was doing what we wanted it to do, before we “turned it loose.” After that, the tool easily paid for itself in less than a day.
We are getting around the growth ceiling of scouting by finding wholesale items. There are two different approaches to take here. First approach, which is the one we are using now, is finding an item to buy, and getting it shipped directly to us for re-packaging and labeling. There is an obvious growth ceiling there, because there is a strict upper limit on the amount of inventory we can label and re-pack ourselves.
The second approach is outsourcing the re-packing and labeling to the vendor. In that approach, we pay the vendor a fee to apply labels and ship directly to Amazon. We can even pay Amazon to re-label inventory for us. That greatly increases the passive component of the business at the expense of reducing the margins by the amount paid for that service. The growth ceiling is raised considerably with that approach, and our activities become mostly management. A danger there is that if the vendor catches on, it would be easy to cut us out of the loop.
On the positive side, if you never have to touch or even see the inventory, the business becomes geographically independent. That is even more important to us right now than the element of passivity.
You have to diversify. The market for any one item could tank quickly and with no warning. If you are doing really well on something, other FBA sellers are going to notice, and move into that niche with you. The tradeoff is that the more unrelated items you have, the more time required to manage them, but the impact of any one item that has to be dumped at a loss in reduced. We will probably increase the number of items until we we hit that particular growth ceiling.
A variant of the second approach is private labeling. That might raise the ceiling a bit more, at the price of some increased risk. Markets change, and if you are involved directly in any part of the manufacturing, you can’t react as quickly. You also have the risk of product liability. In my more cynical moments, I speculate that may have something to do with the fact that the guys behind that $4000 course are pitching it from a location in France.
We are looking into private labeling, but we have not made a decision to do it. I may try it on a relatively small scale to see if it works for us.
SM: When I was doing a bit of research on FBA, one of the things that stuck in my mind was a quote I read somewhere, that said to succeed in this kind of business you have to enjoy retail. You have to enjoy thinking about, looking for and working with these products. If that’s not your thing, this business won’t be for you.
I get a similar impression from your story. Would you confirm this? Or do you know people who have removed themselves from these processes almost from the outset?
HLH: That really depends. Some FBA’ers do only retail, some do only wholesale, and some do a mixture, and there are robust and successful businesses in each group. Most FBA’ers start out with retail, but there are some that have never done it.
If you stick only with retail arbitrage, then your income may be capped somewhere in the low 6-figure range, primarily because it’s difficult to outsource the work to any great extent. The sellers who achieve that level of income are working at it full-time, and usually pursue it as a family activity. In one case we know of, a lady (sometimes with the help of her daughter) will scout for several hours, bringing home a van-full of merchandise, and the rest of the family will immediately unload, sort, label, and pack everything under her supervision, and have everything ready for shipping the same day. It might be possible to hire some help, but that would not enable a lot of scaling, and would not increase the potential income by much.
There are some high-volume FBA retail arbitragers who outsource labeling, packing, and shipping. That outsourcing has a big risk: We know of one whose (now former) employee figured out what she was doing, and is now competing directly against her — with the advantage of knowing exactly where to start sourcing.
I mentioned that an enjoyment of retail is not really needed. Case in point: Georgene does not like to shop. I like to shop more than she does, or more accurately, I dislike it a lot less than she does. When we do grocery shopping, we almost always go together, and we use a list so that we can grab what we need and get out of the store as quickly as possible. The shopping experience is definitely not something we live for.
So the enjoyment of the retail experience is clearly not the driving force. We are willing to shop, and the experience of shopping for merchandise to resell differs a lot from just shopping in general.
For her, if she wasn’t looking for stuff to sell, she would never enter most of the places we use for FBA sourcing in the first place. The process of scanning and evaluating as many items as we can typically keeps us in a store for an hour or so — and a lot of that time is spent waiting for the scan to return the information we use to make our purchase decisions. There is a bit of the “thrill of the hunt,” but I don’t consider that to be the same as “enjoying retail.”
It’s mostly just work, although it beats having to appear in a specific place every day wearing a specified costume and participating in a mind-numbing routine involving sitting in a cubicle or attending meetings whose sole purpose is making your management feel important.
Retail arbitrage is a really strange business. At its heart, it is only possible because of what the economists call “market friction,” and the process works by reducing that friction — just a little. If too many people engage in reducing market friction, it is eventually reduced to the point where the arbitrage opportunities go away. That was my initial concern when I saw the $4000 Amazing Selling Machine launch, which has the potential of dumping a bunch of clueless newbies into the business, thereby fouling up the whole business.
Fortunately for us, there are two large barriers to entry in the FBA business:
- It requires a lot of work, a lot of which is complex and time-consuming, and some of which is fairly difficult.
- You have to invest a substantial amount of money into the business, and the income you can expect is directly related to how much inventory you have, and how well you chose that inventory.
You mentioned in your blog that just the mention of something like 6 weeks of work was a tremendous deterrent to most Internet marketing wannabees. That gives us an excellent advantage! Here, we are taking about several months of challenging work, involving some risk with your own money, before you can expect to get enough income to have a decent living. If that prospect scares off most of the competition, so much the better.