The Journal. - What Is Amazon's Secret ‘Project Nessie’?

Episode Date: October 6, 2023

When the Federal Trade Commission filed a lawsuit against Amazon last week, there was a big redacted section. WSJ’s Dana Mattioli on what she discovered underneath the redactions.  Further Reading: - Amazon Used Secret ‘Project Nessie’ Algorithm to Raise Prices  - FTC Sues Amazon, Alleging Illegal Online-Marketplace Monopoly  Further Listening: - Congress’s Case to Break Up Amazon  - Biden’s New FTC CHair Squares Off With Big Tech  Learn more about your ad choices. Visit megaphone.fm/adchoices

Last week, the Federal Trade Commission sued one of the biggest tech companies in the world, Amazon. The Federal Trade Commission and 17 states have brought a sweeping lawsuit against Amazon. Alleging that the company abused its power to raise prices for shoppers. Claiming it operates an illegal monopoly. And also levy all sorts of high fees against businesses that happen to sell on its platform. I asked my colleague Dana Mattioli about the lawsuit. How long is the lawsuit?

It's 172 pages. It's not light reading. How long did it take you to read all 172 pages of this lawsuit? Oh, I had like a cram session the night it came out and it just stayed up until I read it. Did anything jump out at you? Yeah. So there was something like pretty mysterious about this lawsuit when it was filed. There was a section called Project Nessie. I can't tell you how many cartridges of ink I went through printing this because it was almost fully redacted.

So this like peaked your curiosity? I think it peaked everyone's curiosity. And did you find out what Project Nessie is? We did. Welcome to The Journal, our show about money, business, and power. I'm Kate Leinbaugh. It's Friday, October 6th. Coming up on the show, Amazon's mysterious Project Nessie. The Federal Trade Commission, or the FTC, was founded in 1914. It was set up to protect Americans from deceptive or unfair business practices.

And a big part of its job is to enforce anti-monopoly laws. In recent years, it's filed antitrust lawsuits against big tech companies like Google and Facebook. And Dana had been anticipating an antitrust case against Amazon. Last Tuesday, that happened. against Amazon. Last Tuesday, that happened. The FTC in 17 states sued Amazon, alleging an illegal online marketplace monopoly. Amazon said that the FTC has the facts wrong. They said that going after Amazon for these sorts of violations per the FTC would harm customers and that they're looking forward to fighting this in court. Within the FTC's lawsuit were lots of allegations, but also lots of redactions.

The level of redactions really stuck with me. And once the dust settled a little bit, I decided to really look into what was behind them. How many pages? I mean, several pages. Like page 57? What page was it? Actually, let me pull it up. Let's see. Nessie, Nessie, Nessie. Okay. So they get into the meat of Project Nessie on page 123. And it really doesn't say much. You keep scrolling and it's black, black, black, black, black. And this goes on until page 127. Why was this section redacted? So when it comes to these sorts of lawsuits, there's sensitivities about companies' business practices and what might be considered proprietary. So it's not abnormal for an FTC or

a DOJ suit to have redactions because there's a negotiation process that will later happen that the two sides come together and the judge will determine what could be unredacted. But this whole section was very redacted, which led to this mystery. And when you looked into this mystery, what did you find out? We were able to find out that underneath those redactions, the FTC is claiming that Amazon had this super secret algorithm, Nessie. And the algorithm essentially was used to improve their profits. Project Nessie is no longer in use.

But according to Dana's reporting, the FTC alleges it worked like this. Amazon would raise prices on its site. Then the algorithm would watch Amazon's competitors across the Internet. If those competitors raised their prices, Amazon would keep the new higher price. If they didn't, Amazon would lower the price back down. new higher price. If they didn't, Amazon would lower the price back down. So one of the ways that the FTC contends it was used is to discreetly test price hikes on numbers of different products across Amazon in order to improve margins and to improve profits. And what would happen there is the complaint says that Amazon would raise the price algorithmically and see if other competitors would also raise their prices and customers would still buy the item.

So it's sort of like, let's say Amazon raises the price of a yoga mat by maybe 50 cents, and then it's watching whether Target or Walmart would do that too. Right. So it's testing out like almost price elasticity. To see how high they could raise prices. Correct. The lawsuit makes the claim that we all pay more money for items. So I think it's pretty well known that there's dynamic pricing on retail, right? That prices fluctuate in real time all the time. I think most people think about that

as prices going down, that companies are matching each other to stay competitive, right? So if there's a sale at one retailer, Amazon and Walmart will match it in order not to lose the sale. Online shopping has usually been a lower price game. Retailers have used their algorithms to push prices down, watching each other and trying to compete. The FTC alleges that Project Nessie was doing the opposite. Amazon was using an algorithm to increase prices. And it worked. Competitors would follow because of Amazon's retail power. According to Dana's reporting, Amazon made more than $1 billion in revenue through use of the algorithm. How has Amazon responded to this?

Amazon responded saying that the FTC's allegation grossly mischaracterized this tool and that Nessie was a project with a simple purpose to try to stop our price matching from resulting in unusual outcomes where prices became so low that they were unsustainable. What does that mean? Because of dynamic pricing in retail, if Walmart or Target cut the price of a Barbie doll from $14.99 to $10.99, Amazon would have to follow as would most other retailers in order to remain competitive.

So they'd cut their price and everyone would be at $10.99. But once Walmart went back to its regular price for the Barbie doll, the other retailers would be stuck at $10.99 because they'd still be competing with each other. So Nessie was also used to get Amazon out of these downward promotion spirals to end the sale essentially and normalize pricing. The FTC's case against Amazon goes well beyond Project Nessie. That's next. Discover more value than ever at Loblaws.

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in online shopping across the internet. One example was Project Nessie. Another revolves around its relationship with so-called third-party sellers. So if you're on amazon. So if you're on Amazon.com and you're on a specific product's page, you'll see there's a line off to the right that says sold by. This tells you whether the product is sold directly by Amazon or sold by a third-party seller. There are millions of third-party sellers in Amazon. And it's pretty staggering. 60% of Amazon's retail

revenue is from these third-party sellers. They are part of the backbone for Amazon's success. And I think most consumers don't realize that when they're shopping on Amazon, there's a very good chance you're buying from these sellers. And what is Amazon's relationship to these sellers? It's interesting. Amazon is a platform, right? And for some of these sellers, it's a pretty tense relationship. It's like a love-hate sort of scenario.

A lot of the people I speak to say they have to be there. If they're not there, they will have no business. It's a love-hate relationship because being a third-party seller on Amazon comes with steep costs. They have to pay a fee to Amazon to be able to sell on the platform. And they also pay for other services as well. So if you want to be successful on Amazon, and the FTC alleges this,

you have to be part of their fulfillment network that comes at an expense. If you want to be successful on Amazon, you have to buy advertising on Amazon. Some of the people I've speak to spend more than a million dollars a year on ads. So the fees that they are charging these sellers is pretty high compared to other websites. The cost to sell is higher. Have Amazon's fees changed over the last few years? They have. There's been independent reporting from the Institute for Local Self-Reliance, which is a third-party organization, that in 2014, Amazon's take of a seller revenue was 19%, and that's gone up to 45% today. So that's a pretty significant jump.

The FTC alleges that for every $2 that a seller makes on Amazon, Amazon's taking one. So it's like 50%. So what does the FTC say is the consequence of this? So the FTC says the upshot of this is that, you know, the prices are artificially high and Amazon really locks sellers into its platform and its services that they might not want to use, like fulfillment by Amazon, like advertising. And the addition of these services, which are kind of an Amazon tax as they describe it, create this scenario of higher prices. Amazon says its fulfillment fees are 30% less expensive than standard shipping methods, and that this helps ensure fast delivery for Amazon Prime members.

Amazon also says that it doesn't force sellers to use its other services. The FTC says that Amazon's size means that higher prices on its site led to higher prices everywhere else. So the thing about Amazon is that almost 40% of all shopping on the internet happens on Amazon.com in the U.S. So because of that, sellers feel that they have to be there. And Amazon knows that. Up until 2019, Amazon contractually required sellers to commit to their prices being the lowest on Amazon. And they'd be penalized. If you were selling a baseball bat on Amazon for $9.99 and Amazon's crawlers found that you were selling it for $8.99 at Walmart, you'd get an email saying you need to rectify the situation or your products would be buried or you could be delisted. That was 2019. How does it work now? So now they've gotten rid of that contract, but the FTC alleges that it still exists in practice.

I get that like added fees could cause you to raise prices, but then if, as the FTC alleges, if Amazon is pressuring on the other side that they should have the best price out there, wouldn't that pull down other prices too? So let me give you an example. Oh, great. Okay. So let's say there's a hat maker on Amazon and he has to list his hats at $20 on amazon.com because he has to cover his costs.

He has to buy ads for it. There's a 15% referral fee to Amazon. Let's say he also has his own website where the cost of doing business is a lot lower because he doesn't have to pay for advertising. He might be able to ship it more economically. He doesn't have to pay a referral fee to anyone. He will then have to charge $20 for that hat

on his own website, even if he could get a better profit for it at $16 because the Amazon price is the floor and the Amazon price has to cover those fees. And that's why it's so high. And I did speak to sellers who have explained this in real time that Amazon has hiked up the fees and they've had to pass those costs along in order to be viable on Amazon. And if they raise their prices on the goods on Amazon, they also have to raise it for the same product on Walmart. So it plays out in real time.

What I think you earlier said was the Amazon tax goes across platforms. Exactly. Why would sellers deal with this? A lot of them that I've spoken to sort of live in fear of being kicked off of Amazon. They have a lot of money tied up in the inventory, and they know that they need Amazon partly to succeed, even if it's becoming harder to succeed in recent years. The FTC's central argument in the lawsuit, that Amazon was causing higher prices, came as a bit of a surprise. came as a bit of a surprise. That's because the current FTC chair, Lina Khan, rose to fame with a 2017 article titled Amazon's Antitrust Paradox.

In it, she argued that Amazon hurt its rivals by heavily lowering its prices. But now, the FTC is arguing the opposite. A lot of people scratched their heads. Why? Why was that a head scratcher? Well, I think the hot takes were that she was contradicting herself, that her arguments had completely changed. But when I really dug into this and spoke to people

that sort of have a similar viewpoint to her in antitrust, they pointed out something pretty important. They said that the Amazon that Lena was writing about in 2017 is much different from the Amazon of today. And Amazon in 2017 or 2016 and 2015, which is what she was basing that argument on, was still cutting prices and using predatory prices to gain market share and to hurt rivals. And that's the sort of behavior that goes into what's called monopoly building. And they said that the Amazon of today is more of a late stage monopoly. And once you cement your dominance and have the monopoly power, you can then raise prices.

You could degrade services because there's fewer rivals. And that's the argument that they make. What do you expect from this case going forward? I think it's going to be very long, very drawn out. These sorts of cases don't move quickly. There's a sense that this could play out over the next few years. This is a landmark case. It's a lawsuit that is very high stakes for the company,

for the future of big tech. And if the FTC is successful, it could have long-lasting ramifications for Amazon.com. And at the most extreme end, it could force a breakup of the company. That's all for today, Friday, October 6th. The Journal is a co-production of Spotify and The Wall Street Journal. The show is made by Annie Baxter, Kylan Burtz, Katherine Brewer, Maria Byrne, Victoria Dominguez, Pia Gadkari, Rachel Humphries, Ryan Knudsen, Matt Kwong, Jessica Mendoza, Annie Minoff, Laura Morris, Enrique Perez de la Rosa, Sarah Platt, Alan Rodriguez-Espinosa, Heather Rogers, Jonathan Sanders, Pierce Singey, Jivika Verma,

Lisa Wang, Catherine Whalen, and me, Kate Leinbach. Our engineers are Griffin Tanner, Nathan Singapak, and Peter Leonard. Our theme music is by So Wiley. Additional music this week from Catherine Anderson, Bobby Lord,

Peter Leonard, Emma Munger, Nathan Singapak, and Blue Dot Sessions. Fact Checking by Nicole Pasolka. This is Nicole's last episode with us. Nicole, thank you for everything. We're truly going to miss you, but are so excited for what's next for you.

Thanks for listening. We'll be back with a new episode on Tuesday.