Amazon and the "profitless business model" fallacy(eugenewei.com)
eugenewei.com
Amazon and the "profitless business model" fallacy
http://www.eugenewei.com/blog/2013/10/25/amazon-and-the-profitless-business-model-narrative
140 comments
This exposes the flaw in the article's argument. The author argues that Amazon can simply choose to stop or slow down their investment for growth. But a lot of that "investment" is actually customer subsidies like lower prices or free shipping. As soon as Amazon ceases those, they will face stronger competition from established profitable businesses like Walmart.
i'm a big fan of Bezos, honestly, but to say that pricing your products in such a way as to make >$100 billion in cash is a "mistake"... that's just crazy talk.
In the short term. Bezos point is that by pricing everything this way, proposing to compete with Amazon is crazy talk for most people: Their margins are razor thin, so you need to be able to beat them consistently on cost to have a chance of surviving, and beating them on cost will requires economies of scale that are impossible for a lot of people.
Apple on the other hand, is marketing high end products with ridiculous margins, which leaves a lot of market niches on the table, and leaves a lot of room to make money even with a cost base that is massively higher than Apples. That's made people line up to get a piece of the cake.
How many people start companies intending to compete with Amazon? Meanwhile, new smart phone companies sprout up on a near daily basis, and there's a whole industry in providing designs, SOCs, cases and components for people who just want to slap one together and put their (or someone elses...) logo on a phone.
Apple on the other hand, is marketing high end products with ridiculous margins, which leaves a lot of market niches on the table, and leaves a lot of room to make money even with a cost base that is massively higher than Apples. That's made people line up to get a piece of the cake.
How many people start companies intending to compete with Amazon? Meanwhile, new smart phone companies sprout up on a near daily basis, and there's a whole industry in providing designs, SOCs, cases and components for people who just want to slap one together and put their (or someone elses...) logo on a phone.
That's fine, but apple makes more profit every quarter than amazon has ever made I think. They have made several hundred billion dollars over the last few years. Who knows if amazon ever gets to flip the switch. Maybe they do, but even then apple will have a several hundred billion dollar head start.
Perhaps both strategies will end up working, but you can't say apples strategy is a failure. It is clearly not, even if they never sell another phone.
Perhaps both strategies will end up working, but you can't say apples strategy is a failure. It is clearly not, even if they never sell another phone.
Don't forget, if the market crashes and AMZN stock gets a 50% haircut, that big pile of cash AAPL has been shoveling their profits onto on can get mighty scary to everyone very quickly.
The problem with the cash pile, and also with other companies' large cash piles, is that a lot of the cash, maybe even the majority, is held overseas. Hence there will be an almighty tax bill if it is brought back to the USA.
Today there's plenty of competition in the cloud space. But amazon had a pretty long run without serious competition and had managed to create pretty strong ecosystem, and probably lockup on its platform.
There's plenty of competition in the cloud space in part because, apart from being new, the cloud space is different from their physical product sales in that there are any number of possible business models in that space which makes Amazon extremely expensive for a lot of possible customers.
I'd say you are wrong that they had a long run without serious competition. They had serious competition from day one: Other hosting businesses ranging from colo providers to managed hosting providers. They made a splash by carving out a new niche. Some people have done well entering that niche (so far), though many of them were well capitalized existing players taking advantage of their position (existing hosting providers adding cloud features to take advantage of existing as-yet unsold/unrented stock to make it cheap to enter this market for example). But the number of new entrants in this market since Amazon is still vanishingly small compared to the number of people salivating over the smartphone market.
But Amazons strategy still puts them in a situation where going head to head with Amazon in this space now puts you in the situation where if you can't compete on features, they will keep chipping away at your ability to extract a high margin.
At the same time they've gradually carved out a larger and larger niche: Additional products, and ways to improve pricing such as having people pay for reserved instances.
This is similar to the physical object space - there were lots of people that could compete with them early on, when Amazon was still mostly selling books, and selling small enough amounts of books that they could not push the distributors around.
But even then Amazons model is devastating to competitors: If your cost base is lower than Amazons, but your investors have come to expect a 5% return every year, yet Amazon gets away with staying around 0% without getting any flak, you are screwed unless you seriously believe that you can continue to keep your costs sufficiently below Amazon to be able to compete on price and retain your margins.
One by one Amazon competitors have fallen because it is incredibly hard to reduce bloat once it has become part of the way you operate, and incredibly hard to wean yourself off higher margins. When they then go up against an organization whose credo is based on cutting cost everywhere it is possible, and then extracting almost nothing in return for it, a lot of people will be in deep trouble.
I don't think Amazon will ever be as devastating in the hosting space as elsewhere, as there are too many ways to differentiate in the hosting space. But they certainly can keep chipping away at the core, and if I was working in hosting, I'd be spending a lot of my time figuring out 1) how to cut costs, 2) what product categories Amazon are unlikely to want to be in soon and/or which doesn't fit with well with Amazon's model (for example anything where customers wants to pay for a lot of reassuring face time and handholding)
I'd say you are wrong that they had a long run without serious competition. They had serious competition from day one: Other hosting businesses ranging from colo providers to managed hosting providers. They made a splash by carving out a new niche. Some people have done well entering that niche (so far), though many of them were well capitalized existing players taking advantage of their position (existing hosting providers adding cloud features to take advantage of existing as-yet unsold/unrented stock to make it cheap to enter this market for example). But the number of new entrants in this market since Amazon is still vanishingly small compared to the number of people salivating over the smartphone market.
But Amazons strategy still puts them in a situation where going head to head with Amazon in this space now puts you in the situation where if you can't compete on features, they will keep chipping away at your ability to extract a high margin.
At the same time they've gradually carved out a larger and larger niche: Additional products, and ways to improve pricing such as having people pay for reserved instances.
This is similar to the physical object space - there were lots of people that could compete with them early on, when Amazon was still mostly selling books, and selling small enough amounts of books that they could not push the distributors around.
But even then Amazons model is devastating to competitors: If your cost base is lower than Amazons, but your investors have come to expect a 5% return every year, yet Amazon gets away with staying around 0% without getting any flak, you are screwed unless you seriously believe that you can continue to keep your costs sufficiently below Amazon to be able to compete on price and retain your margins.
One by one Amazon competitors have fallen because it is incredibly hard to reduce bloat once it has become part of the way you operate, and incredibly hard to wean yourself off higher margins. When they then go up against an organization whose credo is based on cutting cost everywhere it is possible, and then extracting almost nothing in return for it, a lot of people will be in deep trouble.
I don't think Amazon will ever be as devastating in the hosting space as elsewhere, as there are too many ways to differentiate in the hosting space. But they certainly can keep chipping away at the core, and if I was working in hosting, I'd be spending a lot of my time figuring out 1) how to cut costs, 2) what product categories Amazon are unlikely to want to be in soon and/or which doesn't fit with well with Amazon's model (for example anything where customers wants to pay for a lot of reassuring face time and handholding)
Meanwhile, the iPhone has slowly but steadily been losing mindshare to its amazing competition.
So a company essentially invents a segment, so de facto owns 100% mindshare, and the fact that competition shows up over the next several years is somehow..... what? A sign Apple did something wrong?
And if only Apple had the sense not to make any money off the iPhone, they'd hold all the "mindshare"?
As an investor in both companies (though I recently sold my AMZN position), I'm quite pleased with Apple's decision to value revenue over "mindshare." The iPhone business was and is bigger in itself than many entire Fortune 500 companies.
And if only Apple had the sense not to make any money off the iPhone, they'd hold all the "mindshare"?
As an investor in both companies (though I recently sold my AMZN position), I'm quite pleased with Apple's decision to value revenue over "mindshare." The iPhone business was and is bigger in itself than many entire Fortune 500 companies.
"Share" is a stupid way to look at rapidly growing markets. Apple is not losing anything with their iPhone business.
And no one at Apple seems to notice this loss of 'mindshare' because they're too busy figuring out what to do with all the money people are giving them for the iPhone.
You seem to be thinking you're refuting my "loss of mindshare" argument, but you are actually refuting the "iPhone sales are dropping" argument, which nobody here seems to have made.
We'll have to wait and see.
Amazon is on its way to fulfilling all my needs and wants. Why wouldn't I give it all my money?
Amazon is on its way to fulfilling all my needs and wants. Why wouldn't I give it all my money?
That's probably one of the reasons why Amazon has been undercutting almost everyone time & time again. With their razon thin margins they have nowhere to go but up. Even when they don't go down as much as the markets think they would their stock goes up.
Other retailers & technology companies don't have that luxury. They can't lose money at the cost of margin contraction or market share expansion. Heck, they can't lose money at all the way Amazon has been doing since its inception!
It's high time Bezos repeated the "Steve Jobs's mistake". Not that Amazon shareholders want them to.
Other retailers & technology companies don't have that luxury. They can't lose money at the cost of margin contraction or market share expansion. Heck, they can't lose money at all the way Amazon has been doing since its inception!
It's high time Bezos repeated the "Steve Jobs's mistake". Not that Amazon shareholders want them to.
Bezos has found and hacked a feature of public markets: you can get away with no profits as long as you're growing. Therefore, you can construct a profitless business scheme that reinvests all profits (or doesn't generate any) as long as your sales forever climb. It's the business equivalent of the Ponzi scheme--and if you look at Amazon's revenue, it is a classic exponential curve.
If sales ever plateau and investors force you to generate profits, the plane stalls and the whole thing spirals down, because it's the profit reinvestment which actually drives sales growth, and actual profits attract competitors who have been unable to pull off the profitless-hyper-growth trick. So far that hasn't happened.
Amazon's value is in the entire business and not the sum of its parts, which means that at some point, investors expect to own a profit making enterprise and not a bunch of warehouses. However, that won't happen until sales plateau or Bezos dies. Ironically, at that point the business loses a lot of value, both because growth has stopped and because competitors are about to enter the space, emboldened by Amazon's newly discovered profits. The whole thing is a bit of a sham. Any growth industry (Internet retail) can support only one "no profit rocket," and eventually it comes back to earth when that industry matures and ends the hypergrowth phase.
If sales ever plateau and investors force you to generate profits, the plane stalls and the whole thing spirals down, because it's the profit reinvestment which actually drives sales growth, and actual profits attract competitors who have been unable to pull off the profitless-hyper-growth trick. So far that hasn't happened.
Amazon's value is in the entire business and not the sum of its parts, which means that at some point, investors expect to own a profit making enterprise and not a bunch of warehouses. However, that won't happen until sales plateau or Bezos dies. Ironically, at that point the business loses a lot of value, both because growth has stopped and because competitors are about to enter the space, emboldened by Amazon's newly discovered profits. The whole thing is a bit of a sham. Any growth industry (Internet retail) can support only one "no profit rocket," and eventually it comes back to earth when that industry matures and ends the hypergrowth phase.
Right. It is not a Ponzi scheme. Investors price stocks based on the expected future cashflows. And those expected cashflows by the very definition reflect the non-zero probability of failure. Now, investors as a whole may overvalue or undervalue those cashflows - but this has nothing to do with a Ponzi scheme
It is like a Ponzi scheme in that it requires continuous expansion to maintain. Switching metaphors, it's also like a Catch-22: Amazon is successful precisely because it makes no profit. How, then, do you value future cash flows? Any profit it does make will hamper future flows. Furthermore, Bezos is far too into empire building to stop and take profits. His ego and fame is bound up into the size of his company, not how profitable it is, so the expectation of profit should be near zero.
The writing style and grammar in this post interfered with my comprehension. In the end, I was unable to finish reading it.
Some examples:
"Giant, heavy electronics items that Amazon sometimes ships for free when the shipping cost is clearly non-trivial and cost more than the usual thin margins on such goods are another."
"But if you sell a glass of lemonade for $2 and it only costs you $1 to make it, and you decide business is so great you're going to build a lemonade stand on every street corner in the world so you can eventually afford to move humanity into outer space or buy a newspaper in your spare time, and that requires you to invest all your profits in buying up some lemon fields and timber to set up lemonade franchises on every street corner, that sounds like a many things to me, but it doesn't sound like a charitable organization."
"The vast vast majority of products Amazon sells it makes a profit on."
It should be relatively easy to rephrase most of the language. For example, the last sentence should be worded: "Amazon makes a profit on the vast, vast majority of products it sells."
I think it would be worth it. I can't understand a lot of the post without effort.
Some examples:
"Giant, heavy electronics items that Amazon sometimes ships for free when the shipping cost is clearly non-trivial and cost more than the usual thin margins on such goods are another."
"But if you sell a glass of lemonade for $2 and it only costs you $1 to make it, and you decide business is so great you're going to build a lemonade stand on every street corner in the world so you can eventually afford to move humanity into outer space or buy a newspaper in your spare time, and that requires you to invest all your profits in buying up some lemon fields and timber to set up lemonade franchises on every street corner, that sounds like a many things to me, but it doesn't sound like a charitable organization."
"The vast vast majority of products Amazon sells it makes a profit on."
It should be relatively easy to rephrase most of the language. For example, the last sentence should be worded: "Amazon makes a profit on the vast, vast majority of products it sells."
I think it would be worth it. I can't understand a lot of the post without effort.
Out of curiosity, are you a native English speaker? I had no problems at all reading the article. A couple of the sentences are a little awkwardly phrased, but things like "The vast vast majority of products Amazon sells it makes a profit on." are both grammatically fine and reasonably idiomatic.
Yeah, I'm a native English speaker.
The sentence you quoted is not impossible to read, but it is more difficult to comprehend than it should be. A simple rewrite will make it more clear.
Many of the sentences in the article are much worse.
The sentence you quoted is not impossible to read, but it is more difficult to comprehend than it should be. A simple rewrite will make it more clear.
Many of the sentences in the article are much worse.
There is no issue with reinvesting for growth. Businesses that require a lot of capital to grow need to do that and might need to continue operating with lower or minimal profits as they grow.
However at some point it's important to be able to say that they have played out the majority of their growth ambitions and are ready to start optimizing the business for greater profit.
The trouble is that human nature for many CEOs with big egos and the structure of corporations is to want to continue to grow forever. This is a dangerous attitude. For example perhaps Microsoft shareholders would have been much better off if the company was run without ANY ambitions to compete with Google, Apple OR to dominate mobile or tablets or search or any of these areas. Instead if Microsoft was to just focus on Windows and Office and extract as much profits from the business as possible, then return these profits to shareholders, then the shareholders would be free to invest in Apple and Google stock.
The trouble with this is that for an ambitious CEO this might feel like giving up. I don't believe it's giving up. it's called focus. Focusing on what you are really good at (in this case Windows and Office), rather than pretending that you are great at everything.
However at some point it's important to be able to say that they have played out the majority of their growth ambitions and are ready to start optimizing the business for greater profit.
The trouble is that human nature for many CEOs with big egos and the structure of corporations is to want to continue to grow forever. This is a dangerous attitude. For example perhaps Microsoft shareholders would have been much better off if the company was run without ANY ambitions to compete with Google, Apple OR to dominate mobile or tablets or search or any of these areas. Instead if Microsoft was to just focus on Windows and Office and extract as much profits from the business as possible, then return these profits to shareholders, then the shareholders would be free to invest in Apple and Google stock.
The trouble with this is that for an ambitious CEO this might feel like giving up. I don't believe it's giving up. it's called focus. Focusing on what you are really good at (in this case Windows and Office), rather than pretending that you are great at everything.
By running at zero profit margin, Amazon is essentially growing itself as fast as it can manage, i.e. reinvest every dollar. Its current revenue growth is even faster than Google. That ensures itself as the biggest ecommerce platform for years to come. If it wants more profit, it can certainly do it. I believe Amazon will eventually automate most of its systems, like using robots instead of humans for warehouse, and gain significant profit margin. Chinese company Taobao (like eBay) provided free service for 5 years, and gained dominant market share. Now it is hugely profitable.
On the other hand, Jeff is likely more interested in just growing the business than counting profit dollars.
On the other hand, Jeff is likely more interested in just growing the business than counting profit dollars.
I've always thought of Amazon as this last dinosaur of a by gone era. The days where you can have a really big vision, where if you work a spreadsheet a bit here and there you suddenly have massive amounts of profit. We just need to wait for the world to finished being disrupted. If you disagree with the vision, then you "just don't understand". Most of these business failed, but Amazon found just enough profits sitting somewhere that they have managed to keep on living... So they are in this unique position where they are allowed to invest, and grow to unfathomable heights (well theoretically) because its a survivor bias of the investors.
Everything you need to know about Jeff's strategy is in this book: http://www.amazon.com/Sam-Walton-Made-In-America/dp/05535628...
Different medium and market, but basically the same overall strategy.
Different medium and market, but basically the same overall strategy.
Amazon only has around 10 more years before 3d printing starts to kill retail. Beware.
I will bet you $100 that in ten years time, it will not be commonplace to 3D print a fully working:
* Mobile phone * Bottle of beer * Sweatshirt or * Pear
What do you say?
* Mobile phone * Bottle of beer * Sweatshirt or * Pear
What do you say?
Starts to kill retail, not has killed it.
The most important thing for investor trust right now is that the trends are going the right way. In 10 years people will start seeing the writing on the wall for the current distribution model.
The most important thing for investor trust right now is that the trends are going the right way. In 10 years people will start seeing the writing on the wall for the current distribution model.
Is this what photo printers did to prints? People don't buy prints as much because of digital photograph, but when they want prints, people still pay someone else to print them.
Small scale manufacturing can only compete with large scale manufacturing where speed, customization, or luxury are important enough to pay a large premium for.
Bezos is an investor in Makerbot. (http://www.crunchbase.com/company/makerbot)
I'm sure he's well aware of the trends in 3D printing and will position Amazon in the market appropriately.
Plastic precursor doesn't simply appear out of thin air.
I think I might be a in some kind of bubble. That article sounds like absolutely every article I've ever read about Amazon and I don't think I've ever seen any of the posts he said "didn't get Amazon".
I wish Amazon would stop subsidizing Kindle device buyers, by surcharging everyone else by $2 on ebooks - especially when that money isn't even split with the authors.
http://davidgaughran.wordpress.com/2011/07/11/amazon-hold-ba...
http://davidgaughran.wordpress.com/2011/07/11/amazon-hold-ba...
Great explanation, but I don't think this business model is incompatible with "flipping the switch" partially as Amazon already did. Examples: raising the minimum amount for free delivery from 25 to 35, or removing free delivery from Amazon UK to certain countries like Spain to avoid cannibalizing it's own business in those countries.
This is a dangerous narrative that links the founder to the company in the same way that Apple is forever linked to Steve Jobs.
Amazon is Jeff Bezos's company and everyone knows it. He maintains detailed oversight of all the lines of business.
Until he gets hit by a bus or some cancer cells. Then what?
Then Amazon will be a very different company under someone else's leadership.
I hear working at Amazon requires being available on call and working long hours. If this is the future I'm worried.
Its not uncommon for companies to reduce their profit by various stratagems to reduce the tax they pay.
For example Apples massive overseas cash pile that they dont want to repatriate and pay out to the owners of the company
For example Apples massive overseas cash pile that they dont want to repatriate and pay out to the owners of the company
this is classical bait and switch. No idea why everyone is discussing that *
They 'invest in the future' by selling at or close to a loss, until they kill everyone around them. When they are the only ones around they can dictate price and terms.
* actually, just realized. For whatever reason, amazon is spend some PR money to give out the message that they are investing in the future like anyone else. I've seen some articles in several news papers and radios. They are probably in or expecting legal action on that and want to influence some group toughs.
They 'invest in the future' by selling at or close to a loss, until they kill everyone around them. When they are the only ones around they can dictate price and terms.
* actually, just realized. For whatever reason, amazon is spend some PR money to give out the message that they are investing in the future like anyone else. I've seen some articles in several news papers and radios. They are probably in or expecting legal action on that and want to influence some group toughs.
Think about it this way. Profits are dollars that leave the company. By sitting on low profits, Amazon turns all its cash towards itself.
That's the opposite of what those words mean. Profits are dollars that stay with the company. Dollars that leave the company are expenses, some other company's profits. I don't find redefining profit to mean its opposite enlightening here. They're spending cash now in hopes of future profits -- that seems clear enough in plain english.
Money not spent is money that isn't working for you, but instead is just sitting in reserve, at best accruing interest. Amazon is betting it can get a much higher return, and so far, has been right.
"profit" and "money" are two very different things.
"profit" is how much you are making at the end of the year, this is to be reinvested if you are efficient (as you suggest is good, i agree)
"money" is the what is sitting in the bank, not being utilized.
Would you say that a company who is breaking even is utilizing their cash properly? no, they don't have any cash to utilize, therefore profit and cash are different things.
"profit" is how much you are making at the end of the year, this is to be reinvested if you are efficient (as you suggest is good, i agree)
"money" is the what is sitting in the bank, not being utilized.
Would you say that a company who is breaking even is utilizing their cash properly? no, they don't have any cash to utilize, therefore profit and cash are different things.
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Right, but presumably, the company that spends all it's cash gets something in return for all this money, ideally of equal or greater value to said company than cash spent.
Management (jeff and co) elect to spend cash on bettering the position of the company, (and thus keeping the wealth within the company) opposed to just sending money to the owners (spreading the wealth to stock holders/entities external to the company)
Management (jeff and co) elect to spend cash on bettering the position of the company, (and thus keeping the wealth within the company) opposed to just sending money to the owners (spreading the wealth to stock holders/entities external to the company)
No, dividends are dollars that leave the company. Profits are an accounting measure of how much the value of the company increased. Since these accounting measures don't try to fully measure future income, heavy investment will appear unprofitable in accounting statements.
" I sell a used book on Amazon, it takes a cut of the transaction, I am the one packing and shipping that item to the buyer. "
In true Amazon "dominate all retail by making it accessible to consumers" their relatively new "Fulfillment By Amazon" service drastically simplifies consumer reselling by eliminating the need for the consumer to do the "packing and shipping".
It's an amazing service, and they are getting darn close to the "just ship us a box of your stuff"
I bet that we see that inside of the next five years, there are lots of problems (like what is / is not valuable) but you can see them already working around these issues by only accepting items with modern barcodes, charge small warehousing fees if something sits too long in inventory, etc.
(1)http://services.amazon.com/fulfillment-by-amazon/benefits.ht...
In true Amazon "dominate all retail by making it accessible to consumers" their relatively new "Fulfillment By Amazon" service drastically simplifies consumer reselling by eliminating the need for the consumer to do the "packing and shipping".
It's an amazing service, and they are getting darn close to the "just ship us a box of your stuff"
I bet that we see that inside of the next five years, there are lots of problems (like what is / is not valuable) but you can see them already working around these issues by only accepting items with modern barcodes, charge small warehousing fees if something sits too long in inventory, etc.
(1)http://services.amazon.com/fulfillment-by-amazon/benefits.ht...
I wasn't aware of that service. So to some extent Amazon is doing to Craigslist and eBay what Craigslist and eBay did to the classifies and Nickel Ads?
This service is even more useful to merchants and manufacturers. Amazon handles :fulfillment, customer service, offering you a global supply chain using simple tools, good financing options for some sellers and options to sell on amazon and outside of it. And from what I read it's priced quite well.
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I think Amazon is a great example of the kind of company that makes genuine long term fundamental change to the way the world functions. I really wish that more companies had a less quarterly mindset and would pursue things similarly.
I agree completely.
The catch, though, is that Jeff had to endure years of vitriol and abuse from Wall Street and the press to get into this position. I have met a lot of founders who think they could get through that, and very few who actually can.
I think Jeff was helped enormously by having this dark period for Amazon happen (a) during a broad-based tech recession and (b) in Seattle. I'm not sure how possible it is to do what he did through that period in a normal era and in the Bay Area.
The catch, though, is that Jeff had to endure years of vitriol and abuse from Wall Street and the press to get into this position. I have met a lot of founders who think they could get through that, and very few who actually can.
I think Jeff was helped enormously by having this dark period for Amazon happen (a) during a broad-based tech recession and (b) in Seattle. I'm not sure how possible it is to do what he did through that period in a normal era and in the Bay Area.
Amazon is the proof that corporations are not all short-term-focused, and the shareholders have amply rewarded Amazon for that with a huge P/E.
Isn't Bezos into the whole "Long Now" long-term thinking organization?
Isn't Amazon's P/E negative?
It fluctuates tremendously because the denominator is so close to zero.
Right now, it's 1,286.56.
I believe in Jeff's long term vision theory. He is even building a $42 million giant clock called the '10,000 Year Clock' atop the Mount Washington in Nevada. This is to portray his long term vision.
(I feel guilty to mention, but this reminds me something of the 1000 Year Reich sorts)
(I feel guilty to mention, but this reminds me something of the 1000 Year Reich sorts)
Out of all the articles I have read on the issue, this one most accurately sums up the views and opinions of the upper half of the organization. Nobody is scared. Nobody is feeling defensive. Nobody thinks the business as a whole is on the wrong path (although there are definitely a few ventures that some feel are in the wrong).
I don't have the most broad corporate employment history, but as far as it extends, I've met tons of people who feel like they could join a competitor to their own employer and win against them within a decade or so. I have never met a single person who worked at Amazon that has felt that way about competing against Amazon. Even if that competitor had the pocketbooks of Wal-Mart. To me, that speaks volumes about a business strategy.
I don't have the most broad corporate employment history, but as far as it extends, I've met tons of people who feel like they could join a competitor to their own employer and win against them within a decade or so. I have never met a single person who worked at Amazon that has felt that way about competing against Amazon. Even if that competitor had the pocketbooks of Wal-Mart. To me, that speaks volumes about a business strategy.
Of course they're not scared, they have a nice stock price and seemingly no need to justify it.
At one point in time, Zynga had a good price. I was scared to accept their stock as compensation at that time, and I'm relieved about not pursuing it now.
With Amazon, I actually daydream about the stock taking a nose dive right before I get my next compensation offer. That way I get more stock. I have never had to worry about the long term future value of the company, so a dip is an arbitrage opportunity, as opposed to a risk (like Zynga).
With Amazon, I actually daydream about the stock taking a nose dive right before I get my next compensation offer. That way I get more stock. I have never had to worry about the long term future value of the company, so a dip is an arbitrage opportunity, as opposed to a risk (like Zynga).
Strangly, this was the business model of cable companies for the longest time. They never turned a profit. When they expanded, they could use the increased income stream to go deeper into debt. The profits and extra capital went into more expansion. Eventually, they ran out of room to expand, and where are they now?
Someday, Amazon will need to face the brutal reality of profit.
Someday, Amazon will need to face the brutal reality of profit.
They are enormously profitable, is where they are now. Same with mobile carriers who ran the same play.
The whole point of this business model is that once you stop expanding, you don't need to make huge investments anymore and suddenly the same prices&revenue bring in huge amounts of cash.
So, which cable companies, having run out of room to expand, have started going broke?
Interesting that the other replies to your question are so assured of the dominance of the cable companies. In other words, the perfect industry to disrupt. Before Apple came along, Nokia, RIM and Windows Mobile were poised to rule the mobile world, and could not imagine being relegated to niche marketshare in merely 7 years…
The cable companies are pretty terrifying to mess with. In Seattle, the city wants to provide gigabit fiber to residents, with a pilot project in many neighborhoods. Unfortunately, the champion of that effort, Mayor McGinn, is probably not going to win reelection and Comcast has already bought his challenger.
How did cable companies run out of room to expand?
There are very few areas in the developed world that are not covered, and few competitors left to buy out (in the UK, we're down to one major cable provider), so the easy gains where they'd roll into a new area and find a substantial proportion of residents waiting eagerly to be able to get cable service, are gone. Now they have to compete for customers that already have some other service they have actively chosen despite the availability of cable, and similarly face losing customers to those same services, both of which makes continued growth much more difficult.
Would it be so terrible if Amazon just stayed as a break-even company forever?
It would certainly be terrible for the shareholders. The whole point of investing in a company is to share in the profit.
Being a shareholder, you have a share in the ownership of the company. You make money when the value of the company increases. This is especially true with Amazon, which does not pay dividends (a share of profits to investors).
For a static, non-growing company, you can treat its value as equivalent to a bond paying as much interest as that company pays in dividends.
Company can have value w/o giving out money if it's expected that it will give out more money tomorrow; but it can't be expected to keep that way forever.
A stable, static company that brings $0 profit is worth $0 if it's intended to keep running that way; or worth $assets-$liabilities if it's intended to be stopped and dismantled.
Company can have value w/o giving out money if it's expected that it will give out more money tomorrow; but it can't be expected to keep that way forever.
A stable, static company that brings $0 profit is worth $0 if it's intended to keep running that way; or worth $assets-$liabilities if it's intended to be stopped and dismantled.
That's true. However, the value of the company will only increase if it develops profitable business units or it accumulates salable assets. In both cases this represents delayed profit, not nonexistent profit.
Yes; everyone investing it would be wasting their money.
Not if Amazon decides to use some of it's free cash to buy back shares...
Share buybacks and dividends are the end game for all public companies. Profits don't mean anything if money isn't being returned to shareholders.
Amazon's generous valuation means that long-term investors think they'll continue to grow, and someday they'll return money to shareholders...
Share buybacks and dividends are the end game for all public companies. Profits don't mean anything if money isn't being returned to shareholders.
Amazon's generous valuation means that long-term investors think they'll continue to grow, and someday they'll return money to shareholders...
If they never make a profit, how do they obtain the cash to spend on buying back shares?
Their businesses are profitable, they just aren't booking profits. Odds are eventually they'll simply use free cash to buy back shares instead of reinvesting it. Which is why Amazon attracts quite a few very sophisticated long-term investors, and why they command a relatively high valuation.
Well, it's possible to have free cash without being profitable on paper. For instance, remember that depreciation is a major expense for capitalised assets (such as fulfillment centres, data centres, computer equipment, real estate, etc.) but isn't actually a hard cash expense, just a formal expense. The hard cash expense came at the time that the investment was made, i.e. when the data centre or what have you was actually bought and paid for.
So, the difference between that "virtual" expense and actual cash is one accounting category that free cash can come from. There are others.
So, the difference between that "virtual" expense and actual cash is one accounting category that free cash can come from. There are others.
Yes, but in the long run if you're depreciating assets and don't have capital costs to buy new assets, you end up running out of assets.
Forever seems a bit long. But as long as Amazon feels it can reinvest above some threshold, it is prudent to continue investing instead of making profits.
There are some issues with this explanation. The main issue is that the rules of accounting have a very good provision to take into account investing into the future. It is called capitalization.
Thus, if a company spends money to build or acquire a new asset, it is called capital spending and it is not subtracted from the profits. Thus, for example, if a company had a million dollars of profit and decided to spend these million dollars on a new fulfillment center, they could spend the money for their fulfillment center and still report a million dollars in profit.
So it is not quite clear-cut to say that Amazon's desire to build fulfillment centers around the world is costing them their profits. Those things should be capitalized and once they are capitalized they should not affect the profits. Amazon did in fact report significant capital spending (as one can see on their cash flow statement).
However, things are not that simple. Sometimes some expenses which are about building for the future and investing into new growth are not capitalized. This is the case because for some expenses the benefits are so uncertain and difficult to quantify that the SEC requires that they are reported as ordinary expenses instead of capital spending. These types of expenses tend to involve R&D and may include certain administrative expenses associated with growth initiatives.
Therefore, many companies that are trying to grow do report lower profits because they have those expenses that are associated with investment into future growth but are not capitalized. This may be the case for amazon. But it is a question to what extent it is the case for amazon. For example, they do capitalize software and website development for new products and websites. So one cannot simply say that they are showing losses because they are spending all the money on making great new products. But then again, they expense software development for existing products. So perhaps the losses are associated with new growth features that are built into existing software.
So all in all it is a big muddle and it is not at all clear whether amazon is an inherently highly profitable company that happens to be investing in the future, or they are wasting money, or their business model is just not that profitable.
Thus, if a company spends money to build or acquire a new asset, it is called capital spending and it is not subtracted from the profits. Thus, for example, if a company had a million dollars of profit and decided to spend these million dollars on a new fulfillment center, they could spend the money for their fulfillment center and still report a million dollars in profit.
So it is not quite clear-cut to say that Amazon's desire to build fulfillment centers around the world is costing them their profits. Those things should be capitalized and once they are capitalized they should not affect the profits. Amazon did in fact report significant capital spending (as one can see on their cash flow statement).
However, things are not that simple. Sometimes some expenses which are about building for the future and investing into new growth are not capitalized. This is the case because for some expenses the benefits are so uncertain and difficult to quantify that the SEC requires that they are reported as ordinary expenses instead of capital spending. These types of expenses tend to involve R&D and may include certain administrative expenses associated with growth initiatives.
Therefore, many companies that are trying to grow do report lower profits because they have those expenses that are associated with investment into future growth but are not capitalized. This may be the case for amazon. But it is a question to what extent it is the case for amazon. For example, they do capitalize software and website development for new products and websites. So one cannot simply say that they are showing losses because they are spending all the money on making great new products. But then again, they expense software development for existing products. So perhaps the losses are associated with new growth features that are built into existing software.
So all in all it is a big muddle and it is not at all clear whether amazon is an inherently highly profitable company that happens to be investing in the future, or they are wasting money, or their business model is just not that profitable.
The accounting rules (GAAP) have only a loose correlation to how most modern large companies actually operate the levers of their businesses. Management teams of well-run companies spend very little time thinking about the formal financial statements.
Accounting bears the same relationship to actually running a business that the Efficient Market Hypothesis does to actually effectively investing -- which is to say, almost nothing.
Accounting bears the same relationship to actually running a business that the Efficient Market Hypothesis does to actually effectively investing -- which is to say, almost nothing.
While I agree that GAAP only vaguely represents reality, Management teams of all well run companies /DO/ think about formal financial statements.
These statements require thought or liability to potential jail time. In addition, the impact of these statements on financial markets (ie: stock price) is tremendous. Management damn well should be thinking about shareholder value.
These statements require thought or liability to potential jail time. In addition, the impact of these statements on financial markets (ie: stock price) is tremendous. Management damn well should be thinking about shareholder value.
> liability to potential jail time
Are there any examples of this? It seems to me the SEC didn't make much use of all the archived emails (guaranteed to be in place due to SOX) during the 2008 banking crisis which makes me generally distrustful of these formal written rules.
Are there any examples of this? It seems to me the SEC didn't make much use of all the archived emails (guaranteed to be in place due to SOX) during the 2008 banking crisis which makes me generally distrustful of these formal written rules.
Yes, WorldCom leaps to mind
http://www.accounting-degree.org/scandals/
They misstated costs as investments and were able to show big profits - for a while.
http://www.accounting-degree.org/scandals/
They misstated costs as investments and were able to show big profits - for a while.
While Worldcom is one incident where one(?) person was punished, it is from 2002, and from that page, it was following that incident that they enacted SOX, which afaik hasn't been used since. Or if it has, the incidents have been few and far between. I will continue to believe the system is rigged.
GAAP book value and GAAP earnings are definitely correlated with stronger returns for shareholders. Which seems to call into question the efficient market hypothesis, but says good things about GAAP.
"Management teams of well-run companies spend very little time thinking about the formal financial statements."
Not true at all. Well run companies do spend a lot of time in preparing their financial statements. First, it is required by law, see - Dodd-Frank, Sarbanes-Oxley, etc.
Second, it can get well-run companies with good intentions into a lot of trouble with the SEC and investor lobbying groups.
Not true at all. Well run companies do spend a lot of time in preparing their financial statements. First, it is required by law, see - Dodd-Frank, Sarbanes-Oxley, etc.
Second, it can get well-run companies with good intentions into a lot of trouble with the SEC and investor lobbying groups.
Sure, it's something the CFO thinks about, but it isn't really something that plays a factor into decisions about how to run the business for other C-level executives.
The majority of the article talks about free cash flow which takes capex into account. And capex does impact the p&l once it is built and being depreciated.
That's all true, but Amazon is free cash flow positive. So it's not like they're making huge "losses" after deducting capex.
The fcf for retailers can simply come from paying suppliers later than getting paid by customers. While a cheap source of capital (even this is doubtful), not exactly a winning strategy in the long run. The fcf will stop once revenue growth slows. As capital it is only cheap in the sense that you don't have to constantly raise equity for growth. Without earnings your equity base can't grow w/o getting more from shareholders.
Only ignorant investors can get fooled by large account payables. It's not a source of capital..
It is if it is stable enough (that is the negative working capital). In other settings (such as insurance) it is also known as float. Negative working capital is great if you can get it and keep it. The problem with the associated fcf is that the fcf is the derivative, literally. So if the working capital stops going more negative the associated fcf goes to zero.
Free cash flow is falling in the last couple of years.
http://i.imgur.com/sJWam5L.png
http://i.imgur.com/sJWam5L.png
Can you explain how capital expenditures do not affect profits? Doesn't capitalization just mean that expenses are applied over time? They don't disappear, correct?
Capital expenses do not affect profits for the reporting period they happen in. It is true that after that reporting period there is a depreciation cost applied to take account of loss of value of an asset.
For example, if a company buys a distribution center, it will not expense the cost of the distribution center as an expense. But as time goes on it will expense a depreciation expense that accounts for the loss of value of the distribution center as the building gets older, less useful, etc. But buildings last for a long time, and a building with the land it is on never actually goes down to a value of zero. So not all expenses associated with the distribution center will be applied over time.
So capitalizing something definitely helps you get more income.
For example, if a company buys a distribution center, it will not expense the cost of the distribution center as an expense. But as time goes on it will expense a depreciation expense that accounts for the loss of value of the distribution center as the building gets older, less useful, etc. But buildings last for a long time, and a building with the land it is on never actually goes down to a value of zero. So not all expenses associated with the distribution center will be applied over time.
So capitalizing something definitely helps you get more income.
Profit is how much your total assets have increased in value. Cash is an asset and a warehouse is an asset. If you spend $1m of your cash that would otherwise have been cash profits to build a warehouse worth $1m, your total assets remain the same and thus your profits remain the same.
But, unlike cash, a building doesn't retain its (dollar) value forever, it must be written off. I'm not sure how buildings are written off since they have a rather long "shelf" life, but laptops are generally written off over three year. So if you buy a $1500 laptop with cash in year 0, your profits in year zero are unaffected, but you must book a depreciation (a reduction in the value of your assets) worth $500 in years 1, 2 and 3. Hopefully you will, as with your warehouse, use your new asset to book profits in each of these years in excess of your write-offs.
But, unlike cash, a building doesn't retain its (dollar) value forever, it must be written off. I'm not sure how buildings are written off since they have a rather long "shelf" life, but laptops are generally written off over three year. So if you buy a $1500 laptop with cash in year 0, your profits in year zero are unaffected, but you must book a depreciation (a reduction in the value of your assets) worth $500 in years 1, 2 and 3. Hopefully you will, as with your warehouse, use your new asset to book profits in each of these years in excess of your write-offs.
Last quarter, Amazon had 834M of depreciation, and 281M of stock-based compensation: 1.1 billion of non-cash deductions from revenue. They made capital expenditures of 1.03 billion. They ended the quarter with about $100 million more cash than they started with.
281M of stock-based compensation ... ended the quarter with about $100 million more cash than they started with.
This looks like a loss to me. They could have sold $281M of stock and gotten $281M in cash; instead they ended up $181M short of that.
This looks like a loss to me. They could have sold $281M of stock and gotten $281M in cash; instead they ended up $181M short of that.
In general when you're a CEO or board member you'll make more money by granting yourself $x million in stock than you'll make by paying a dividend of $x million which has to be shared among all investors.
Not to mention, there are tax benefits to stock based comp. First, you often have the choice of when to exercise the stock which can make a world of difference especially with AMT, and second, if you hold for a year you'll pay the long term cap gains rate. For lower income people (hehe in this case that would be people who make less than $400k) that's still 15% which is an incredible discount. For higher income folks it's now about 23% but, again, that represents a tidy discount against their marginal tax rate.
Bezos doesn't take any stock-based compensation and takes only a minimal salary (less than 90K/year).
He makes money by increasing the value of his existing stock.
He makes money by increasing the value of his existing stock.
Yes. Capital expenditures don't disappear. You can buy a piece of land to build a warehouse. You can sell the land to get money back if needed, so you can't report the money for the land as loss.
Amazon has ~no profits before taking into account the ways that Capex (might) impact profits.
It's worth noting that Yglesias actually knows this[1]. His point is that public companies generally aren't allowed by their shareholders to be this ambitious.
Which 100% vindicates Eugenewei's point about tech companies being wary of capital markets.
[1]: http://www.slate.com/blogs/moneybox/2013/10/22/amazon_profit...
Which 100% vindicates Eugenewei's point about tech companies being wary of capital markets.
[1]: http://www.slate.com/blogs/moneybox/2013/10/22/amazon_profit...
If the stock market refused to acknowledge the value of long term investment, then all stocks would have the same book-to-market ratio.
However, investors and CEOs will rarely see eye-to-eye on the correct level of company growth, since CEOs by their nature tend to want to increase the size and scope of their company. Investors know that only some companies will benefit from this increase in size and scope, and others need to be kept focused on their core business.
However a key point that is often missed is that there is very little that shareholders can do to force CEOs to do their bidding. In spite of a lot of talk about activist shareholders, the only real discipline that management face is the thread of being bought out.
However, investors and CEOs will rarely see eye-to-eye on the correct level of company growth, since CEOs by their nature tend to want to increase the size and scope of their company. Investors know that only some companies will benefit from this increase in size and scope, and others need to be kept focused on their core business.
However a key point that is often missed is that there is very little that shareholders can do to force CEOs to do their bidding. In spite of a lot of talk about activist shareholders, the only real discipline that management face is the thread of being bought out.
>However a key point that is often missed is that there is very little that shareholders can do to force CEOs to do their bidding. In spite of a lot of talk about activist shareholders, the only real discipline that management face is the thread of being bought out.
Eh? Shareholders elect the board, and the CEO serves at the pleasure of the board. The shareholders can absolutely do something to force the CEO to do their bidding - they can fire him. It happens all the time.
Eh? Shareholders elect the board, and the CEO serves at the pleasure of the board. The shareholders can absolutely do something to force the CEO to do their bidding - they can fire him. It happens all the time.
Yes, it does indeed happen occasionally. However, such actions are relatively rare, hence the term "wall street walk" for large block holders selling their shares when they are unhappy with management, rather than trying to influence them.
That's a very idealized view. The reality is harsher. Public CEOs are under enormous pressure from many fronts.
The author may not fully appreciate the long game Bezos has been uniquely blessed to play: the sooner Bezos can effectively expand what's working, without over-expanding, it's bootstrapping on a massive scale: buying speed without diluting ownership to even more money sooner. It's not deficit spending (until it is), it's reinvesting profit to grow assets that are the body of the money monster. (For Starcraft fans out there: It's like being broke because of focusing on building SCVs.)
On the other side of the gorge of eternal peril: Cash is king, and should not be underestimated. Or those with the war-chests may try to puke all over Bezos' cake by mistaking lack of current reserves for an actual weakness. I'm sure Bezos is fully aware the ridge-line he's walking on. He probably has aces up both sleeves to clobber anyone that tries to make a move.
Long term, I'd say walmart continues to cash in on the greater unwashed that don't know any better for b&m impulse buys while amzn goes after suppliers and logistics, maybe even an Ali Baba and/or Kickstarter to bring in more product pipes.
On the other side of the gorge of eternal peril: Cash is king, and should not be underestimated. Or those with the war-chests may try to puke all over Bezos' cake by mistaking lack of current reserves for an actual weakness. I'm sure Bezos is fully aware the ridge-line he's walking on. He probably has aces up both sleeves to clobber anyone that tries to make a move.
Long term, I'd say walmart continues to cash in on the greater unwashed that don't know any better for b&m impulse buys while amzn goes after suppliers and logistics, maybe even an Ali Baba and/or Kickstarter to bring in more product pipes.
> For Starcraft fans out there: It's like being broke because of focusing on building SCVs
While I personally play Protoss, I think this is an awesome way of thinking about it. "Keep your money low" is a mantra that you must remember when playing SC2, and I've always been curious how that translates to actual economics.
If I recall correctly, there was an actual paper written applying Starcraft economics to "real world" econ. Wonder if I can find it..
While I personally play Protoss, I think this is an awesome way of thinking about it. "Keep your money low" is a mantra that you must remember when playing SC2, and I've always been curious how that translates to actual economics.
If I recall correctly, there was an actual paper written applying Starcraft economics to "real world" econ. Wonder if I can find it..
I'm not sure if it is a 100% perfect analogy to real-world economics, but the best analogy is that all money you use in Starcraft is "working capital". Money in the bank only does you any good insofar as it allows you to handle unexpected emergencies, all other cash should be deployed towards your goals. Which in Starcraft would be to defeat your opponent with generating more cash as a subordinate objective, and in business would be to either make as much money as possible throughout the history of your company, or fulfill whichever goals your company has. Amazon does this by keeping low margins to discourage competition and reinvesting as much as possible.
The biggest difference between Starcraft economics and real-world economics is that Starcraft has no regular expenses or debt, so there is no way to go bankrupt. This removes a large risk element in reinvesting your money.
The biggest difference between Starcraft economics and real-world economics is that Starcraft has no regular expenses or debt, so there is no way to go bankrupt. This removes a large risk element in reinvesting your money.
Starcraft uses supply depots to represent the recurring costs of supporting your army. Using the normal resources would over complicate the game. In a way you could be "in debt" if you ever don't have enough supply.
I believe the business term is worrying about a "lazy balance sheet". You want every dollar working its bum off, not lazing around in a bank.
This is usually an argument for taking on debt to finance new projects.
That said, the complicated way capital gains and income tax interact in the USA mean that lots of investors prefer share prices to rise to any dividend; so when there's nothing to spend cash on, it just piles up.
Compare Australia, where franking credits mean that major companies regularly pay dividends. It's a different kind of complication, but I think on balance it's the better outcome.
This is usually an argument for taking on debt to finance new projects.
That said, the complicated way capital gains and income tax interact in the USA mean that lots of investors prefer share prices to rise to any dividend; so when there's nothing to spend cash on, it just piles up.
Compare Australia, where franking credits mean that major companies regularly pay dividends. It's a different kind of complication, but I think on balance it's the better outcome.
> He probably has aces up both sleeves to clobber anyone that tries to make a move.
The razor thin margins are a great moat in themselves.
The razor thin margins are a great moat in themselves.
I'm still trying to work out whether (1) ballard's remarkable cascade of mixed metaphors was itself a joke, or (2) eru's comment was poking fun at it, or (3) both comments were intended entirely straight and it's just coincidence that the density of metaphor mixture is so high.
Both comments make perfectly good sense taken "straight". I'm leaning towards #3, with apologies to ballard and/or eru if I missed their joke.
(My father was in a meeting once when someone said "Let's not beat about the bush. | When all's said and done, | at the end of the day | you just have to take the bull by the horns." At which, at least the way he tells it, everyone else nodded sagely while he desperately tried not to laugh too loudly.)
Both comments make perfectly good sense taken "straight". I'm leaning towards #3, with apologies to ballard and/or eru if I missed their joke.
(My father was in a meeting once when someone said "Let's not beat about the bush. | When all's said and done, | at the end of the day | you just have to take the bull by the horns." At which, at least the way he tells it, everyone else nodded sagely while he desperately tried not to laugh too loudly.)
My father-in-law who himself was a director in a large international company told me about a game they used to play in meetings: bullshit bingo. You have to make up your cards ahead of time and then mark off the squares as you hear buzzwords.
That was an actual game at some MIT presentations. Eventually the speaker noticed.
I'm not a native speaker. And, I spent too much time with managers, recently.
So I wish it could have been 1 and 2, but for me it's 3.
So I wish it could have been 1 and 2, but for me it's 3.
Bezos wanted AWS to be a utility with discount rates, even if that meant losing money in the short term. Willem van Biljon, who worked with Chris Pinkham on EC2 and stayed for a few months after Pinkham quit in 2006, proposed pricing EC2 instances at fifteen cents an hour, a rate that he believed would allow the company to break even on the service. In an S Team meeting before EC2 launched, Bezos unilaterally revised that to ten cents. “You realize you could lose money on that for a long time,” van Biljon told him. “Great,” Bezos said.
Bezos believed his company had a natural advantage in its cost structure and ability to survive in the thin atmosphere of low-margin businesses. Companies like IBM, Microsoft, and Google, he suspected, would hesitate to get into such markets because it would depress their overall profit margins. Bill Miller, the chief investment officer at Legg Mason Capital Management and a major Amazon shareholder, asked Bezos at the time about the profitability prospects for AWS. Bezos predicted they would be good over the long term but said that he didn’t want to repeat “Steve Jobs’s mistake” of pricing the iPhone in a way that was so fantastically profitable that the smartphone market became a magnet for competition.