Brands in the News

Three Questions about Amazon

12 May , 2014  

Amazon recently released its quarterly results. The company grew revenue sharply, exceeding $16 billion for the quarter. Profit, well, there wasn’t much of that. The company made just $82 million, a margin of 0.5%.

Amazon is a very strange operation. Here are three questions to think about.

 

Question #1: Where is the profit?

Amazon is not a very profitable company. Indeed, it isn’t far from being a non-profit organization.

The company’s latest quarterly results were not an exception; Amazon has a long history of limited profitability. Last year Amazon had net income of just $274 million on revenue of $74.5 billion, just 0.36%. This was actually an improvement; Amazon lost money the prior year. New companies often lose money but Amazon is not a new venture.

The issue isn’t that retailing is an impossible business. Last year Wal-Mart made $15.9 billion. Gap made $1.3 billion. Even Lululemon made more than Amazon, delivering $280 million in net income despite having just 2% of Amazon’s revenue.

Amazon’s lack of profitability is breathtaking.

 

Question #2: Why do people buy the stock?

Amazon’s close to non-profit status is not a problem for investors. Even after a recent drop, Amazon’s stock is over $300 per share, giving the company a market cap of $134.5 billion. Amazon’s P/E ratio is 473. Wal-Mart’s is 16. Lululemon’s is 23.

Investors clearly believe the future is bright for Amazon. Anyone buying the stock must be fairly confident that Amazon will eventually make big profits.

To justify the stock price, investors are apparently counting on an amazing transformation. If we take Wal-Mart’s P/E ratio of 16 as typical for a large retailer, then people must think Amazon’s profit will eventually jump from last year’s $274 million to more than $8 billion.

 

Question #3: Will Amazon ever make big profits?

This, of course, is the critical question.

I predict it will come down to a simple issue: how much customer advantage does Amazon have? Is there a unique benefit people value and will pay more for? If there is, then Amazon can eventually raise prices, increase margins and deliver real profits. If there isn’t, then profits will be low; when Amazon raises prices people will simply buy from other firms.

My concern is that Amazon competes today partly on value. In many states it starts off cheaper than other retailers since Amazon doesn’t always have to pay sales taxes. With the company’s big selection, low prices and free shipping it is a tough proposition to beat.

But will people eventually pay a premium to buy from Amazon? I’m not at all certain. And that could be a long-term problem.


2 Responses

  1. nanotech2 says:

    I think Amazon used to win because it had the lowest prices. I think Amazon can continue to win because it delivers the best value. Amazon delivers value in a combination of price (which doesn’t have to be the lowest), convenience (via selection, ultra-fast delivery), and the most amazing customer service I have ever experienced (just try chatting or emailing them with a request sometime). As consumers begin to understand this value they will be willing to pay a premium for it, especially as real incomes eventually rise.

    At this point, Amazon has the scale to match the lowest prices while still increasing margins because it now has an ultra-low cost structure. Indeed, Amazon has decent gross margins on its traditional retail business, but the net income margins are practically zero because of the rapid expensing of investments in software and infrastructure which enable the development of new businesses (Kindle, AWS, Amazon Locker, etc.)

    I believe Amazon is trying to expand the “moat” around the trust and top-of-mindedness it has built with its customers by continuing to offer incredible value in other purchase areas of a consumer (movies, songs, groceries, etc.) This allows it to build a business with a low cost of acquisition because customers already trust Amazon, unlike someone such as WebVan who may have had to acquire customers through expensive advertisements.

    But I agree with you that we probably won’t see profits from Amazon anytime soon, at least not until Amazon finally feels that it has exhausted all potentially profitable avenues of investment that are even tangentially relevant to its beloved customer base. And due to a rapidly changing technological and business environment combined with Amazon’s ambitions, exhausting potentially profitably avenues of investment may take a while.

  2. Fabio says:

    Now I understand why they cancelled all “free shipments” from the UK to Belgium. Since I got that e-mail from customer services, I haven’t ordered anything. And I was a very frequent user.

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