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“Percentage margins are not one of the things we are seeking to optimize. It’s the absolute dollar free cash flow per share that you want to maximize, and if yo

by mbesto 8y ago

“Percentage margins are not one of the things we are seeking to optimize. It’s the absolute dollar free cash flow per share that you want to maximize, and if you can do that by lowering margins, we would do that. So if you could take the free cash flow, that’s something that investors can spend. Investors can’t spend percentage margins.” “What matters always is dollar margins: the actual dollar amount. Companies are valued not on their percentage margins, but on how many dollars they actually make, and a multiple of that.” “When forced to choose between optimizing the appearance of our GAAP accounting and maximizing the present value of future cash flows, we’ll take the cash flows.” Jeff Bezos is very focused on this “absolute dollar free cash flow metric.” https://25iq.com/2014/04/26/a-dozen-things-i-have-learned-from-jeff-bezos/ https://25iq.com/2014/04/26/a-dozen-things-i-have-learned-fr... People really need to get off of the "income analysis" trope with Amazon. It's not how they operate their business, so why do people (analysts and media mainly) analyze it any other way?

got2surf 8y ago
Great read. Points #5 (on being able to use a longer time horizon when investing in ideas to let them grow) and #6 (on the growing importance of consumers) stood out to me as well.
landryraccoon 8y ago
There's a tradeoff here. Bezos is of course a world class executive and founder, but he's underselling the advantage of big margins which is risk. In a downturn, a slight decrease in margins across the board will push a company on the razor's edge from profitability to unprofitability. Margin means margin for error - when the company isn't doing well and investors are scattering to safety and liquidity is nowhere to be found a higher margin gives your company a buffer when you have to cut. Of course when revenues are growing like crazy and the economy is gangbusters it sounds great to cut margins for absolute growth but that's a booming economy. Things are very different in a downturn.
- nostrademons 8y ago
  There's also an asymmetry of information and of control. In a downturn, Bezos has full visibility into where all of Amazon's COGS is going, and a number of levers he can turn to axe some of that spending, reduce future investment, or shed unprofitable business lines. Wall Street has virtually zero of that information (they get the consolidated financial statements, but none of the detailed breakdown) and zero of that leverage. Therefore, it's significantly less risky to Bezos to run on razor-thin margins than it is to an Amazon shareholder. Same reason that founding a startup is significantly less risky for a world expert in its problem domain than for a random investor in that startup. The founder has full knowledge of the domain and a lot of levers they can pull to adjust strategy; the investor has none of that. That's also why many VCs require terms to reduce their risk (liquidation preferences, participation, anti-dilution, warrants) or increase their control (board seats, voting rights, information rights).
- mbesto 8y ago
  > when the company isn't doing well and investors are scattering to safety and liquidity is nowhere to be found a higher margin gives your company a buffer when you have to cut And how has that worked out for 440 companies that used to be in the F500 that no longer are there? > In a downturn, a slight decrease in margins across the board will push a company on the razor's edge from profitability to unprofitability. Except the reason their margins are so low is because they keep feeding capital into the business to fund new projects. > Of course when revenues are growing like crazy and the economy is gangbusters it sounds great to cut margins for absolute growth but that's a booming economy. Things are very different in a downturn. Yup, you're right, things are very different in a downturn. Great listen about how NetSuite navigated downturns: https://a16z.com/2015/05/15/a16z-podcast-why-saas-revenue-is-worth-more-than-traditional-software-sales/ https://a16z.com/2015/05/15/a16z-podcast-why-saas-revenue-is...
  - kevin_thibedeau 8y ago
    > And how has that worked out for 440 companies that used to be in the F500 that no longer are there? Most of them were raped by their corporate officers.
  - ethbro 8y ago
    This seems like a dilemma between a superior strategy, but only if executed with discipline. In reality the majority of businesses which run on large margins get lazy, allocate capital ineffectively, and underinvest in R&D. Thin margins force you be lean. Thick margins afford you the opportunity (and risk) not to be.
- petra 8y ago
  Amazon retail has gross margins of 37% and net margin of, lets say 3.7%. That means it cost it 63% to buy products(on credit like terms), and 33.3% to fullfil orders. So from a risk terms we can say their margin is equivalent to 3.7/33.3 = about 10%. Which isn't bad. Furthermore, a lot of those costs are variable costs, like shipping, which go down if demand drops.
- aaronblohowiak 8y ago
  Using systems theory, i think margin is a buffer for profitability that (to your point) allows for shock absorbing (as all buffers do.) Higher margins are also a risk of losing market share to a price-competitor, and you can suggest that market share is also a buffer for consumer engagement -- the ability of a firm to successfully raise prices (in the short term) is proportional to its market share. Does the buffer of market share outweigh the buffer of margin? Interestingly, the "what companies are valued on" is an increasingly surprising thing when you think about how real estate development works. Properties are valued on a multiple of their Net Operating Income, which creates a scenario where capital improvements that have low ROI in terms of NOI are actually high ROI when you include the effect on equity (future sale price.) In the current environment of 4% cap rates (NOI / Sale price) each additional dollar of income increases the value of the property by $26 (one dollar for the income and 25 dollars for the sale price bump.) This is why every landlord is very incentivized to borrow as much as possible to improve property as much as possible to raise rents as high as the market will reliably bear (vacancy kills your NOI and scares off acquirers) and then sell the property.
- samstave 8y ago
  ANd what better what to obfuscate actual company footing - and real power than to prevent people from looking at, analyzing or even knowing what level of error margins you're capable of floating in a downturn. What better way to additionally hedge against that than to have a many-billion-dollar contract for hosting with the government.
  - anongraddebt 8y ago
    Exactly. Your comment is the most astute so far in this thread. Amazon is a cash cow that simply feeds a relatively decentralized innovation engine. Moreover, the strategic moves they make (intentionally keeping GAAP margins thin, not separately disclosing AWS in the financial statements for years, etc.) should always be assumed to come from multiple, well-considered motivations. Someone says, "It's just customer-obsession." Yes, that's the simple myth/story they want you to believe.
- a13n 8y ago
  Amazon has massive control over their margins. Therefore in a downturn, they just turn a dial and are profitable again. They're just choosing to reinvest profits into growth, and can stop doing that whenever they want. I think we mostly agree, but not about how much risk they're exposing themselves to in a downturn.
- andy_ppp 8y ago
  Sure but who will have lower margins than Amazon in a downturn; also higher margins also means more competition from people with lower margins so I can’t really agree with your analysis.
- ksec 8y ago
  That is of course looking only at Net margins. Assuming they are actually on thin margins from there Gross Margins which is still a respectable 30+%. Amazon does go into very deep to try and hide their net margins or competitive advantage. They continue to invest and optimise their operation.
dba7dba 8y ago
> Jeff Bezos is very focused on this “absolute dollar free cash flow metric. I wish Apple operated that way, as lowering Apple device price will very likely increase the absolute amount of dollars coming into their back acct. I mean I get Amazon and Apple ear their income via different methods but still.
- tossaccount123 8y ago
  >I wish Apple operated that way, as lowering Apple device price will very likely increase the absolute amount of dollars coming into their back acct. I've always thought they should make a $10,000+ model. iPhones are essentially a status symbol unless you buy it for privacy purposes. There is a decent market who would pay a lot of money to have a iPhone that the plebes can't afford. Hell, even a lot of broke people would save up to buy one It's like cars, if you just want a tool to get from point A to B you can buy one cheap. On the other hand you can also spend hundreds of thousands on luxury cars. Make some limited edition iPhones every year and I'm sure there would be demand and an eventual collector market
  - scarface74 8y ago
    How is anything a “status symbol” with over 30%-50% market share in industrialized nations? There are a lot more reasons to buy iPhones than status symbols and privacy. Chief of which is better performance and longevity. The iPhone 5s from 2013 is still getting OS updates. The iPhone 6s from 2015 will still outperform most new Android phones and should be getting updates for at least another two years.
    - tossaccount123 8y ago
      >How is anything a “status symbol” with over 30%-50% market share in industrialized nations? That's my point, when it came out the marketing around the iPhone was how using apple made you a trendsetter and you were ahead of the curve, now everybody has one. So raise the price and bring back the sense of exclusivity as for performance, it really doesn't matter for luxury items. People pay hundreds of thousands of dollars for old cars and it's not because they perform better than a modern economy class vehicle
roenxi 8y ago
Businesses are judged by the income they produce because the reason businesses exist is to generate income. If people want to run a charity they would presumably register as a charity. There are interesting edge cases, but the No 1 company on the NASDAQ by market cap is not one of them. "It's not how they run their business" is an interesting observation, but businesses ultimately don't get to choose the yardstick they are measured by. In the long term, that is income.
sonnyblarney 8y ago
Because GAAP is a useful tool for analyzing a business, independent of what the CEO might say. The CEO is not exactly an objective observer to his own company.
scarface74 8y ago
When you don’t have a standard means of describing a company’s numbers like GAAP you end up with something like what WeWork does. https://www.gfmag.com/topics/blogs/wework-works-bond-market-despite-unusual-accounting-practices https://www.gfmag.com/topics/blogs/wework-works-bond-market-... However, in its disclosures to bond investors, the company added back items like stock-based compensation, sales and marketing expenses, even general and administrative expenses to arrive at what it called a “community-adjusted EBITDA” of positive $233 million.
scott00 8y ago
Company executives are often smart, and often know their business better than anyone else, but they're also biased. What comes out of a CEO's mouth is very likely to have more to do with what he or she wants _you_ to think than with what _they_ actually think. So taking CEO's grand theories with a grain of salt is in general a good idea for investors. As to why margins matter... Bezos' quote talks about how valuations are multiples of cash flows. This is true, but multiples aren't constants. Basic investment theory suggests that the multiple should be an increasing function of the company's growth rate, its ratio of sales to assets, and its margins. So if you want to maximize your company's value you ought to be concerned with all of those things. Which isn't to say that trading lower margins for higher growth is a bad decision in Amazon's case, but it's not like it's an irrelevant number.
nwellnhof 8y ago
> People really need to get off of the "income analysis" trope with Amazon. What does this have to do with the article? Percentage margins aren't mentioned anywhere. It mostly talks about absolute dollar operating income which, unlike GAAP income, isn't too different from free cash flow. For example: "Operating income for AWS was $7.29 billion in 2018, up from $4.31 billion in 2017. [...] And AWS is the lion's share of Amazon's operating income: Nearly 58% in the fourth quarter of 2018, and nearly 59% for the full year." So AWS is certainly a major driver for Amazon's free cash flow.

by mbesto 8y ago

got2surf 8y ago

Great read. Points #5 (on being able to use a longer time horizon when investing in ideas to let them grow) and #6 (on the growing importance of consumers) stood out to me as well.

landryraccoon 8y ago

There's a tradeoff here. Bezos is of course a world class executive and founder, but he's underselling the advantage of big margins which is risk. In a downturn, a slight decrease in margins across the board will push a company on the razor's edge from profitability to unprofitability. Margin means margin for error - when the company isn't doing well and investors are scattering to safety and liquidity is nowhere to be found a higher margin gives your company a buffer when you have to cut. Of course when revenues are growing like crazy and the economy is gangbusters it sounds great to cut margins for absolute growth but that's a booming economy. Things are very different in a downturn.

nostrademons 8y ago
There's also an asymmetry of information and of control. In a downturn, Bezos has full visibility into where all of Amazon's COGS is going, and a number of levers he can turn to axe some of that spending, reduce future investment, or shed unprofitable business lines. Wall Street has virtually zero of that information (they get the consolidated financial statements, but none of the detailed breakdown) and zero of that leverage. Therefore, it's significantly less risky to Bezos to run on razor-thin margins than it is to an Amazon shareholder. Same reason that founding a startup is significantly less risky for a world expert in its problem domain than for a random investor in that startup. The founder has full knowledge of the domain and a lot of levers they can pull to adjust strategy; the investor has none of that. That's also why many VCs require terms to reduce their risk (liquidation preferences, participation, anti-dilution, warrants) or increase their control (board seats, voting rights, information rights).
mbesto 8y ago
> when the company isn't doing well and investors are scattering to safety and liquidity is nowhere to be found a higher margin gives your company a buffer when you have to cut And how has that worked out for 440 companies that used to be in the F500 that no longer are there? > In a downturn, a slight decrease in margins across the board will push a company on the razor's edge from profitability to unprofitability. Except the reason their margins are so low is because they keep feeding capital into the business to fund new projects. > Of course when revenues are growing like crazy and the economy is gangbusters it sounds great to cut margins for absolute growth but that's a booming economy. Things are very different in a downturn. Yup, you're right, things are very different in a downturn. Great listen about how NetSuite navigated downturns: https://a16z.com/2015/05/15/a16z-podcast-why-saas-revenue-is-worth-more-than-traditional-software-sales/ https://a16z.com/2015/05/15/a16z-podcast-why-saas-revenue-is...
- kevin_thibedeau 8y ago
  > And how has that worked out for 440 companies that used to be in the F500 that no longer are there? Most of them were raped by their corporate officers.
- ethbro 8y ago
  This seems like a dilemma between a superior strategy, but only if executed with discipline. In reality the majority of businesses which run on large margins get lazy, allocate capital ineffectively, and underinvest in R&D. Thin margins force you be lean. Thick margins afford you the opportunity (and risk) not to be.
petra 8y ago
Amazon retail has gross margins of 37% and net margin of, lets say 3.7%. That means it cost it 63% to buy products(on credit like terms), and 33.3% to fullfil orders. So from a risk terms we can say their margin is equivalent to 3.7/33.3 = about 10%. Which isn't bad. Furthermore, a lot of those costs are variable costs, like shipping, which go down if demand drops.
aaronblohowiak 8y ago
Using systems theory, i think margin is a buffer for profitability that (to your point) allows for shock absorbing (as all buffers do.) Higher margins are also a risk of losing market share to a price-competitor, and you can suggest that market share is also a buffer for consumer engagement -- the ability of a firm to successfully raise prices (in the short term) is proportional to its market share. Does the buffer of market share outweigh the buffer of margin? Interestingly, the "what companies are valued on" is an increasingly surprising thing when you think about how real estate development works. Properties are valued on a multiple of their Net Operating Income, which creates a scenario where capital improvements that have low ROI in terms of NOI are actually high ROI when you include the effect on equity (future sale price.) In the current environment of 4% cap rates (NOI / Sale price) each additional dollar of income increases the value of the property by $26 (one dollar for the income and 25 dollars for the sale price bump.) This is why every landlord is very incentivized to borrow as much as possible to improve property as much as possible to raise rents as high as the market will reliably bear (vacancy kills your NOI and scares off acquirers) and then sell the property.
samstave 8y ago
ANd what better what to obfuscate actual company footing - and real power than to prevent people from looking at, analyzing or even knowing what level of error margins you're capable of floating in a downturn. What better way to additionally hedge against that than to have a many-billion-dollar contract for hosting with the government.
- anongraddebt 8y ago
  Exactly. Your comment is the most astute so far in this thread. Amazon is a cash cow that simply feeds a relatively decentralized innovation engine. Moreover, the strategic moves they make (intentionally keeping GAAP margins thin, not separately disclosing AWS in the financial statements for years, etc.) should always be assumed to come from multiple, well-considered motivations. Someone says, "It's just customer-obsession." Yes, that's the simple myth/story they want you to believe.
a13n 8y ago
Amazon has massive control over their margins. Therefore in a downturn, they just turn a dial and are profitable again. They're just choosing to reinvest profits into growth, and can stop doing that whenever they want. I think we mostly agree, but not about how much risk they're exposing themselves to in a downturn.
andy_ppp 8y ago
Sure but who will have lower margins than Amazon in a downturn; also higher margins also means more competition from people with lower margins so I can’t really agree with your analysis.
ksec 8y ago
That is of course looking only at Net margins. Assuming they are actually on thin margins from there Gross Margins which is still a respectable 30+%. Amazon does go into very deep to try and hide their net margins or competitive advantage. They continue to invest and optimise their operation.

dba7dba 8y ago

> Jeff Bezos is very focused on this “absolute dollar free cash flow metric. I wish Apple operated that way, as lowering Apple device price will very likely increase the absolute amount of dollars coming into their back acct. I mean I get Amazon and Apple ear their income via different methods but still.

tossaccount123 8y ago
>I wish Apple operated that way, as lowering Apple device price will very likely increase the absolute amount of dollars coming into their back acct. I've always thought they should make a $10,000+ model. iPhones are essentially a status symbol unless you buy it for privacy purposes. There is a decent market who would pay a lot of money to have a iPhone that the plebes can't afford. Hell, even a lot of broke people would save up to buy one It's like cars, if you just want a tool to get from point A to B you can buy one cheap. On the other hand you can also spend hundreds of thousands on luxury cars. Make some limited edition iPhones every year and I'm sure there would be demand and an eventual collector market
- scarface74 8y ago
  How is anything a “status symbol” with over 30%-50% market share in industrialized nations? There are a lot more reasons to buy iPhones than status symbols and privacy. Chief of which is better performance and longevity. The iPhone 5s from 2013 is still getting OS updates. The iPhone 6s from 2015 will still outperform most new Android phones and should be getting updates for at least another two years.
  - tossaccount123 8y ago
    >How is anything a “status symbol” with over 30%-50% market share in industrialized nations? That's my point, when it came out the marketing around the iPhone was how using apple made you a trendsetter and you were ahead of the curve, now everybody has one. So raise the price and bring back the sense of exclusivity as for performance, it really doesn't matter for luxury items. People pay hundreds of thousands of dollars for old cars and it's not because they perform better than a modern economy class vehicle

roenxi 8y ago

Businesses are judged by the income they produce because the reason businesses exist is to generate income. If people want to run a charity they would presumably register as a charity. There are interesting edge cases, but the No 1 company on the NASDAQ by market cap is not one of them. "It's not how they run their business" is an interesting observation, but businesses ultimately don't get to choose the yardstick they are measured by. In the long term, that is income.

sonnyblarney 8y ago

Because GAAP is a useful tool for analyzing a business, independent of what the CEO might say. The CEO is not exactly an objective observer to his own company.

scarface74 8y ago

When you don’t have a standard means of describing a company’s numbers like GAAP you end up with something like what WeWork does. https://www.gfmag.com/topics/blogs/wework-works-bond-market-despite-unusual-accounting-practices https://www.gfmag.com/topics/blogs/wework-works-bond-market-... However, in its disclosures to bond investors, the company added back items like stock-based compensation, sales and marketing expenses, even general and administrative expenses to arrive at what it called a “community-adjusted EBITDA” of positive $233 million.

scott00 8y ago

Company executives are often smart, and often know their business better than anyone else, but they're also biased. What comes out of a CEO's mouth is very likely to have more to do with what he or she wants _you_ to think than with what _they_ actually think. So taking CEO's grand theories with a grain of salt is in general a good idea for investors. As to why margins matter... Bezos' quote talks about how valuations are multiples of cash flows. This is true, but multiples aren't constants. Basic investment theory suggests that the multiple should be an increasing function of the company's growth rate, its ratio of sales to assets, and its margins. So if you want to maximize your company's value you ought to be concerned with all of those things. Which isn't to say that trading lower margins for higher growth is a bad decision in Amazon's case, but it's not like it's an irrelevant number.

nwellnhof 8y ago

> People really need to get off of the "income analysis" trope with Amazon. What does this have to do with the article? Percentage margins aren't mentioned anywhere. It mostly talks about absolute dollar operating income which, unlike GAAP income, isn't too different from free cash flow. For example: "Operating income for AWS was $7.29 billion in 2018, up from $4.31 billion in 2017. [...] And AWS is the lion's share of Amazon's operating income: Nearly 58% in the fourth quarter of 2018, and nearly 59% for the full year." So AWS is certainly a major driver for Amazon's free cash flow.