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Amazon and the "profitless business model" fallacy
- hayksaakian 13y agoThink about it this way. Profits are dollars that leave the company. By sitting on low profits, Amazon turns all its cash towards itself.
- dangrossman 13y agoThat'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.
- quaunaut 13y agoMoney 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.
- deleted 13y ago[deleted]
- epa 13y ago"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.
- ImprovedSilence 13y agoRight, 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)
- graeme 13y agoA certain portion of profits will leave the company as taxes. Investing the money now means that amazon gets to use 100% of those dollars.
- epa 13y agonet income != taxable income
- yetanotherphd 13y agoNo, 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.
- aresant 13y ago" 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.htm http://services.amazon.com/fulfillment-by-amazon/benefits.ht...
- nhebb 13y agoI 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?
- deleted 13y ago[deleted]
- hershel 13y agoThis 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.
- jaggederest 13y agoI 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.
- pmarca 13y agoI 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.
- WalterBright 13y agoAmazon 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.
- eru 13y agoIsn't Amazon's P/E negative?
- selectodude 13y agoRight now, it's 1,286.56.
- brianberns 13y agoIt fluctuates tremendously because the denominator is so close to zero.
- gamegoblin 13y agoIsn't Bezos into the whole "Long Now" long-term thinking organization?
- sidcool 13y agoI 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)
- saosebastiao 13y agoOut 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.
- snowwrestler 13y agoOf course they're not scared, they have a nice stock price and seemingly no need to justify it.
- saosebastiao 13y agoAt 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).
- gizbot 13y agoStrangly, 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.
- Zombieball 13y agoHow did cable companies run out of room to expand?
- vidarh 13y agoThere 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.
- MaysonL 13y agoSo, which cable companies, having run out of room to expand, have started going broke?
- ericd 13y agoThey ran out of room to expand and now they're regional monopolies, and can gouge their customers with impunity. Was that your point?
- yuhong 13y agoSo I wonder what led the cable companies to try this.
- pmarca 13y ago
- ars 13y agoWould it be so terrible if Amazon just stayed as a break-even company forever?
- tptacek 13y agoYes; everyone investing it would be wasting their money.
- Mikeb85 13y agoNot 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...
- cperciva 13y agoIf they never make a profit, how do they obtain the cash to spend on buying back shares?
- abalashov 13y agoWell, 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.
- cperciva 13y agoYes, 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.
- hristov 13y agoThere 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.
- pbreit 13y agoCan 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?
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- krakensden 13y agoIt'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_profits_not_there_and_they_re_not_worried.html http://www.slate.com/blogs/moneybox/2013/10/22/amazon_profit...
- yetanotherphd 13y agoIf 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.
- tsotha 13y ago>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.
- yetanotherphd 13y agoYes, 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.
- ballard 13y agoThe 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.
- eru 13y ago> 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.
- gjm11 13y agoI'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.)
- eru 13y agoI'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.
- moca 13y agoBy 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.
- minouye 13y agoIf you're not familiar with the "long-term" thinking of Bezos, this anecdote from Brad Stone's recent book on Amazon is particularly interesting: 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.
- gotrecruit 13y agoi'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.
- KaoruAoiShiho 13y agoAmazon only has around 10 more years before 3d printing starts to kill retail. Beware.
- vacri 13y agoPlastic precursor doesn't simply appear out of thin air.
- michaelt 13y agoI 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?
- KaoruAoiShiho 13y agoStarts 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.
- netrus 13y agoebooks were the far far bigger challange for Amazon compared to 3d printing. Printing clothes? Printing Mobiles? Printing Washing machines? Never. Ever.
- craytheon 13y agoNever say never
- qq66 13y agoSmall scale manufacturing can only compete with large scale manufacturing where speed, customization, or luxury are important enough to pay a large premium for.
- darkarmani 13y agoIs 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.
- sdepablos 13y agoGreat 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.
- timedoctor 13y agoThere 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.
- devx 13y agoI 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-back-the-growth-of-e-books-around-the-world/ http://davidgaughran.wordpress.com/2011/07/11/amazon-hold-ba...
- tks2103 13y agoThe 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.
- deong 13y agoOut 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.
- tks2103 13y agoYeah, 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.
- swalsh 13y agoI'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.
- don_draper 13y agoI hear working at Amazon requires being available on call and working long hours. If this is the future I'm worried.
- Semaphor 13y agoI 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".
- hownottowrite 13y agoEverything you need to know about Jeff's strategy is in this book: http://www.amazon.com/Sam-Walton-Made-In-America/dp/0553562835 http://www.amazon.com/Sam-Walton-Made-In-America/dp/05535628... Different medium and market, but basically the same overall strategy.
- brisance 13y agoThis is a dangerous narrative that links the founder to the company in the same way that Apple is forever linked to Steve Jobs.
- snowwrestler 13y agoAmazon is Jeff Bezos's company and everyone knows it. He maintains detailed oversight of all the lines of business.
- coldcode 13y agoUntil he gets hit by a bus or some cancer cells. Then what?
- snowwrestler 13y agoThen Amazon will be a very different company under someone else's leadership.
- walshemj 13y agoIts 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
- codex 13y agoBezos 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.
- vasilipupkin 13y agoRight. 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
- codex 13y agoIt 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.
- gcb0 13y agothis 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.