Is Amazon’s Strategy Starting to Work?

Amazon’s goal is to sell you pretty much everything including not just consumer goods as they always have, but also streaming services (movies, TV shows, and now games), credit card reading ability, smartphone/tablet apps, and probably more things to come.  The main drawback to their dominating this market has been shipping issues.  Walmart and Target are right there so that people can go buy things and have them in hand immediately, and they only have to ship their products to a few thousand stores.  Amazon has a delay built in from the time you order to the time it shows up, and they have to deliver to millions of end users.  Over the past several years Amazon has spent a lot of money trying to close that gap between itself and its competitors.

Amazon Prime was set up to be the flagship for this change in approach for the company, but they are continually offering more related services.  Two of the initiatives that have allowed this are sorting centers and their same-day delivery that is becoming available in more places over time.  They now can control their products farther down the stream and are getting ever closer to directly handing things to consumers just like their brick and mortar competition.  Having more centers to work from helps, but it also costs money, so let’s look at the financial impact.

Amazon Annual Reports Data
Year 2010 2011 2012 2013
Revenue $34 Billion 48 B 61B 74.5B
COGS % of Rev. 77.7% 77.6% 75.2% 72.8%
SG&A% 17.3% 15.9% 14.3% 12.9%
Operating Exp.% 99% 98.9% 98.2% 95.9%
Net Income $1.15B 63M -39M 274M

 

Revenue growth has not been a problem for Amazon more than doubling from 2010 to 2013, but you can see some of the underlying costs have changed and affected their profitability.  Net income was a lot healthier in 2010.  In 2011 it was almost zero (0.1% of sales) and it was slightly negative in 2012.  What you also see though, is that cost of goods sold has steadily decreased as a percent of revenue and was down 5% from only three years ago, and SG&A costs have come down too.  Total operating costs are following a little more slowly, but that means that their variable income on a sale is increasing overall.  The new structure allows Amazon to fulfill orders quicker and to control shipping costs, which is what they wanted, but if the cost structure is better where are the profits?  They might be coming.

If we look at what is eating up the profits outside of these basic costs a couple of things pop up, but the main issue is an increase in Reasearch and Development spending.  R&D has gone from $1.7 billion in 2010 up to almost $6.6 billion in 2013, so it has more than tripled.  That nearly $5 billion difference is what is keeping the Net Income down.  The Asset structure has also changed going from $3.3 Billion in PPE all the way to $14.8 billion, so the new fulfillment centers have changed the look of the company drastically.

Research and development is likely going toward something that Amazon has already pointed toward for the future, drones.  If you read that article, is says Amazon will be able to deliver in half an hour in the future with their drones, which might be faster than driving to Walmart and back for a lot of people.  This is in line with the other strategies.  It seems that Amazon is unconcerned about profitability in the short term as long as money not hitting the bottom line will make their future brighter.  So far this has paid off with lower variable costs, and if the drones work it could lead to even more gains in that area as well as the ability to eat more of the market share for basic consumer goods.  For instance, we saw the 72.8% of revenue for COGS last year, but Amazon has had even lower than that for this year so far hanging around 70%.  Walmart’s is 75% and Target’s is about the same as Amazon now.  What if that goes lower for Amazon and they can literally beat the big boys on price, service, and selection?

We do need to keep in mind the downsides to this approach.  A larger asset base, which Amazon has now, means more fixed costs and drones would add to that as well.  Though they are nowhere near Walmart’s $180+ billion in fixed assets, they are climbing rapidly, and increased “operating leverage” could increase their risk both by setting a higher bar prior to profitability as well as make them less nimble like their competition.  So far they have been able to generate enough cash to cover capital expenditures, but that may be hard to continue and they did issue almost $3 billion in debt in 2012.  Right now they have a relatively low debt load, but that may be hard to maintain as they continue to grow assets and that might add financial leverage on top of the operating and increase their risk profile even more.

Overall this strategy is starting to look like it is working, but it is also making Amazon a more risky company than it was before in the short term at the very least.  They do tend to try and do things like pay debt down with extra cash that might keep them from ever being too highly levered.  More risk means a higher cost of capital and in this case some of that is likely to come from a capital structure that starts moving toward more debt usage.  So far their share price has increased despite a lack of profits, even outpacing the S&P 500 which has gone up significantly over the same period.  The question is how long before investors stop being happy with revenue gains and start demanding income and/or dividends?  If they can start taking significant numbers of customers out of Walmart’s stores, this will pay off in a huge way.  Walmart won’t sit and let that happen without striking back though, so it could be a tough plan to pull off even if Amazon does everything right.

Experiential Learning

It has been an exciting first week back to classes at Benedictine College. I have been revitalized when talking to returning students who share their summer activities – particularly their Experiential Learning activities. Students are reporting a number of opportunities to connect their course experiences with work in the wider world. Those connections are really what experiential learning is all about. And many of the students are coming back for their senior year with job offers in hand. As an example, one of many of our students who received and accepted an offer, came to me to report that his big decision this week is where to get his tires rotated. What a great way to experience the senior year. Students can focus on course work and polishing their skill sets without the worry of the next step in their career. I am reminded of how blessed we are that our business partners so willingly reach out to the BC campus for these students. Thanks to everyone that makes this happen. It HAS been rewarding.

-Don Hoy

The Michael Brown Effect

Please know that I am not judging the victim, the accused, or anyone else associated with the Michael Brown case in Ferguson, Missouri, but the implications of a post by an ex-police officer on Facebook speaks loudly to the effect of, not unhealthy leaders, but unhealthy employees – those doing work – in business enterprises.

The ex-police officer contends that the fact the accused police officer, Darren Wilson, did not know that Michael Brown was a suspect in a recent store robbery was inconsequential.  The key fact is that Michael Brown knew.  He contends that because Michael Brown knew of the crime (caught on video) that when confronted by an authority figure in the person of Officer Wilson, he behaved in an aggressive way as most would do if they thought they were being caught.  He offered numerous examples where this phenomenon has ended in police officer/highway patrol officer deaths.  The officers were ignorant of who they were confronting, but the people confronted were wholly aware of their previous activities and crimes.

This event had a horrible ending for all involved – especially the friends and family of Michael Brown.  A lack of respect for authority or an aggressive response thereto, often solicits a response.  Hopefully, the response is not inappropriate.

This is not dissimilar to business leaders interacting or intervening with employees in the context of work.  Very often, a business leader is thought of as heavy-handed or aggressive if they approach an employee about the need to improve something.  How often might the employee’s response, often aggressive in return, be a consequence of them knowing they can do better and that they violated expectations they know to be important in the enterprise?

Organizational health trumps everything.  (Patrick Lencioni – The Advantage)  There is no such thing as an unhealthy organization; only unhealthy people – both leaders and employees.  Please share your thoughts about this.

Jobs, Debt And Home Prices Since The Crisis, In Five Charts

Jobs, Debt And Home Prices Since The Crisis, In Five Charts

The charts in the linked post are interesting to talk about on whether we should be positive about the economy currently or not.  Home prices have rebounded, which seems great, but the chart makes me think about how we referred to home prices as a bubble when it was bursting 5 years ago.  The chart saying we are back to bubble level pricing does not make me feel warm and cozy, but makes me wonder if depressed interest rates are inflating home prices and setting us up for another fall.

The second chart is unequivocally good in my opinion.  Less debt per household should make the economy more stable.

On to the third chart and the one type of debt load that has grown, student loans.  I am biased toward higher education for obvious reasons, but I have friends who have struggled with student loans, so this could be a bad thing.  There is too much here for me to discuss in a short post.

Their fourth and fifth charts are concerning in some ways and in others may just be indicative of a shift in how our country lives.  A smaller work force that that makes more per worker may make for a more efficient economy.  It also may mean that standards of living on a per household basis my go down.  That sounds bad, but if people are willing to accept it so that one of the parents can stay home or other such reason it could lead to happier people even if our country takes a hit in wealth.

 

Investing In Graduates

http://video.foxbusiness.com/v/2637118287001/investing-in-college-graduates/

This is an interesting idea, thanks to Andrew Gowasack for the link. Upstart allows recent college graduates to find people to pay off their student loans with the idea that the debt reduction will allow them to follow their entrepreneurial ideas. You agree to give the backers a percent of your salary for a 5-10 year period to entice them to pay off your student debt. It is interesting but may lead to a double whammy should your venture fail and you now have to pay part of your corporate salary away to boot.

Our First Day of Classes

Monday was our first day of classes at the Maastricht University School of Business and Economics. The university is a 10 minute walk down the cobble stone streets of the inner city. We leave Hotel Derlon at 8:00 every morning.

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Professor David Geenens, the Director of the BC School of Businesses, leads his students to classes. Notice that we walk down the middle of the street, instead of on the sidewalks where the pedestrians technically belong! Cars, trucks, and bikes usually slow down enough to give us time to get out of the way.

Maastricht University was founded in 1976, so the school is located in various buildings throughout the central part of the city. The School of Business and Economics is located in an old Jesuit monastery.

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The main entrance to the School of Business and Economics.

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EMBA students entering the university for the first day of classes.

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Settling in for our first lecture

Benoit Wesly, a well-known entrepreneur from Maastricht, welcomed us to the university. He used to own a lot of property in the Westport area in Kansas City, and received honorary doctorates from Missouri Valley College and the University of Central Missouri. Dr. Morgan and Mr. Wesly met in Kansas City a number of years ago, and their relation eventually lead to the EMBA residency in Maastricht.

Our residency includes lectures from local entrepreneurs and university professors.

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One of these local entrepreneurs, René, told us about his new project in the Netherlands. He and some of the other university students joined us for the lectures and added some good perspective to our group conversations.

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Jos Nielsen is an entrepenuer in the Agro-Food and Life Sciences field. He gave a presentation on how his company is using the technology in eggs to develop new pharmaceutical products

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Dr. Morgan and Grant in class

After a full day of classes, some of our hosts joined us for fellowship and wine and hors d’oeuvres in an old ammunition bunker.Image

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At the end of a long day, we head back to Hotel Derlon.

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