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.

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.

Liberal Arts Business Students

Liberal Arts Business Students

The link here is encouraging if business leaders are all thinking that liberal arts students come out with better critical thinking skills that are needed.  Also, our whole department has been discussing things like problem based learning as a way to do more of this sort of work in the classroom.  I hope my classes make you think critically, but am I doing enough?  The nuts and bolts, as they put it, are also necessary though, so how do we balance this?

Thanks to Andrew Gowasack for the article.

The Platinum Coin is Dead. Now About that Ceiling…

So the treasury department has said they will not create a commemorative coin in the amount of $1 Trillion this weekend.  The Atlantic had a great piece talking about the plan, and explaining that we were in fact living out something akin to an episode of the Simpsons.  Click through the link to read more about the platinum coin.  Thankfully this makes it so that our congress can go back to sane discussions of how to fix the debt ceiling.  I was a little worried that Democrats might lord the $1 Trillion coin over the debates as if that might be productive, but the Treasury and Obama have done the right thing and avoided strong hand tactics.  The debt ceiling itself is almost as silly as a platinum commemorative coin for such a crazy amount though.

Why the Debt Ceiling makes no sense:

Our government has a budget.  Whether or not you approve of the amount, or how it is spent, is irrelevant to this discussion.  The people who sign off on this budget are in congress.  If said budget causes the national debt to threaten the artificial, self-imposed debt ceiling, then we go back to congress to ask politely, “Will you please raise the debt ceiling so that we can spend the money on the budget that you said was a okay?”  If congress had a problem with the amount of spending, and the debt that would be needed to fund said spending, then they should have fixed it when they approved the budget in the first place.

That means that our current position is this.  When a democratic president asks for the debt ceiling to be raised the republicans moan and threaten to stop it from happening (see right now, or last year if you need examples).  Also, if a republican president asks for the debt ceiling to be raised the democrats moan and threaten to stop it from happening (see 2006 when Bush wanted the ceiling raised).  In fact, Obama and other democratic leaders voted against raising the ceiling when Bush was president less than a decade ago.

The current situation is crazy.  The United States defaulting on their debt would not be a good precedent to set.  I think that increasing our debt at the rate we currently are is a bad idea, but not paying our current outstanding debt is not the way to solve the problem.  At least we didn’t try a trillion dollar coin.

Which retail dies?

Which retail dies?

The linked article is some fun food for thought on the ways we are buying things, and what they mean for the future of retail.  Obviously, Amazon and other online retailers have made it hard for brick and mortar book stores to compete with Borders’ bankruptcy being the most glaring example.  Best Buy more recently has been showing a lot of signs of struggle which could be attributed to online retail.

If we accept this premise, that online retail will dominate in the future.  What areas will online dominate?  What things will still be purchased in person?  For instance, I know that my wife will not buy pants online.  She must try on clothes before buying them.  I have no such proclivity.  I would gladly order pants online.  So leaving the easily purchased online items like books, movie, video games, etc. where I know exactly what I am getting because Harry Potter is the same book no matter where I buy it, where is the line for you that makes you uncomfortable putting your money down without seeing/feeling whatever you are buying first?  Grocery stores seem like the easiest one for me.  I will not be buying produce online in the foreseeable future, but outside of that I am having a hard time thinking of things that I would not purchase and have shipped to me rather than heading to the store.  That might only leave convenience type stores like Walgreens, in case of immediate need and controlled substances from the pharmacy.