Can Someone Please Explain the Amazon Business Model???

[GRG55]

Re: The Everything Store

I think EJ's comments are spot on from a business standpoint … and jk hit another big nail on the head.

I would also add ...

3) You live in Canada or rural USA, and most stores cannot afford to stock all items, especially if you're looking for a more unique item, size, colour, feature etc. Amazon fulfills the "I can get you exactly what you are looking for" spot.

FWIW - I don't understand their valuation no matter how I try to rationalize it.

Ever since the inventory blowouts of the financial crisis, due to suddenly withdrawn credit lines, I have noticed that almost all bricks and mortar retailers have never re-stocked the range or quantity of product they used to have in the past. Even WalMart, with its much vaunted near-real-time-store-specific demand tracking, is unable to keep stock of a great many items on the shelves any longer (at least in Canada).

One the important things that bricks and mortar retailers offer above internet retailers such as Amazon is instant gratification...you take the item home and enjoy the purchase immediately. However, that differentiation is seriously eroded if inventory (or the sales acumen to close the sale to the walk in customer) is missing. Sadly, in far too many instances these days that seems to be the case (RIP Sears)...

[ST]

Re: The Everything Store

Eric's comment on inventory made me think how they manage with all the products. Does their revenue rise faster than their inventory? Not by much as shown in attached and this is a problem. The other point that stuck how is their decrease in operating margins to less than 1%. ...

Inventories are somewhat skewed by the growth of their FBA effort (Fulfillment by Amazon) for third party resellers (their 3P business), for which sellers pay a fee. I believe there's also a clear trend of purposeful build out of fulfillment centers for Amazon's 1P segment (first party sales) in an effort to drive Prime subscriber-ship growth which they likely see as key for their new media model.

Gross margins have been increasing over the last few years from ~24% to ~30%. Operating margin recently is around 1-2%, but looking to go negative. We tend to equate the company, naturally to a retailer, but I think we have start thinking about the company as four businesses esp. considering the large investment spend over the last few years, some of which will pay off and some of which will not. I would suspect that what they are trying to do with these new businesses is to find the, so far, elusive operating leverage since their main business (1P) is structurally single digit margin. The 3P business is far more profitable. Now, the big push into AWS (cloud data services) and Other (movie/show streaming, phones (failed, so far, $170m write off this past quarter), fresh (grocery delivery), etc..). Their ROIC (return on invested capital looks terrible right now during this investment phase), where as it was stellar previously, at least for a few years while Bezo's conglomerate ambitions were hibernating (?).

Milton & Fiat - Keep in mind that for the net income graph below, depreciation (along with other non-cash charge items) reduce earnings; things for which the company doesn't actually write a cheque. FCF has been between $400m - $3b annually for the last ~10 yrs which is one reason why the stock is up 730% over that period (1060% until recently). Positive cash flow accompanied by negative earnings is a more common occurrence, broadly speaking for companies, than we might guess.

The company generates free cash flow ($780m -about half this year compared to last year), but that's post capex spend (investment) of $5b+ Return on invested capital (ROIC, arguably the most important indicator) is going to look terrible for a while longer. For a long time investors gave them a pass since top-line was growing at 40%, but with that slowing to 20% everyone wants profit & ROIC now to justify the valuation.

I'm a loyal customer who buys probably 95% of my purchases on Amazon for many reasons (price, massive time savings of not going to the mall which I deplore, reliability of reviews [above 20, I assume 10-15 are arranged], flawless customer satisfaction policy, product discovery, 1-click, prime (media, now HBO , streaming music, ), but I have a tough time seeing how they can push the key metrics to their favor with several of the new initiatives. Have to hand it to them though - they're not afraid to try, question is how quickly will they cut their losses if one doesn't work, esp. considering their historical Japanese-company-like tolerance for low margins. Cloud services should be interesting to watch. (Delivery drones? I'm a little biased considering my previous association with the FAA safety cert. process for airborne electronics -if an Amazon flying chainsaw gets within 200 yards of my family, I'd be inclined to snipe it down from a distance.)

[lakedaemonian]

Re: The Everything Store

did you read the whole thing, jb?

until i read that story, i never really thot much about em - altho like GRG's question above - esp as it pertains to FB - have wondered how it is they have kept going this far - what, going on 20 years - headed toward 100 BILLION in sales - without a nickle in 'profit' ?

this piece really brings it all together - esp from the POV of those being 'disrupted' - and eye REALLY like that in a news story - even if it is more op/ed than 'news' - tho i tend to gravitate toward that section of newspapers anyway - on the idea that the writers of op/eds likely know more about the topic than i do (hopefully, anyway - not that its all that difficult on most topics ;) and appreciate some sort of analytical perspective vs 'just the facts, ma'am' (= why i'm here)

but wow - when WMT's 'efficiency' M.O. starts to sound 'outmoded' ? - one gets the idea that AMZN has been getting 'special treatment' from the lamerstream media - and never mind wall st - since its the first time eye've seen that kind of language used about AMZN in the same news space (without WMT getting bashed even harder)

and dont get me wrong here, i buy from whoever offers the best price vs service/quality - but a lot of times - hell, MOST of the time lately - the price is all i can afford to think about

altho once upon a time - the 'category killer' concept seemed like it was valid/good biz, acceptable even - but after reading this?

and the very idea that with its current course/speed, that tween them and wmt we'll end up with the same sitch as say like with the airlines (never mind TBTF, inc)?

methinks it just about time to bring back the trust busters

but i'll be very interested to hear lake-d's take on all this....

sez this disrupted type
(tho it wasnt amzn who caused it)

Sorry, I've been out in the field for a bit and short on free time accessing via mobile internet.

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One thing I'm thinking about it is if Amazon would use consider using pricing models akin to the airline industry.

I wonder what future big data opportunities exist for Amazon in terms of soaking remote customers?

Do product prices need to be the same for every customer?

While I worked mostly in the very very early "gen 1" Amazon distribution/logistics when we started with just books and moved to CD/DVD/VHS(dating myself), and then went to selling everything directly(old school projection TVs, 1 per pallet delivered and returned no questions asked for free…..XMas Purchase and post Superbowl return ) and indirectly under the sun….and spent/wasted heaps along the way crawl, walk, run, fly, BORG.

I recall a conversation I had with some folks elsewhere in the company that involved the idea of using the fast growing customer base to model for auto ordering of household consumables.

Over time a large enough customer base of customers ordering tooth paste for example could determine with pretty good accuracy the need for automatic replacement. Such an arrangement could be argued to have some advantages for both customer and company in predicting forward ordering and shipping.

Think predictive subscription.

It never went anywhere at the time…too many other short-term issues to sort back in the 90's. And maybe not even worth pursuing.

But looking at problems differently was ingrained in that early Amazon culture.

What if product pricing was adjustable like airline seats?

Way down here in NZ pricing between major metro centres is incredibly cheap where the volume is.

Connections to, from, between regional centres is horrifically expensive at times.

Fast forward 18 years from when I first started with the company and they now possess NSA level of computational horsepower and customer database depth and breadth.

How hard would it be to predict the physical alternative purchase options of individual customers?

An algorithm to present a unique price for each customer right up to the point of purchase or purchase abandonment.

How much would an algorithm that could extract an extra couple of pennies or dollars from every transaction be worth?

If I ran Amazon and was thinking like the Borg, that's what I'd be looking to do…..

I do commend Jeff and the company on their ability to keep shareholders onboard and not rioting…it's a case study on delaying shareholder gratification on company earnings.

Or maybe, some shareholders are placing a value on the "For Eventual Profit Commercial NSA" aspect of the company.

How much is all that deep customer data worth?

I remember back in the late 90's valuations seemed to be based on "network effect"…often placing a crazy number multiplied by users….a "biggest/fastest network builder wins" mentality. Scale, Scale, Scale…stop questioning the cost.

So I wonder if a more mature version 2.0 of that risky strategy is coming into play?

Estimating lifetime revenue potential for customers……maybe enhanced by smarter incremental revenue extraction opportunities…..such as the aforementioned airline variable pricing models combined with use of advanced consumer psychology capabilities.

Who else on the planet, beyond the NSA and Google have a better understanding of what you REALLY want?

In the industry of a company I own, I met with my peers(mostly older, on cruise control, and not very "digitally inclined") and asked them the following:

1)How much would you pay for a name?
2)How much would you pay for a name and an email address?
3)How much would you pay for a name, email, mobile number?
4)How much would you pay for a name, email, mobile, and they are an existing user of a certain product brand?
5)How much would you pay for all of the above and permission to contact them?

The value accelerates dramatically.

I told them I would pay up to XXX amount for an unlimited number of customer contacts(as above) knowing I could easily profit from it.

Or maybe it's like Coca Cola in the 80's…….some thought their growth was sure to flatten…..but a look at large developing world countries achieving a fraction of the penetration achieved by Coke in Japan and Korea the decades prior indicated massive growth and profit potential was still in the future.

Amazon does has considerable future international potential…….my experience was limited to being on the edges of the very early(and very, very small) overseas Amazon division start ups/acquisitions in Germany, France, UK, and Japan. Laughably small in retrospect.

Don't underestimate the Borg like capabilities of what Amazon has mutated into…..

Where they go from here….I wouldn't have a clue…..but I would guess they become increasingly intertwined with the usual special interest suspects and building a political moat around themselves.

It's not the same company I used to work for……..I was proud of that experience….I don't think I'd be proud of being a part of it today.

It seems to hold some dangerously unfair advantages.

I think of it like 1984 with real computational horsepower to eliminate the need for the unsustainable STASI like human overwatch.

The difference is our Amazon Big Brother wants to eventually PROFIT, shipping our Thought Crimes in a box with a smile on it, somehow making it ok.

[ProdigyofZen]

Re: The Everything Store

Not sure if the Amazon business model applies in any way to Uber or airbnb, both of which annihilate overhead cost by pushing them on to desperate providers. Uber, which our daughter provided on our trip to California a few weeks ago, is a driver using his personal vehicle for a trip fee, period. Insurance, gas, vehicle wear and tear, tip, etc. are in his financial bailiwick. Airbnb is similarly constructed. Both are businesses of our times . . . .

A different perspective on Uber and Airbnb:

In 1920, General Motors had less than 12% of the U.S. car market; by the 1950s it held more than 50%. During World War II it was a critical part of the “Arsenal of Democracy”, and without it the war would have certainly lasted longer and cost many more lives. Even in the 1990s, when other carmakers struggled – Chrysler almost went bankrupt in 1991 – GM rolled along with an “A” credit rating and a +30% share of the U.S. automobile market. And while we all know the GM of today, it pays to remember that it was once the Apple/Google/Facebook of an earlier era.

That GM’s success lasted as long as it did is more the function of one man and one financial discipline than most people realize today. Alfred Sloan, who ran the company from 1923 to 1956 as Chief Executive Officer and then Chairman of the Board, was the epitome of the 20th century focused and dedicated manager. He centralized administrative functions and left everything else to operating heads. He regularly traveled the country, visiting 5-10 dealers a day to hear their concerns. He never shouted – his nickname was “Silent Sloan” – preferring to lead with quiet consensus building. He was on the wrong side of history as the industry unionized, to be sure, but afterwards he certainly ran a company that delivered a huge slice of the American dream to millions of workers and their families.

The core of the financial system he used to run the company actually came from outside, in the form of a former DuPont executive named Frank (F.) Donaldson Brown. The approach Brown took from his prior employer – and large GM shareholder – was to analyze all the activities of the company along two lines: the assets it took to run the business and the return on those assets in the form of income. We know this approach today, aptly enough, as the DuPont model and every aspiring stock analyst commits it to memory either in the classroom or from their CFA Level One textbook.

While the DuPont model may seem like an archaic approach, soiled in the grease of the manufacturing-oriented 20th century, it is just as relevant in today’s online “Virtual” economy. Consider a few examples:

The hottest venture-backed company at the moment is Uber, the online car service, with a recent $17 billion valuation. Its value proposition to drivers/car owners is an automated and location-optimizing dispatch service that promises more fares than standard human operators can deliver. The driver already has the car – a fixed asset – and Uber offers a better return on that investment than the traditional car service company may be able to provide. For the Uber user, the geolocating feature (in the Uber app) offers potentially shorter wait times and the facility to see how close your ride is to your location. Time is the user’s asset, and less time waiting means more time for everything else. In areas where driver licensing allows it, part time/non professional drivers can more efficiently choose which hours they wish to work, giving them better utilization of their vehicle/fixed asset and their time.

Airbnb, the house/apartment-sharing business, allows a homeowner or renter to use their capital to earn a return above the utility of simply providing shelter. What was once simply a spare bedroom becomes an income-generating property. F. Donaldson Brown and Alfred Sloan would have given that kind of project a big thumbs up at the old General Motors.

Less well known on this side of the Atlantic is the amusingly named BlaBlaCar, a U.K. company that offers ride sharing services. Want to go from London to Edinburgh for the Fringe Festival? Log on and see who is driving the same way on the same day and determine how much of a contribution you’ll need to make to share in expenses. Better asset utilization for the car owner (cheaper trip) and more affordable for the rider than public transport.

The DuPont model isn’t just for new business analysis – it also explains a lot of mergers and acquisitions/new business activity as well. A key here is an often-overlooked part of M&A analysis – how long can the acquirer really keep their business going in the face of new competition or opportunities? Advances in technology create a constant stream of disruptive threats to existing businesses, and sometimes it is better to buy your new competitor than try to fight it out with them. Unless you can develop something on your own… A few examples of popular M&A/business development themes:

Mobile. Consumers generally use smartphone-enabled technology for one simple reason: it is more time efficient than waiting until you are in front of a computer. Businesses like it because they can determine your location – just look on your own smartphone to see how many apps automatically update your location even when you aren’t using them. (Why does the Flashlight app on my iPhone need to know where I am?) In both cases “Time” is the asset in question, and mobile technology leverages that asset in a manner entirely consistent with what the DuPont model instructs: make the most of it. Always.

Money and Payments. Investors always want new and profitable places to invest their financial capital, and peer-to-peer lending is one growth area that addresses this market. These businesses match lenders with borrowers, based on credit scores and other factors, essentially allowing owners of capital to act as a bank and earn the interest on such loans. And bear the risk, of course…

• Vendors and merchants would prefer faster payments than the existing banking system affords – assets now are always preferable to assets later – and new payment systems offer the chance to get paid for that skinny latte in seconds rather than days. Alfred Sloan built the General Motors Acceptance Corporation into a lending juggernaut for precisely this reason – getting paid from the dealers immediately, and earning the interest from consumer loans – is a more efficient use of capital. And yes, he would have probably taken bitcoin for car purchases, but only because it is cheaper and faster than GMAC could ever be.

Buying customers and their attention. Some of the more head-scratching tech industry acquisitions of the past year or two (no names here, but you know who we mean) seem to revolve around buying businesses with a customer list and a popular technology. No profits, mind you, and none easily visible in the near future. But lots of users.

• I can’t help but think that the acquiring companies feel the heat of “Time as an asset” as they sign on the dotted line for their expensive purchases. It’s not the financial intrinsic value they are buying. Rather, they are buying the time it would take to compete with the business they are purchasing. Time better spent, apparently, doing other things. Especially fighting a competitor who beat them to the punch and bought the same asset.

Taken as a whole, these examples point to two conclusions. First, the nature of capital has changed from the days of Sloan and Brown and the GM of the 1930s-1950s. Valuable assets – time, for example – don’t appear on a balance sheet but that omission is irrelevant to modern business practices. Business owners still have to manage and optimize them just as they did when owning a tool and die machine was the starting point for a new venture. Second, the essential challenge of managing a successful enterprise has not actually changed all that much from when Alfred Sloan used to take his morning walk to work at the GM Building in New York. Manage what it scarce – physical capital, time, talent, opportunity, whatever – and make the most of it.

[lektrode]

Re: The Everything Store

thanks for the comeback lake'd - very thought provoking/insightful (esp the 1984/borg bit and 'who else knows better')
methinks Mr J's comment/obs about 'mall operators being a sell' starts to look more plausible every day...
(along with crowd-review value component of their model)

i suppose that if the transportation-distribution-logistix equation gets worked out better, then it might make trips to the grocery store (or even the entire concept of brix/mortar retailing) go the way of buggy whips.

quite unsure that this would be a 'good thing' however (esp since crowd watching and quality/freshness checking is the primary draw for me ;)

[lektrode]

Re: The Everything Store

I'm playing devil's advocate with my analysis of Amazon's business plan. ...
...
But over the years I've noticed that the products available at stores like Target have gone from costing less than I'd expect for the quality to costing more.

Low quality, low cost products are now ubiquitous at brick-and-mortar retail stores like Target. Seems that Amazon is one of the few places I can go to buy high quality products that are well rated and not over-priced.

not just them - even home depot is now on the ole WMT 'rollback' bandwagon - with costco now employing the same 'merchandising strategy' - of filling up the aisles of their warehouse-retailing format with what i'd call 'discounter' junk (while the competition for their former 'mainstays' in the food aisles is heating up in the rapidly consolidating 'grocery' sector, with more than a few items now available at same or less cost than the warehouses and ya DONT have to buy a 'lifetime supply' to get a price break or 'better' meat) - with nearly all em now jumping into each others 'niches' - like the increasingly larger food sections at places like walgreens, cvs etc)

I have no data to support this but I can't help thinking that this has something to do with the fact that even though 1/2 of all US states now collect a sales tax on Amazon purchases, the other fixed cost advantages of rent, float, and labor still give Amazon a significant advantage at providing higher price/value than competitors can.

would say that its the fixed costs of real estate thats driving a lot of that - the question remains however that if the online retailing phenom ultimately succeeds, what happens to the commercial tax base in the process?

either the online distribution centers will get hit that much harder, or the municipalities will squeeze the homeowner class that much harder

read: for 'convenience' of goods consumption we'll get to pay more in property taxes?

that oughta go over big....

[lakedaemonian]

Re: The Everything Store

not just them - even home depot is now on the ole WMT 'rollback' bandwagon - with costco now employing the same 'merchandising strategy' - of filling up the aisles of their warehouse-retailing format with what i'd call 'discounter' junk (while the competition for their former 'mainstays' in the food aisles is heating up in the rapidly consolidating 'grocery' sector, with more than a few items now available at same or less cost than the warehouses and ya DONT have to buy a 'lifetime supply' to get a price break or 'better' meat) - with nearly all em now jumping into each others 'niches' - like the increasingly larger food sections at places like walgreens, cvs etc)



would say that its the fixed costs of real estate thats driving a lot of that - the question remains however that if the online retailing phenom ultimately succeeds, what happens to the commercial tax base in the process?

either the online distribution centers will get hit that much harder, or the municipalities will squeeze the homeowner class that much harder

read: for 'convenience' of goods consumption we'll get to pay more in property taxes?

that oughta go over big....

Maybe the death of the shopping mall could lead to an uptake in municipalities/states using mall owner like behavior.

Such as rent(tax) plus % of takings(tax).

If revenue per square foot/metre explodes for online distribution and collapses to the point of liquidation fir retail distribution, could tax assessor start chasing the remaining and higher revenue per square foot/metre in "their" municipal/state open air shopping mall?