
Amazon, Apple, and the beauty of low margins - tortilla
http://www.eugenewei.com/blog/2012/11/28/amazon-and-margins
======
fleitz
BMW could launch a bargain basement 0 series, or Wal-mart could start selling
quality products.

Fundamentally there isn't much point for either because it's not the right
customer base. This is what branding is about, if Apple acquires a whole bunch
of customers that don't care about quality and then complain that their
devices don't have half-baked features it doesn't do the brand any good. These
customers will destroy the brand.

I don't want to have to walk into an Apple store and wonder which is the low
margin device that will fall apart / fail to perform, if I wanted to ask those
questions I'd go to Best Buy.

The low margin Apple market is craigslist, if you want a 3 year old Apple
device that's where you can get it.

The most confusing thing about AMZN and APPL are their respective PEs. They
are priced as if each are going to adopt the other's business model.

~~~
anactofgod
AAPL's P/E ratio is ~10x. For comparision, GOOG's is ~23x. AMZN's P/E is
~3,257x.

At $13.1B AAPL made 4.5x what GOOG ($2.89B) did last quarter, And, in that one
quarter, earned profits that are ~7x what AMZN has made during its _entire_
existence.

So, yes. It's not entirely clear how "Wall Street" is assessing these tech
companies against respective share prices.

~~~
xenophanes
I think it might be fairer to look at AMZN's price to revenue ratio and
compare that with other big companies which have margins AMZN might reasonably
have when they start trying to make profits. That would maybe give a
reasonable understanding of expected upside. Looking at their profits when
they aren't trying to make a profit is a little silly.

GOOG on the other hand I think is a fair enough comparison. Actually GOOG has
pretty much failed at all their attempts to make money off anything but ads,
which I consider kind of worrying.

PS FYI you posted this twice and the other one is marked dead. I recommend
deleting it.

~~~
tedunangst
For example, Amazon has about half the market cap of walmart, but has 10% of
the revenue. If you think Amazon can expand 5x, then focus on making similar
margins as walmart, that would justify the current price.

~~~
clarky07
While I think Amazon could potentially grow their revenues 5x, I don't think
it makes a lot of sense to own something that has to grow 500% to be fairly
valued. To me that shows just how absurd their current valuation is. If I have
a company grow 5x I'd like to think I'll make some money. In this scenario
though, it just becomes fairly valued at that point.

Frankly, I'd love to own some Amazon stock. I think it's an amazing company
with lots of potential. I just can't justify paying the current valuation.
I'll probably regret it someday, but for now I'll stick with Apple and their 7
pe. Even if they lose all growth its worth much more than this. It's priced as
if they are going out of business right now. I'd pay this much for either
their iPhone or iPad business, not to mention having both, Mac, iPod, and
anything new they come up with. They sold > 75 million devices last quarter.
Doesn't exactly seem like a dying business to me.

~~~
tedunangst
If you "know" a company is going to grow 5x, other people are going to know
that too. And if I know a company's stock price will soon be 5x what it is
today, I'll happily pay 2x for it; 2.5x return is still amazing. Hell, I'd pay
4x today's price, because a 20% return is nothing to sneeze at. Other people
will too. Pretty soon today's price becomes tomorrow's (estimated) price, with
various discounts applied for risk and whatnot.

~~~
clarky07
True, but based on our logic and math, it has to grow 5x to break even.
Apparently everyone "knows" it's going to grow 6x soon. It just seems to me
there aren't any discounts being applied for risk.

While I have no doubt amazon can grow 5x, I do have some doubt as to
timeframe. If it did it this year I'd be happy to own it at these prices. I
think it's probably at least 5-10 years from that. 0-20% return over that
timeframe isn't very good.

~~~
xenophanes
I think your take is reasonable.

That makes amazon overpriced by, what, 25%? Which is not particularly
shocking. Lots of stocks are a bit overpriced. AMZN is popular. Don't buy it.
Shrug.

When you compare a 3000 P/E to a 20 P/E, you might come away thinking amazon
is overpriced by a factor of 100, which would be shocking. But I don't think
there's any reasonable case that it's overpriced by a factor of more than 2.

------
mjfern
Low margins, per se, isn't a strategy. Amazon is pursuing a cost advantage
[1], and it's choosing to keep its prices very low, hence the low margins.
With a cost advantage and low prices, Amazon gives away a lot of value to
customers (instead of capturing a lot of value for itself in the form of
profits). Its primary objective is to gain market share (i.e., both new
customers and a greater portion of existing customers' everyday shopping).
With an increase in market share, Amazon can further reduce its costs through
economies of scale (i.e., spreading its fixed costs, such as infrastructure
and R&D, over a greater number of customers served and products sold).

Amazon's cost advantage and low prices explains why most other online
retailers have been unable to gain significant market share and why Amazon is
posing an increasing threat to companies like Wal-mart, Target, and Costco.

-

[1] I'd argue that Amazon is actually pursuing a dual advantage, both a cost
and value advantage (at least for customers that favor convenience over
impulse buying). The value advantage stems from the ability to shop at home,
its product reviews, its excellent customer service, extensive selection, etc.

~~~
fspeech
No Amazon does not have a cost advantage over Costco. It is operational cost
is FAR higher than Costco: 18% vs 10%. It is easy to see why. Costco thrives
on high volume/low count of SKU and customers pay for delivery themselves.
Costco's gross margin is 12% vs 23% for Amazon. Amazon's cost advantage over
WalMart is only marginal. About 1 pt lower on the SG&A and 2.5 pts lower on
gross margin. But Walmart is a lot more profitable. The advantage of Amazon vs
WalMart is really in the long tail. It can keep more SKUs than even the
largest WalMart Supercenter could hope for and still turn its inventory over
much faster. And for items you can wait for you get them delivered to the
door. My own family's shopping behavior is consistent with the data: we buy
from Costco if it carries them, esp recurrent consumables; my wife
occasionally goes to Target if she needs something soon; for things that we
can take time to shop and do some research on I buy from Amazon, sometimes for
price but mostly for convenience of not having to go to the store.

~~~
mjfern
Great points on SKU counts and the long-tail. However, can you tell me the
source of your financial data?

I had a quick look at Google Finance (Financials, Annual Data) and I see the
following for 2012: Amazon's total operating expenses as a percentage of
revenue was 98.2%. Costco's was 97.2%. Wal-mart's was 94.1%. Based on this
data, you might argue that Amazon has a cost disadvantage relative to both
Costco and Wal-mart. But before reaching any conclusions you would need to
back out Amazon Web Services and the Kindle (from Amazon) [1].

As a quick and dirty analysis, we can back out the $2.909b Amazon invested in
R&D in 2012. Note, neither Costco nor Wal-mart have a line item for R&D. In
this case, Amazon's operating expenses as a percentage of revenue is 92%, or
about 5% less than Costco's and 2% less than Wal-mart's. [2]

-

[1] You might also want to back out Sam's Club from Wal-mart.

[2] Given Amazon has revenues that are just 11% of Wal-mart's, you could argue
that Amazon's cost advantage will likely increase as it further scales revenue
and operations.

~~~
fspeech
I had these in a spreadsheet a couple of years ago when I was studying
retailers. I think I got the data from Yahoo Finance like this:
[http://finance.yahoo.com/q/is?s=AMZN+Income+Statement&an...](http://finance.yahoo.com/q/is?s=AMZN+Income+Statement&annual)
which breaks out Cost of Revenue and SG&A. I was quoting AMZN for 2010, which
had been pretty stable -- in 2011 it looks like that it kicked up spending
quite a bit.

You made very good points w.r.t. Sam's Club for Walmart or Kindle for Amazon.
One needs to adjust the data in order to be precise. The effect though is
probably second order and shouldn't change the picture that much. At least it
seems consistent with my own anecdotal experience.

It is also that possible Amazon's expense is exaggerated by accelerated
depreciation. In the expansion phase if your facility is not fully utilized
you get dinged again on appreciation. WalMart owns a lot of real estate and
has capitalized lease as well I think so some of the operational cost may show
up as interest expenses. To get a true picture one needs to account for all
those as well.

The beauty of Amazon's model is that it uses little to no capital (all
operations can be funded by negative working capital and other liabilities
incidental to operations), so it can expand unconstrained by capital needs, as
long as it can find new customers.

------
LnxPrgr3
Interesting thoughts, but I'm confused: how exactly is Apple going wrong here?
Despite their sky-high margins, they're finding enough customers to rake in
record-breaking earnings. New products are often hard to find in stock: even
iMac demand still outstrips supply. Samsung actually ran commercials mocking
supposedly stereotypical Apple customer loyalty.

How is Apple hurting exactly? What are the symptoms of their failure to go
after the low end market? From here, it looks like their big ailment is not
making money as much faster than everyone else as some people would like.

~~~
cageface
The only market in which Apple enjoys a healthy phone market share now is the
U.S. and I strongly suspect that is largely a product of the carrier subsidy
model. If people had to pay the full price of a phone upfront I'm sure a lot
of iPhone buyers would opt for cheaper alternatives. Any company that's
growing should post "record-breaking" earnings every quarter.

Luckily for Apple the U.S. market is also by far the most lucrative, at least
for now.

~~~
Bockit
Australia is a market where Apple holds a healthy phone market share and has
both subsidised and unsubsidised iPhones available. Anecdotally, people who
can afford get it outright and those that can't take the 2 year carrier
contract.

~~~
cageface
Even there Android has overtaken iOS from next to nothing in just two years:
[http://www.theage.com.au/digital-life/mobiles/android-
overta...](http://www.theage.com.au/digital-life/mobiles/android-overtakes-
apple-in-australia-20121212-2b8q2.html)

Remove the subsidies and I think you'd see an even greater tilt to Android.

------
kyllo
So what does Amazon do when it has finished using loss-leader pricing to drive
its competitors out of business in every retail market where it wants to play?
Clearly market share at any cost is the name of the game for Amazon. It is a
well-oiled, market-share-taking machine. But when it has swallowed up so much
of the retail market that it becomes a monopoly? Then what?

~~~
scarmig
1) Win a monopoly market share.

2) Profit.

As far as business plans go, it's pretty obvious and pretty solid. It'll be
implemented as a dual monopoly-monopsomy setup: consumers go to it to buy most
goods, get screwed. Suppliers sell to it, get screwed.

There's a reason Wall Street likes AMZN.

~~~
Steko
Amazon's goal is to be a bigger version of Visa, taking a tiny slice of a
ridiculous large pie.

Anyone thinking that they are going to wind up as the Standard Oil of retail
is going to be hugely disappointed. First they have plenty of quality
competition that isn't going to just keel over and die. Second their tax
advantages are gone long term. Third, as the internet erases frictions, Amazon
is just another middleman begging to be cut out of the picture if he takes too
big of a cut. Fourth Amazon has to deal with real antitrust in Europe and
protectionism in Asia. Fifth even US antitrust wakes up and does something
from time to time.

~~~
rtpg
>Amazon is just another middleman begging to be cut out of the picture

Can you really cut storefronts out of the picture? Even if you replace that
with google+paypal, does paypal become the middleman?

------
ethyreal
"A lot of folks, especially Apple supporters, like to characterize Amazon as
irrational, even crazy, for its willingness to live with low margins. It must
be frustrating to compete with a company like that."

This assumes that Apple is actually competing with amazon. Does BMW compete
with say Ford.... maybe but really they are after different markets. Apple has
said numerous times they are not interested in going after the low end market.

~~~
atdrummond
BMW competes directly with Ford in Europe. Prior to the sale of PAG (Aston
Martin, Volvo, Jaguar, Land Rover) BMW also competed with Ford-owned brands in
the United States.

I'm also certain more people cross shop Fords and Bimmers than one might
initially assume.

~~~
dublinben
Ford might be competition for BMW in Europe, but they certainly aren't in the
US. The only Ford I could believe a BMW customer even considering is the
Mustang. The base model 3-series coupe is significantly more expensive than
all but the top three Mustangs available (GT Premium convertible, Shelby GT
500, GT 500 convertible). If one is in the market for a $40k coupe, they're
not going to compare the BMW to the Ford, they'll compare the BMW to the
Mercedes, Infinity, and Audi.

------
jusben1369
I enjoyed this article. I was a little confused though by the final
conclusion. Amazon shouldn't do a nice, high end tablet as that's not its
competitive strength while also being Apple's strength. So don't play on their
turf - I get that. But then Apple should do a lower margin mass market iPad
for example? The author appears to argue that Apple has done this with iPod's
- I guess it would be great if he fleshed that out further because the general
consensus is Apple doesn't care for/get the lower margin/high volume play. If
they did they might have maintained an early PC lead.

~~~
hayksaakian
They prefer high margin high volume :-)

How did they take over mp3 players? They made a high cost product everyone wet
their lips with, and year later made cheaper versions everyone who was
enviously waiting for could afford. They make an excellent play on consumer
psychology.

------
hkmurakami
_> Attacking the market with a low margin strategy has other benefits, though,
ones often overlooked or undervalued. For one thing, it strongly deters others
from entering your market...

Not having to sweat a constant onslaught of new competitors is really
underrated. You can allocate your best employees to explore new lines of
business, you can count on a consistent flow of cash from your more mature
product or service lines..._

Isn't this contradictory? Having a low margin business by definition should
mean that you have a smaller cash flow available to fund your R&D?

Also, somewhat unrelated, but I think one needs to draw a distinction between
a low margin consumer staple style business (like cosmetics, food, or Amazon)
and a low margin discretionary style business (luxury goods or consumer tech).

~~~
atdrummond
"Isn't this contradictory? Having a low margin business by definition should
mean that you have a smaller cash flow available to fund your R&D?"

Not always. It depends on how consumers react to the price of your products. A
drop in profit per unit (by lowering one's price) might yield a large enough
increase in units sold such that the total profit is higher. This is
especially important for retailers who can't price discriminate easily.

------
ActVen
"Your margin is my opportunity" -Jeff Bezos

------
bobbles
Yeah I'm sure Apple is just SOOO frustrated at Amazons low margins. It's not
like Apple is generating record profits or anything now is it?

------
anactofgod
It would make sense for Apple to lower its prices to capture and lock in a
bigger market share, but only if they were able to meet the resulting demand.

But, if they are constrained by supply chain and manufacturing capacity, then
maintaining the highest prices the market will bear makes the most sense.

~~~
jusben1369
The author's arguing that's a good short term view and a poor long term one
(unless they are constraining the _entire_ SC which does happen for very short
periods of time in high tech around chips or screens etc) Those high prices
(really margins/profits) will attract competitors.

------
Andy_Troutman
Andy Jassy's keynote from this year's AWS conference (amazon's web service
business) talks about running AWS as a high-volume, low margin business and
why that's so different from high-margin businesses. The whole keynote is
interesting, but here is the part that's pertinent to this discussion:
[http://www.youtube.com/watch?v=8FJ5DBLSFe4&t=30m35s](http://www.youtube.com/watch?v=8FJ5DBLSFe4&t=30m35s)

------
hef19898
This sums up the major differences between companies like Apple and Amazon in
really good way.

I for myself thought about this a couple of days back. It was more like brain
training in Supply Chain Management (the execution of the mentioned low and
high margin strategies if you want). Now, Low vs. High margins looks more than
just obvious.

What I came up with, and please feel free to give feed-back, as one big
difference between Amazon and Apple is the product range. Amazon has orders of
magnitude more products and commodities than Apple. What makes it eassier (not
easy, mind you, just easier) for Apple to manage their supply chain. You can
see this in their release schedule, everthing is planned according to that.
Hard to do with thousands of product lines. In this area, Apple is really
doing great in the planning part of supply chain management, from my outside
perspective they are a benchmark here for everybody else. Plus, one could
argue their supply chain strategy matches perfectl their business strategy.

Amazon on the other excels at the logistics part of supply chain management.
As mentioned in the article, they have to in order to get their low margins
and high customer satisfaction. Currently, I'd say Amazon is doing to
logistics what Toyota did up to the lets say 80s and Wal-Mart did up to the
early 2000s (no coincidence that Amazon hired Wal-Mart people back then).

What both companies have in comon is really good view of Point-of-Sales data.
Big difference here to most other companies around.

How does all that match with high and low margins? In the place of Apple
excellence in supply chain planning is used in combination with a narrow
product range to allow for high margins and high inventory turn rates (again,
a narrow product range is helping a lot here). Supplier management is critical
point here, too.

In the place of Amazon logistic excellence is used to run an very efficient
ditribution network. This efficiency allows them things like next-day delivery
and their low margins. Think Toyota Production System and Lean and all the
businesses that tried to copy that since the late ninties.

So, as long as both companies can keep their respective levels of operational
performance up I don't think they are in trouble.

Back on the OP, the low margin-attack was what the whole Android industry did
on Apple, Samsung in particular. But Samsung is different story all together.

------
tyang
Amazon has a defensible moat for physical products. Apple has Samsung.

------
rayiner
Didn't Amazon post a loss last quarter?

~~~
jrockway
Didn't they make a lot of money and then spend it on new fulfillment centers?
Nothing wrong with investing capital into your business. If you just
accumulate cash and sit on it, your company won't grow.

------
atechie
It should be titled " Amazon, Apple and the beauty of high volumes"

------
monochromatic
_Amazon could have had a margin of zero and still made money._

What?

~~~
snowwindwaves
the article says because they get the customer's money right away, but don't
pay the supplier for months, they have a big pile of cash. I suppose they
could make money with that money before they have to pay their bills.

~~~
DanBC
This is such a well known problem that the UK had to implement laws.

If you can get people to pay you quickly (in advance is best, on delivery is
ok, 30 days after delivery is standard) _and_ you can delay paying your
suppliers (90 days after delivery is best, 60 days is ok, 30 days is standard)
you can improve cash flow and there are a bunch of benefits to it.

I don't think it's legal in the UK anymore. It's very easy for a big company
to squeeze little companies into accepting really lousy terms.

------
kbar13
what's that crazy data-block-json? SEO stuff?

~~~
rcsorensen
Looks like it comes from squarespace?

[http://static.squarespace.com/universal/scripts-v6/012420132...](http://static.squarespace.com/universal/scripts-v6/01242013221044728/yui-
seed.js) is the thing that references it. Lines like

    
    
      a.all(".sqs-block.map-block[data-block-json]").each(function(e) {
        d.Squarespace.Rendering.renderMap(e.one(".sqs-block-content"), d.JSON.parse(e.getAttribute("data-block-json")))
      });
    

inside the "var Squarespace = {load: function()" namespace.

~~~
kbar13
interesting. thanks!

------
OGinparadise
I don't understand Amazon investors. They own a piece of of a $100+ billion
company that makes virtually no profit (relatively speaking) for a decade
plus. To make money they'd have to increase prices drastically but that's
Amazon's selling point (along with customer service,) their competition isn't
going away any time soon.

~~~
chime
> their competition isn't going away any time soon.

That's where the investors disagree with you. Amazon is trying to do to big
box stores what big box stores did to mom and pop stores. I buy everything
from $2 batteries to $5000 electronics on Amazon. Only reason I go to local
stores is groceries or emergency goods (meds, last-minute-gifts). Nobody knows
what will happen to Office Depot or Kohls in 20 years but unless Amazon
royally screws something up, I am certain they will remain significant for
decades to come.

~~~
OGinparadise
So you think Amazon will drive everyone serious enough out of business and
then be able to raise prices? Personally, I doubt it. They will not surrender
that easily

I love Amazon by the way, and do a lot of my shopping there. But, IMO, its
hard for investors at these levels to see a decent return.

~~~
rednukleus
This is a misconception. Amazon aren't making any profits because they are
pumping all of their margins into new facilities and other infrastructure
investments. If they stopped expanding and just squeezed profit out of their
existing business, then they would be very profitable.

After Walmart destroyed the mom and pop store they didn't incrase prices, and
Amazon probably won't either. Particularly since Amazon are an online
retailer, and it is very easy for customers to shop around.

~~~
OGinparadise
_Amazon aren't making any profits because they are pumping all of their
margins into new facilities and other infrastructure investments. If they
stopped expanding and just squeezed profit out of their existing business,
then they would be very profitable._

Not sure if they can ever stop, maybe slow down but they will still need to
buy companies. And, Amazon needs to make $5+ Billion in profit with this
valuation, something missing

 _After Walmart destroyed the mom and pop store they didn't incrase prices_

Well they "forced" companies to lower the prices Walmart paid
<http://www.fastcompany.com/47593/wal-mart-you-dont-know> so the net is more
or less the same.

