
Why Amazon Has No Profits and Why It Works - taylorbuley
https://a16z.com/2014/09/05/why-amazon-has-no-profits-and-why-it-works/
======
exelius
I listened to a talk by Amazon's CTO, Werner Vogels, where he was explaining
that Amazon's entire strategy is to build an infrastructure for itself, then
rent that infrastructure out to its competitors. That way, increased
competition can actually fuel your growth. The talk was about APIs, but Amazon
views APIs as a general term: "Fulfilled by Amazon" is an example of a non-
technical API.

Likewise, I think Amazon's self-funded retail operations are largely a break-
even enterprise. Other businesses have been successful with this -- Costco
comes to mind -- but the scope of capabilities Amazon is looking to develop is
staggering.

If they can build a completely vertically integrated retail platform from
procurement to payment to delivery, basically they're operating a retail
enterprise without taking any inventory risk on themselves. Which is what this
article means by "capture a significant portion of US retail": if they can
provide merchant services to investors, it turns Amazon into basically an
investment bank. Amazon takes a retailers money, turns it into inventory,
sells it, takes a cut, then returns money. The only inputs and outputs into
the Amazon machine are money, and it turns retail operations into an
investment product.

~~~
macspoofing
That's all great but at some point they still need to turn a profit.

~~~
ChuckMcM
As the article points out, they don't. By running the business this way they
are constantly building / growing new businesses but during a downturn they
just build more slowly (rather than lose money). It is a very different way of
operating but one which has provided some interesting benefits for them.
Nominally a business uses profits to either pay dividends or fund unexpected
opportunities (like buying some small company or what not) Amazon doesn't pay
dividends and they invest every dollar they make "extra" back into the
business to increase the total number of dollars in the pipes. They don't need
to turn a profit, they just need to manage their investment profile to their
revenue forecasts.

Interestingly enough, after reading that, I realized that Google doesn't stand
a chance in hell of beating them at commerce.

~~~
mkaziz
If they don't want a profit, what's their motivation for existing?

~~~
tim333
Profit in this case is generally a quantity calculated by accounting rules (US
GAAP probably) and is a different thing from wealth created. Amazon has
produced a lot of wealth for it's shareholders, enough for Bezos to be worth
~$30bn build spacecraft as his hobby. The difference is more obvious with a
company like Facebook. Say they spend $1bn building the company from zero to
500m users and at the same time receive $1bn in ad revenue. Their accounting
profit is $0 but their wealth is a lot due to the value of the 500m users.
There are advantages to keeping the GAAP profit near zero because you pay no
corporation tax that way.

~~~
wodenokoto
But in the end that wealth is based on people's belief that 500m users can be
turned into a profit.

------
cm2012
Interesting note: Over 50% of the volume and driving force of Amazon's huge
merchandise growth mentioned in the article is from small ($100k - $20m a
year) mom and pop businesses around the country selling on Amazon. I wrote a
blog post about it a while ago - [http://www.kevinlordbarry.com/amazons-
little-known-world-cha...](http://www.kevinlordbarry.com/amazons-little-known-
world-changing-good-deed.html).

a16z touches on this, but it has wider reaching implications than just
Amazon's revenue.

~~~
jacquesm
$20m / year is a mom & pop business?

~~~
exelius
In retail, yes. Retail margins are usually less than 3%; so $20m/yr in revenue
would give you less than $600k/yr in profit. Not bad money by any means; but
certainly not enough to need a bunch of shareholders.

Contrast this with the fact that an average Walmart does over $100 million a
year in revenue (though Walmart's margins are closer to 1%), and it's actually
not that huge.

~~~
arbuge
I am not sure what kind of retail you are referring to (offline grocery
perhaps?) but most ecommerce retail operations are running margins
significantly higher than 3%. 10-30% is more typical in my experience, and
40-60% for operations selling unique products they make themselves.

~~~
jljljl
Gross or net margins?

------
AndrewKemendo
_With Amazon, Bezos is deferring that profit-producing, investor-rewarding day
almost indefinitely into the future. This prompts the suggestion that Amazon
is the world’s biggest ‘lifestyle business’ – Bezos is running it for fun, not
to deliver economic returns to shareholders, at least not any time soon._

Sorry but that is ridiculous. Look at the stock price for Amazon. Anyone who
has invested in Amazon has seen an amazing unprecedented ride upward,
institutional benefiting the most.

I also take umbrage with the idea that Bezos is running Amazon for "fun" as
though it is frivolous. Bezos seems to have a grand vision and that is not
something that matches with the ridiculously short term and arguably
irresponsible thinking of the vast majority of investors.

We collectively need to get away from the idea that the only valid fiduciary
duty for a for-profit organization is to make profit for their shareholders
instead of _creating value_ for humanity.[1]

[1] This is refuting the broader point that Benedict Evans is making, and does
not necessarily apply to Amazon perfectly.

~~~
hnnewguy
> _Anyone who has invested in Amazon has seen an amazing unprecedented ride
> upward_

Only if they sell to realize those gains, and that can only occur if they can
find a buyer who has an even _greater_ expectation of profit in the future.

This concept seems to elude people, but the value of a company that never
makes a profit is precisely $0.

~~~
mseebach
Amazon makes a profit, it just invests all of it in itself, returning you a
more valuable stock instead of a dividend. Investors let them do it because
the investment made with the profit is worth more than the cash would be.

Even with all that, the value of a company that doesn't turn a profit isn't 0,
it's the value of it's assets, and Amazon has a lot of those.

~~~
hnnewguy
> _the value of a company that doesn 't turn a profit isn't 0, it's the value
> of it's assets_

Touche. They also have liabilities.

I suppose we could be even more precise and say the price is $0 above the
expected value of the net assets at the time of liquidation. But my point
stands.

~~~
1stop
Well go and try a hostile take over of amazon where you purchase 100% of the
stocks for $1. Given it's worth $0, $1 is infinitely more than they are
expecting.

Or admit that your point is absurd.

------
clamprecht
Isn't this similar to Berkshire Hathaway's strategy - never pay dividends, but
reinvest everything into growth opportunities? Although Berkshire Hathaway
likes to hold a pig pile of cash until the right growth opportunities can be
found, while I'm not sure about Amazon's cash reserves.

* Also, this means no capital gains taxes until you sell your shares, because there are no dividend payments.

------
bengali3
Investing in themselves is the right thing to do from a finance perspective as
long as they continue to have an overall internal rate of return greater than
their cost of capital (IRR > WACC)

according to thatswacc.com, AMZNs Weighted avg Cost of Capital is 10.05%

So until their overall growth slows down to less than 10% per year they will
have less pressure to return dividends.

AMZN (WACC 10.05%) net sales growth: 22% (2011-2012) vs 18% (2012-2013)

AAPL (WACC 9.45%) net sales growth: 31% (2011-2012) vs 8% (2012-2013)

From Wikipedia: "The WACC is the minimum return that a company must earn on an
existing asset base to satisfy its creditors, owners, and other providers of
capital, or they will invest elsewhere"

"a corporation will evaluate an investment in a new [x] versus an extension of
an existing [y] based on the IRR of each project. In such a case, each new
capital project must produce an IRR that is higher than the company's cost of
capital"

For more info, see sources:
[http://en.wikipedia.org/wiki/Weighted_average_cost_of_capita...](http://en.wikipedia.org/wiki/Weighted_average_cost_of_capital)
[http://thatswacc.com/](http://thatswacc.com/)
[http://www.investopedia.com/walkthrough/corporate-
finance/4/...](http://www.investopedia.com/walkthrough/corporate-
finance/4/npv-irr/internal-rate-return.aspx)

~~~
vasilipupkin
that's not entirely correct. this is useful for choosing among internal
projects. Do decide whether to invest in growth or pay the shareholders, you
need to assume that you can earn greater return than the shareholders could do
on their own.

------
Estragon
This is a familiar argument, but you have to admit there's a lot of wishful
thinking involved because Amazon is so opaque about its operations and
finances. Bezos is basically saying "Trust me." I don't blame people who do,
he's an amazing guy. Still, it's interesting to see how widely views about the
company can differ, based on apparently rational analysis of exactly the same
financial reports.

[http://seekingalpha.com/author/paulo-
santos/articles/symbol/...](http://seekingalpha.com/author/paulo-
santos/articles/symbol/amzn)

While this guy seems to have lost his shirt betting against AMZN over the past
couple of years, his bearish analyses of its valuation are quite precisely
articulated and make interesting reading.

Alibaba may eat the 3P revenue: [http://seekingalpha.com/article/2263623-this-
is-amazon-coms-...](http://seekingalpha.com/article/2263623-this-is-amazon-
coms-d-day-and-the-alibaba-troops-are-disembarking)

Amazon.com's profitability decline is structural and tied to its sales mix:
[http://seekingalpha.com/article/2169003-the-latest-
developme...](http://seekingalpha.com/article/2169003-the-latest-developments-
in-the-amazon-com-saga)

I wouldn't short this monster, though, at least not until QE ends.

------
philip1209
Excellent analysis.

> Amazon has perhaps 1% of the US retail market by value

> With Amazon, Bezos is deferring that profit-producing, investor-rewarding
> day almost indefinitely into the future. This prompts the suggestion that
> Amazon is the world’s biggest ‘lifestyle business’ – Bezos is running it for
> fun, not to deliver economic returns to shareholders, at least not any time
> soon.

~~~
shill
My AMZN shares are in a Roth IRA. I can wait.

~~~
jeffreyrogers
Amazon stock trades at a P/E of 910. S&P 500 average is currently around
19-20. Do you really expect Amazon to continue to grow at such a rate that its
current P/E is justified?

~~~
crucifiction
Or perhaps P/E is not the end-all-be-all of metrics for judging value?

~~~
jeffreyrogers
I completely agree, however, it is still a useful metric. And when a stock has
a P/E of 910 the growth rate that the underlying business must grow at in
order to justify such a price is astounding.

~~~
apostate
P/E approaches infinity as you near "break even", so for a company like AMZN
with both massive revenues and expenses, P/E is not useful when the two are
almost equal. You must dig further and look at things like cash flow, revenue
(not earnings) growth, operating margin (not profit margin), etc. These things
give a much clearer picture than an odd-looking P/E. If a company with high
P/E had operating margins that ware closer to profit margins (not triple, like
AMZN) I would be a bit more concerned.

If capital expenditures are reduced just a bit, or if margins are improved
slightly, the E part of the fraction will jump and P/E will fall massively.

All of that being said, there are still plenty of things that could go wrong
for AMZN.

------
hoprocker
Reading this article reminded me of Steve Yegge's summary of Amazon's overall
strategy: build a platform, not a product[0]. My takeaway here is that Amazon
keeps reinvesting in making itself the platform through which sales run
(warehouses, media, AWS, third-party storefronts). With the octo-copter
idea[1] -- especially in combination with its third-party seller services --
it skirted the surface of becoming a physical delivery platform as well.

Anyways, fascinating post, really enjoyed the different cross sections of
perspective presented.

[0]
[https://plus.google.com/112678702228711889851/posts/eVeouesv...](https://plus.google.com/112678702228711889851/posts/eVeouesvaVX)
[1]
[http://www.amazon.com/b?ie=UTF8&node=8037720011](http://www.amazon.com/b?ie=UTF8&node=8037720011)

------
johnrob
From: [http://paulgraham.com/good.html](http://paulgraham.com/good.html):

In Patrick O'Brian's novels, his captains always try to get upwind of their
opponents. If you're upwind, you decide when and if to engage the other
ship...

In this case, Amazon is upwind of becoming a giant, profitable company. They
could have taken profits earlier but it would have shrunk their overall pie.

~~~
notatoad
Where "becoming a giant, profitable company" is another way of saying "paying
their shareholders". Amazon is making money, for all intents and purposes they
are profitable. They've just found something more interesting to do with that
money than pay dividends. The opponent in this scenario is the shareholders,
they're the ones who want to take the money away from Amazon.

It's a very interesting dynamic, certainly not the way i've normally thought
of a shareholder-company relationship but one that must apply to many
companies.

~~~
hnnewguy
> _The opponent in this scenario is the shareholders, they 're the ones who
> want to take the money away from Amazon._

Take the money _away_ from Amazon? The shareholders _are_ Amazon. It isn't
Amazon's money, it's the shareholders. If/when they want dividends instead of
re-investment (which doesn't seem to be the case yet), they are entitled to
it.

~~~
Swannie
Do you know how much of Amazon is publicly traded? How much of Amazon is held
by the Amazon management team?

You're correct in asserting that the shareholders are entitled to direct the
board to do their will. However, you seem to be assuming that the publicly
traded shares of Amazon a) have significant voting rights, b) are a large
enough share to be significant, and c) are not held in majority by those
within the company.

I can't find information on either of these three... so I continue to assume
it's entirely possible that Amazon's publicly traded share holders are a
minority, with little voting rights.

------
uptown
It'll be interesting to see how their profitability trends as they adjust
their prices. I've seen a trend over the past year or more of dramatically
higher prices for things I've previously purchased from Amazon. I can do a
1-for-1 comparison on receipts, and see the huge bump. In some cases, those
products are more expensive everywhere, but in most cases, I'm able to find
those items at a price close-to or better than what I'd originally paid at
Amazon if I shop around. It'll be interesting to see if they've trained
consumer mindsets enough to retain them as customers if more shoppers notice a
similar trend.

~~~
tdees40
The real question is if buyers will stick around once prices go up. I
remember, during the bubble, buy.com's strategy was to sell at a loss, grow
customer base and then raise prices. The first two parts worked reasonably
well, but once they raised prices, everyone left.

~~~
cm2012
At least 50% of Amazon's volume by sales is by 3rd party sellers who most
certainly DO NOT sell at a loss! For many Amazon products, prices will never
raise appreciably. The post above goes into more detail on other reasons for
this.

------
ctdonath
TL;DR - No matter how you squint at it, Amazon drives all profits back into
growing capacity and market coverage. Amazon alone accounts for around 1% of
US retail revenue.

~~~
bowlofpetunias
That 1% means nothing without knowing how much of that retail revenue
currently goes through e-commerce. But I have sneaking suspicion that there's
still a lot of room for growth.

Also, outside of the US Amazon has just barely started to expand beyond books.
In most countries online retailers are bracing themselves for the moment
Amazon starts eating their lunch.

Unless Bezos suddenly has a change of heart, this growth strategy could go on
for many, many years.

~~~
pinkyand
> outside of the US Amazon has just barely started to expand beyond books.

Not sure it's correct. For example amazon has a 2-day service across Europe
from any amazon warehouse in the continent. But maybe what they do is not
enough for Europe?

~~~
eru
Asia is a bit less well served. Australia not at all apart from digital goods.

------
toasted
I've stopped buying much at all off amazon because I get it all from
Aliexpress.

They package up and address individual items in shenzhen/guanzhou, stick them
all in big containers, then when they reach the US/europe they deliver them by
the cheapest means possible in a totally commoditised fashion. What
competitive advantage does amazon.com have now? Why do all those small sellers
need to exist? everything they sell is made in china anyway.

------
QuantumChaos
At the risk of being boring, Amazon's "no profit" model works because profit
is an accounting measure, not an economic measure.

Amazon is increasing in value, but because they are investing in themselves,
on paper (i.e. according to accounting measures) they are not profitable.

All companies have a "book to market" ratio that indicates they are worth more
as a company than accounting measures would suggest.

~~~
eru
In general, yes. In practice, some companies have a subpar book to market
ratio.

------
dmourati
Check out Simon Wardley for some insight into what games Amazon may be
playing, specifically on cloud. [http://www.infoq.com/interviews/Cloud-
Landscape-Simon-Wardle...](http://www.infoq.com/interviews/Cloud-Landscape-
Simon-Wardley)

"This is a model known as ILC, which stands for innovate leverage commoditize.
The model is pretty simple: what you do is you provide a commodity service,
you enable everybody else to innovate on top of it. They are actually your
research and development group. You do not bother to do it yourself, you get
everybody else to build on your services. Anything which is successful and
starts to spread in your ecosystem, you can identify through consumption
information, so you can leverage the ecosystem to spot successful development
and then you commoditize these new components."

------
aeturnum
Am I the only one shocked that online sales make up only ~8% of US retail
activity? I buy everything I can online, and expect to maintain that trend as
much as possible. Is this just a case of me being relatively young and
affluent, or are there sectors of the economy that will never go online?

~~~
marincounty
I think affluent is a factor? When I go to other areas of the country I'm
surprised to see the the huge amount of entrenched poverty. Many of these
people don't have access to debit cards, and any ruined their chances of
getting a checking account through a bank(banks have there own credit checking
system). I see too many check cashing places, a pawn shop on too many corners,
billboards targeting the poor, and naive. Yes--people buy, but it's food at
Safeway, or the Dollar store, or Goodwill?

The America that is rich and poor is here. I hope the U.S. dosen't turn into
Mexico; where the wealthy can't leave their house for fear of kidnapping, or
worse. I know I casually slip off my watch when traveling to certain areas,
and wouldn't think about buying an expensive road bike again.

------
jeffreyrogers
The real question is this: does the dollar of earnings Amazon retains generate
more than a dollar of value for owners of the company (i.e. shareholders)?

I don't know either way, and I don't want this post to seem like a criticism
of Amazon. I know some people who work in upper level management there and
they all speak very highly of the way the company is run (very meritocratic).
But reinvesting earnings is only a good strategy if those earnings are put to
good use, otherwise they should be paid out as a dividend.

Anyways, just something to think about whenever the topic of Amazon's
profits/earnings comes up.

~~~
eru
> The real question is this: does the dollar of earnings Amazon retains
> generate more than a dollar of value for owners of the company (i.e.
> shareholders)?

Taxes bias this question.

------
jusben1369
I found this fascinating to read but made very difficult in part due to the
overuse of commas. Maybe the folks at a16 could have this proof read.

Investors in Amazon typically look to selling their stock for higher than they
bought it as the way they "get their money out of their investment" So not
sure why the fascination on profits. Profits are important if they become the
means to achieving a higher stock price. But lack of profits hasn't hurt
AMZN's price over the years or made it an unattractive stock.

~~~
walshemj
In an era (which is coming to an end) of fabulously cheap money though - I
suggest you and read the intelligent investor by graham and re think your view
that profits an dividends don't matter

~~~
jusben1369
It's worth comparing to Apple who's stock price went backward when growth
slowed (even though cash was piling up literally by the billions) AMZN could
create profits but, unlike Apple, it wants to take every penny and reinvest it
directly into new markets.

------
jaunkst
Defending against last man advantage here. The more they self invest the more
their competitors will have to invest to compete or enter one of their
markets.

------
pbreit
So basically, companies that switch to profit-making are indicating that they
no longer know how to generate new acceptable returns on investment.

~~~
pmarca
Bingo.

~~~
mikeg8
I've never really thought of it like this – interesting. Are there any other
examples of large/popular companies on par with Amazon"re-invest" mentality? I
can't think of any off the top of my head but would be interested to look at
others. Thanks

~~~
nostrademons
Berkshire Hathaway. Microsoft until c. 2006. Apple. Google. Most hedge funds.
Standard Oil and U.S. Steel if you go back to the last century.

Basically, it's rational for a company CEO to invest all profits back into the
business as long as he expects he can make a better return for them than the
market can. Berkshire Hathaway's annual reports go into more detail in this.
The trick is in recognizing the size of the market opportunity in front of
you, so that you know when to switch from reinvesting profits to distributing
them as dividends. Microsoft waited too long for this - they burned (and are
still burning) billion on unprofitable business lines. Google has had
debatable success - some of their new businesses are brilliant, some are huge
flops.

~~~
mikeg8
Thanks for your reply.

Apple, and even Google, don't seem nearly as similar to Amazon in the question
I asked. While they both invest heavily in R&D and other capex's areas, they
also store a lot more cash (at least apple) and seem to report a lot more of a
"profit" than Amazon. Do they re-invest _all_ profits or just a portion like
most companies?

People don't talk about Apple, Google, or Microsoft as companies that failed
to become "profitable" in nearly the same way people talk about Amazon, at
least from what I see. AMZN still seems like such an outlier...

~~~
nostrademons
They have different growth strategies because of their different core
competencies, and those get accounted for differently under GAAP.

Google tries to accumulate cash so that when there's an opportunity - say,
buying DoubleClick or YouTube or Motorola - they can pounce. Since Google is
basically an IP company and tries to avoid having physical assets on the
books, these are usually whole other companies, usually technology-related.
These opportunities are unpredictable, so they bank the cash on the books,
invest it in liquid instruments, and then spend it all at once.

Apple is a mature company now - it pays a dividend. But during their big
growth years between the iPod & iMac and the iPad, they suspended the
dividend, and ran very close to break even then too.

------
arbuge
The fly in the ointment that I see is that if shareholders become
disillusioned and decide to return Amazon stock to a more reasonable
valuation, alot of things could come apart in a company which bases a
significant portion of its employee compensation on stock/stock options, as
Amazon does.

------
stuaxo
While they pay so little tax, their smaller competitors that do, effectively
subsidise them.

------
pinkyand
Great analysis with lots of details.I wonder thought: what percentage of u.s.
eCommerce orders are done through amazon's warehouses? and what percentage is
using their store(even though it's 3rd party) ?

------
known
$20 million income is generating $160 billion market capitalization which is
very high IMO

~~~
Falkon1313
That seems a very short-term view IMO - that substantially increasing value
should indicate that a company is less successful than it would be if it was
giving money away and therefore losing value.

If the net worth is about $40 billion or more and growing (almost tripled
since 2009?), and revenues are growing (almost tripled since 2009?), and it's
not hugely inefficient (has relatively steady or increasing profits instead of
increasing losses) - I don't understand why people think that sounds like
failure.

------
jgalt212
Software is eating Andressen Horowitz's brain.

------
mck-
Can't see the graphs on mobile :(

------
tinkerrr
Original:
[https://news.ycombinator.com/item?id=8274319](https://news.ycombinator.com/item?id=8274319)

Wonder why that didn't garner any traction. Perhaps it has something to do
with the fact that this duplicate link is from a16z?

~~~
scott_s
There's an enormous amount of randomness to what makes it to the front page -
I wouldn't read much into the fact that one got traction and the other did
not.

------
notastartup
This part worries me a lot

    
    
        With Amazon, Bezos is deferring that profit-producing, 
        investor-rewarding day almost indefinitely into the 
        future. 
    

It kind of sounds like never.

