
Amazon and the "profitless business model" fallacy - steveb
http://www.eugenewei.com/blog/2013/10/25/amazon-and-the-profitless-business-model-narrative
======
hristov
There are some issues with this explanation. The main issue is that the rules
of accounting have a very good provision to take into account investing into
the future. It is called capitalization.

Thus, if a company spends money to build or acquire a new asset, it is called
capital spending and it is not subtracted from the profits. Thus, for example,
if a company had a million dollars of profit and decided to spend these
million dollars on a new fulfillment center, they could spend the money for
their fulfillment center and still report a million dollars in profit.

So it is not quite clear-cut to say that Amazon's desire to build fulfillment
centers around the world is costing them their profits. Those things should be
capitalized and once they are capitalized they should not affect the profits.
Amazon did in fact report significant capital spending (as one can see on
their cash flow statement).

However, things are not that simple. Sometimes some expenses which are about
building for the future and investing into new growth are not capitalized.
This is the case because for some expenses the benefits are so uncertain and
difficult to quantify that the SEC requires that they are reported as ordinary
expenses instead of capital spending. These types of expenses tend to involve
R&D and may include certain administrative expenses associated with growth
initiatives.

Therefore, many companies that are trying to grow do report lower profits
because they have those expenses that are associated with investment into
future growth but are not capitalized. This may be the case for amazon. But it
is a question to what extent it is the case for amazon. For example, they do
capitalize software and website development for new products and websites. So
one cannot simply say that they are showing losses because they are spending
all the money on making great new products. But then again, they expense
software development for existing products. So perhaps the losses are
associated with new growth features that are built into existing software.

So all in all it is a big muddle and it is not at all clear whether amazon is
an inherently highly profitable company that happens to be investing in the
future, or they are wasting money, or their business model is just not that
profitable.

~~~
pbreit
Can you explain how capital expenditures do not affect profits? Doesn't
capitalization just mean that expenses are applied over time? They don't
disappear, correct?

~~~
hristov
Capital expenses do not affect profits for the reporting period they happen
in. It is true that after that reporting period there is a depreciation cost
applied to take account of loss of value of an asset.

For example, if a company buys a distribution center, it will not expense the
cost of the distribution center as an expense. But as time goes on it will
expense a depreciation expense that accounts for the loss of value of the
distribution center as the building gets older, less useful, etc. But
buildings last for a long time, and a building with the land it is on never
actually goes down to a value of zero. So not all expenses associated with the
distribution center will be applied over time.

So capitalizing something definitely helps you get more income.

~~~
PeterisP
Capitalizing doesn't help you "get" more income, it simply allows you to write
some of the same income in an earlier year.

------
minouye
If you're not familiar with the "long-term" thinking of Bezos, this anecdote
from Brad Stone's recent book on Amazon is particularly interesting:

 _Bezos wanted AWS to be a utility with discount rates, even if that meant
losing money in the short term. Willem van Biljon, who worked with Chris
Pinkham on EC2 and stayed for a few months after Pinkham quit in 2006,
proposed pricing EC2 instances at fifteen cents an hour, a rate that he
believed would allow the company to break even on the service. In an S Team
meeting before EC2 launched, Bezos unilaterally revised that to ten cents.
“You realize you could lose money on that for a long time,” van Biljon told
him. “Great,” Bezos said._

 _Bezos believed his company had a natural advantage in its cost structure and
ability to survive in the thin atmosphere of low-margin businesses. Companies
like IBM, Microsoft, and Google, he suspected, would hesitate to get into such
markets because it would depress their overall profit margins. Bill Miller,
the chief investment officer at Legg Mason Capital Management and a major
Amazon shareholder, asked Bezos at the time about the profitability prospects
for AWS. Bezos predicted they would be good over the long term but said that
he didn’t want to repeat “Steve Jobs’s mistake” of pricing the iPhone in a way
that was so fantastically profitable that the smartphone market became a
magnet for competition._

~~~
gotrecruit
i'm a big fan of Bezos, honestly, but to say that pricing your products in
such a way as to make >$100 billion in cash is a "mistake"... that's just
crazy talk.

~~~
StavrosK
Meanwhile, the iPhone has slowly but steadily been losing mindshare to its
amazing competition.

~~~
benihana
And no one at Apple seems to notice this loss of 'mindshare' because they're
too busy figuring out what to do with all the money people are giving them for
the iPhone.

~~~
StavrosK
You seem to be thinking you're refuting my "loss of mindshare" argument, but
you are actually refuting the "iPhone sales are dropping" argument, which
nobody here seems to have made.

------
saosebastiao
Out of all the articles I have read on the issue, this one most accurately
sums up the views and opinions of the upper half of the organization. Nobody
is scared. Nobody is feeling defensive. Nobody thinks the business as a whole
is on the wrong path (although there are definitely a few ventures that some
feel are in the wrong).

I don't have the most broad corporate employment history, but as far as it
extends, I've met tons of people who feel like they could join a competitor to
their own employer and win against them within a decade or so. I have never
met a single person who worked at Amazon that has felt that way about
competing against Amazon. Even if that competitor had the pocketbooks of Wal-
Mart. To me, that speaks volumes about a business strategy.

~~~
snowwrestler
Of course they're not scared, they have a nice stock price and seemingly no
need to justify it.

~~~
saosebastiao
At one point in time, Zynga had a good price. I was scared to accept their
stock as compensation at that time, and I'm relieved about not pursuing it
now.

With Amazon, I actually daydream about the stock taking a nose dive right
before I get my next compensation offer. That way I get more stock. I have
never had to worry about the long term future value of the company, so a dip
is an arbitrage opportunity, as opposed to a risk (like Zynga).

------
aresant
" I sell a used book on Amazon, it takes a cut of the transaction, I am the
one packing and shipping that item to the buyer. "

In true Amazon "dominate all retail by making it accessible to consumers"
their relatively new "Fulfillment By Amazon" service drastically simplifies
consumer reselling by eliminating the need for the consumer to do the "packing
and shipping".

It's an amazing service, and they are getting darn close to the "just ship us
a box of your stuff"

I bet that we see that inside of the next five years, there are lots of
problems (like what is / is not valuable) but you can see them already working
around these issues by only accepting items with modern barcodes, charge small
warehousing fees if something sits too long in inventory, etc.

(1)[http://services.amazon.com/fulfillment-by-
amazon/benefits.ht...](http://services.amazon.com/fulfillment-by-
amazon/benefits.htm)

~~~
nhebb
I wasn't aware of that service. So to some extent Amazon is doing to
Craigslist and eBay what Craigslist and eBay did to the classifies and Nickel
Ads?

------
ballard
The author may not fully appreciate the long game Bezos has been uniquely
blessed to play: the sooner Bezos can effectively expand what's working,
without over-expanding, it's bootstrapping on a massive scale: buying speed
without diluting ownership to even more money sooner. It's not deficit
spending (until it is), it's reinvesting profit to grow assets that are the
body of the money monster. (For Starcraft fans out there: It's like being
broke because of focusing on building SCVs.)

On the other side of the gorge of eternal peril: Cash is king, and should not
be underestimated. Or those with the war-chests may try to puke all over
Bezos' cake by mistaking lack of current reserves for an actual weakness. I'm
sure Bezos is fully aware the ridge-line he's walking on. He probably has aces
up both sleeves to clobber anyone that tries to make a move.

Long term, I'd say walmart continues to cash in on the greater unwashed that
don't know any better for b&m impulse buys while amzn goes after suppliers and
logistics, maybe even an Ali Baba and/or Kickstarter to bring in more product
pipes.

~~~
girvo
> For Starcraft fans out there: It's like being broke because of focusing on
> building SCVs

While I personally play Protoss, I think this is an awesome way of thinking
about it. "Keep your money low" is a mantra that you must remember when
playing SC2, and I've always been curious how that translates to actual
economics.

If I recall correctly, there was an actual paper written applying Starcraft
economics to "real world" econ. Wonder if I can find it..

~~~
marvin
I'm not sure if it is a 100% perfect analogy to real-world economics, but the
best analogy is that all money you use in Starcraft is "working capital".
Money in the bank only does you any good insofar as it allows you to handle
unexpected emergencies, all other cash should be deployed towards your goals.
Which in Starcraft would be to defeat your opponent with generating more cash
as a subordinate objective, and in business would be to either make as much
money as possible throughout the history of your company, or fulfill whichever
goals your company has. Amazon does this by keeping low margins to discourage
competition and reinvesting as much as possible.

The biggest difference between Starcraft economics and real-world economics is
that Starcraft has no regular expenses or debt, so there is no way to go
bankrupt. This removes a large risk element in reinvesting your money.

~~~
croddin
Starcraft uses supply depots to represent the recurring costs of supporting
your army. Using the normal resources would over complicate the game. In a way
you could be "in debt" if you ever don't have enough supply.

------
jaggederest
I think Amazon is a great example of the kind of company that makes genuine
long term fundamental change to the way the world functions. I really wish
that more companies had a less quarterly mindset and would pursue things
similarly.

~~~
pmarca
I agree completely.

The catch, though, is that Jeff had to endure years of vitriol and abuse from
Wall Street and the press to get into this position. I have met a lot of
founders who think they could get through that, and very few who actually can.

I think Jeff was helped enormously by having this dark period for Amazon
happen (a) during a broad-based tech recession and (b) in Seattle. I'm not
sure how possible it is to do what he did through that period in a normal era
and in the Bay Area.

------
codex
Bezos has found and hacked a feature of public markets: you can get away with
no profits as long as you're growing. Therefore, you can construct a
profitless business scheme that reinvests all profits (or doesn't generate
any) as long as your sales forever climb. It's the business equivalent of the
Ponzi scheme--and if you look at Amazon's revenue, it is a classic exponential
curve.

If sales ever plateau and investors force you to generate profits, the plane
stalls and the whole thing spirals down, because it's the profit reinvestment
which actually drives sales growth, and actual profits attract competitors who
have been unable to pull off the profitless-hyper-growth trick. So far that
hasn't happened.

Amazon's value is in the entire business and not the sum of its parts, which
means that at some point, investors expect to own a profit making enterprise
and not a bunch of warehouses. However, that won't happen until sales plateau
or Bezos dies. Ironically, at that point the business loses a lot of value,
both because growth has stopped and because competitors are about to enter the
space, emboldened by Amazon's newly discovered profits. The whole thing is a
bit of a sham. Any growth industry (Internet retail) can support only one "no
profit rocket," and eventually it comes back to earth when that industry
matures and ends the hypergrowth phase.

~~~
vasilipupkin
Right. It is not a Ponzi scheme. Investors price stocks based on the expected
future cashflows. And those expected cashflows by the very definition reflect
the non-zero probability of failure. Now, investors as a whole may overvalue
or undervalue those cashflows - but this has nothing to do with a Ponzi scheme

~~~
codex
It is _like_ a Ponzi scheme in that it requires continuous expansion to
maintain. Switching metaphors, it's also like a Catch-22: Amazon is successful
precisely because it makes no profit. How, then, do you value future cash
flows? Any profit it does make will hamper future flows. Furthermore, Bezos is
far too into empire building to stop and take profits. His ego and fame is
bound up into the size of his company, not how profitable it is, so the
expectation of profit should be near zero.

------
WalterBright
Amazon is the proof that corporations are not all short-term-focused, and the
shareholders have amply rewarded Amazon for that with a huge P/E.

~~~
eru
Isn't Amazon's P/E negative?

~~~
brianberns
It fluctuates tremendously because the denominator is so close to zero.

------
krakensden
It's worth noting that Yglesias actually knows this[1]. His point is that
public companies generally aren't allowed by their shareholders to be this
ambitious.

Which 100% vindicates Eugenewei's point about tech companies being wary of
capital markets.

[1]:
[http://www.slate.com/blogs/moneybox/2013/10/22/amazon_profit...](http://www.slate.com/blogs/moneybox/2013/10/22/amazon_profits_not_there_and_they_re_not_worried.html)

~~~
yetanotherphd
If the stock market refused to acknowledge the value of long term investment,
then all stocks would have the same book-to-market ratio.

However, investors and CEOs will rarely see eye-to-eye on the correct level of
company growth, since CEOs by their nature tend to want to increase the size
and scope of their company. Investors know that only some companies will
benefit from this increase in size and scope, and others need to be kept
focused on their core business.

However a key point that is often missed is that there is very little that
shareholders can do to force CEOs to do their bidding. In spite of a lot of
talk about activist shareholders, the only real discipline that management
face is the thread of being bought out.

~~~
tsotha
>However a key point that is often missed is that there is very little that
shareholders can do to force CEOs to do their bidding. In spite of a lot of
talk about activist shareholders, the only real discipline that management
face is the thread of being bought out.

Eh? Shareholders elect the board, and the CEO serves at the pleasure of the
board. The shareholders can absolutely do something to force the CEO to do
their bidding - they can fire him. It happens all the time.

~~~
yetanotherphd
Yes, it does indeed happen occasionally. However, such actions are relatively
rare, hence the term "wall street walk" for large block holders selling their
shares when they are unhappy with management, rather than trying to influence
them.

------
gizbot
Strangly, this was the business model of cable companies for the longest time.
They never turned a profit. When they expanded, they could use the increased
income stream to go _deeper_ into debt. The profits and extra capital went
into more expansion. Eventually, they ran out of room to expand, and where are
they now?

Someday, Amazon will need to face the brutal reality of profit.

~~~
ericd
They ran out of room to expand and now they're regional monopolies, and can
gouge their customers with impunity. Was that your point?

~~~
yuhong
So I wonder what led the cable companies to try this.

------
tks2103
The writing style and grammar in this post interfered with my comprehension.
In the end, I was unable to finish reading it.

Some examples:

"Giant, heavy electronics items that Amazon sometimes ships for free when the
shipping cost is clearly non-trivial and cost more than the usual thin margins
on such goods are another."

"But if you sell a glass of lemonade for $2 and it only costs you $1 to make
it, and you decide business is so great you're going to build a lemonade stand
on every street corner in the world so you can eventually afford to move
humanity into outer space or buy a newspaper in your spare time, and that
requires you to invest all your profits in buying up some lemon fields and
timber to set up lemonade franchises on every street corner, that sounds like
a many things to me, but it doesn't sound like a charitable organization."

"The vast vast majority of products Amazon sells it makes a profit on."

It should be relatively easy to rephrase most of the language. For example,
the last sentence should be worded: "Amazon makes a profit on the vast, vast
majority of products it sells."

I think it would be worth it. I can't understand a lot of the post without
effort.

~~~
deong
Out of curiosity, are you a native English speaker? I had no problems at all
reading the article. A couple of the sentences are a little awkwardly phrased,
but things like "The vast vast majority of products Amazon sells it makes a
profit on." are both grammatically fine and reasonably idiomatic.

~~~
tks2103
Yeah, I'm a native English speaker.

The sentence you quoted is not impossible to read, but it is more difficult to
comprehend than it should be. A simple rewrite will make it more clear.

Many of the sentences in the article are much worse.

------
sidcool
I believe in Jeff's long term vision theory. He is even building a $42 million
giant clock called the '10,000 Year Clock' atop the Mount Washington in
Nevada. This is to portray his long term vision.

(I feel guilty to mention, but this reminds me something of the 1000 Year
Reich sorts)

------
hayksaakian
Think about it this way. Profits are dollars that leave the company. By
sitting on low profits, Amazon turns all its cash towards itself.

~~~
dangrossman
That's the opposite of what those words mean. Profits are dollars that stay
with the company. Dollars that leave the company are expenses, some other
company's profits. I don't find redefining profit to mean its opposite
enlightening here. They're spending cash now in hopes of future profits --
that seems clear enough in plain english.

~~~
quaunaut
Money not spent is money that isn't working for you, but instead is just
sitting in reserve, at best accruing interest. Amazon is betting it can get a
much higher return, and so far, has been right.

~~~
epa
"profit" and "money" are two very different things.

"profit" is how much you are making at the end of the year, this is to be
reinvested if you are efficient (as you suggest is good, i agree)

"money" is the what is sitting in the bank, not being utilized.

Would you say that a company who is breaking even is utilizing their cash
properly? no, they don't have any cash to utilize, therefore profit and cash
are different things.

~~~
quaunaut
...or they could have just already utilized the cash, which is what Amazon is
doing?

~~~
epa
Capital assets are not fully expensed in the year they are bought.

------
timedoctor
There is no issue with reinvesting for growth. Businesses that require a lot
of capital to grow need to do that and might need to continue operating with
lower or minimal profits as they grow.

However at some point it's important to be able to say that they have played
out the majority of their growth ambitions and are ready to start optimizing
the business for greater profit.

The trouble is that human nature for many CEOs with big egos and the structure
of corporations is to want to continue to grow forever. This is a dangerous
attitude. For example perhaps Microsoft shareholders would have been much
better off if the company was run without ANY ambitions to compete with
Google, Apple OR to dominate mobile or tablets or search or any of these
areas. Instead if Microsoft was to just focus on Windows and Office and
extract as much profits from the business as possible, then return these
profits to shareholders, then the shareholders would be free to invest in
Apple and Google stock.

The trouble with this is that for an ambitious CEO this might feel like giving
up. I don't believe it's giving up. it's called focus. Focusing on what you
are really good at (in this case Windows and Office), rather than pretending
that you are great at everything.

------
moca
By running at zero profit margin, Amazon is essentially growing itself as fast
as it can manage, i.e. reinvest every dollar. Its current revenue growth is
even faster than Google. That ensures itself as the biggest ecommerce platform
for years to come. If it wants more profit, it can certainly do it. I believe
Amazon will eventually automate most of its systems, like using robots instead
of humans for warehouse, and gain significant profit margin. Chinese company
Taobao (like eBay) provided free service for 5 years, and gained dominant
market share. Now it is hugely profitable.

On the other hand, Jeff is likely more interested in just growing the business
than counting profit dollars.

------
swalsh
I've always thought of Amazon as this last dinosaur of a by gone era. The days
where you can have a really big vision, where if you work a spreadsheet a bit
here and there you suddenly have massive amounts of profit. We just need to
wait for the world to finished being disrupted. If you disagree with the
vision, then you "just don't understand". Most of these business failed, but
Amazon found just enough profits sitting somewhere that they have managed to
keep on living... So they are in this unique position where they are allowed
to invest, and grow to unfathomable heights (well theoretically) because its a
survivor bias of the investors.

------
hownottowrite
Everything you need to know about Jeff's strategy is in this book:
[http://www.amazon.com/Sam-Walton-Made-In-
America/dp/05535628...](http://www.amazon.com/Sam-Walton-Made-In-
America/dp/0553562835)

Different medium and market, but basically the same overall strategy.

------
KaoruAoiShiho
Amazon only has around 10 more years before 3d printing starts to kill retail.
Beware.

~~~
michaelt
I will bet you $100 that in ten years time, it will not be commonplace to 3D
print a fully working:

* Mobile phone * Bottle of beer * Sweatshirt or * Pear

What do you say?

~~~
KaoruAoiShiho
Starts to kill retail, not has killed it.

The most important thing for investor trust right now is that the trends are
going the right way. In 10 years people will start seeing the writing on the
wall for the current distribution model.

------
Semaphor
I think I might be a in some kind of bubble. That article sounds like
absolutely every article I've ever read about Amazon and I don't think I've
ever seen any of the posts he said "didn't get Amazon".

------
ars
Would it be so terrible if Amazon just stayed as a break-even company forever?

~~~
tsotha
It would certainly be terrible for the shareholders. The whole point of
investing in a company is to share in the profit.

~~~
indymike
Being a shareholder, you have a share in the ownership of the company. You
make money when the value of the company increases. This is especially true
with Amazon, which does not pay dividends (a share of profits to investors).

~~~
PeterisP
For a static, non-growing company, you can treat its value as equivalent to a
bond paying as much interest as that company pays in dividends.

Company can have value w/o giving out money if it's expected that it will give
out more money tomorrow; but it can't be expected to keep that way forever.

A stable, static company that brings $0 profit is worth $0 if it's intended to
keep running that way; or worth $assets-$liabilities if it's intended to be
stopped and dismantled.

------
devx
I wish Amazon would stop subsidizing Kindle device buyers, by surcharging
everyone else by $2 on ebooks - especially when that money isn't even split
with the authors.

[http://davidgaughran.wordpress.com/2011/07/11/amazon-hold-
ba...](http://davidgaughran.wordpress.com/2011/07/11/amazon-hold-back-the-
growth-of-e-books-around-the-world/)

------
sdepablos
Great explanation, but I don't think this business model is incompatible with
"flipping the switch" partially as Amazon already did. Examples: raising the
minimum amount for free delivery from 25 to 35, or removing free delivery from
Amazon UK to certain countries like Spain to avoid cannibalizing it's own
business in those countries.

------
brisance
This is a dangerous narrative that links the founder to the company in the
same way that Apple is forever linked to Steve Jobs.

~~~
snowwrestler
Amazon is Jeff Bezos's company and everyone knows it. He maintains detailed
oversight of all the lines of business.

~~~
coldcode
Until he gets hit by a bus or some cancer cells. Then what?

~~~
snowwrestler
Then Amazon will be a very different company under someone else's leadership.

------
don_draper
I hear working at Amazon requires being available on call and working long
hours. If this is the future I'm worried.

~~~
foobarqux
Not to worry you'll be hearing that less and less. You won't be hearing it
from the WaPo anymore for instance.

------
walshemj
Its not uncommon for companies to reduce their profit by various stratagems to
reduce the tax they pay.

For example Apples massive overseas cash pile that they dont want to
repatriate and pay out to the owners of the company

------
gcb0
this is classical bait and switch. No idea why everyone is discussing that *

They 'invest in the future' by selling at or close to a loss, until they kill
everyone around them. When they are the only ones around they can dictate
price and terms.

* actually, just realized. For whatever reason, amazon is spend some PR money to give out the message that they are investing in the future like anyone else. I've seen some articles in several news papers and radios. They are probably in or expecting legal action on that and want to influence some group toughs.

