Of all the things that are “too good to be true,” Amazon
(NASDAQ:AMZN) may top the list. Back in the halcyon days of the dot-com boom, the company built its reputation on allowing customers to duck one of life’s great certainties: taxes. Later, in the heady euphoria of the housing bubble, Amazon introduced its Prime membership program – unlimited 2-day delivery for a fixed annual cost – and made shipping costs vanish, too.
Today, the spirit of optimism is alive and well. The post-PC era is supposed to change everything we thought we knew about computing. Speculators are flipping social media startups faster than they ever flipped houses, and the cloud, according to one Amazon exec
, “has changed what is fundamentally possible.” This company is leaping into this brave new world with both feet. The Kindle line of eReaders is six years old now, and in 2011, Amazon introduced a fully-fledged Android
NASDAQ:GOOG) tablet called the Kindle Fire. The company also offers a comprehensive array of cloud products – its 2012 annual report boasted of 159 new services and features – and it is one of the dominant cloud infrastructure providers.
True to form, Amazon is selling its newest products for a bargain price. Amazon Web Services (AWS) has cut prices 31 times in the last seven years
, and CEO Jeff Bezos has admitted that the company sells its Kindles at cost
. This is all the result of Amazon’s obsession with customer satisfaction – so the story goes – and surveys routinely show
that customers are indeed happy. After all, who wouldn’t love a retailer that basically gives you the product? And what investor wouldn’t love a trendy tech giant that’s growing 30% annually?
Unfortunately, love is blind, and prone to missing details. For instance, Amazon may sell its hardware at cost, but this doesn’t take into account R&D and marketing expenses. The Prime program may be a reasonable deal at $79/year, which Morningstar estimated
to be a profitable price point; but many "guest" members – myself included – pay nothing. (Amazon allows paying individual members to share their Prime accounts with family members.) Amazon may have impressed Wall Street with its rapid build-out of fulfillment centers, intended to store and ship items for its growing roster of third-party vendors, but the company’s shipping business is a perennial black hole, losing nearly $3 billion last year.
To be sure, Amazon claims that the Kindle leads consumers to buy digital content, and Prime drives the sale of retail merchandise, but Amazon refuses to provide the direct revenue figures from these products, much less the indirect. We’re left with a series of stark facts: Media sales are growing only tepidly (12% last year, vs. 35% for Amazon’s core business); shipping costs continue to outpace shipping revenue; and two years after posting its best year ever, Amazon is no longer profitable. Net income was negative in 2012. Gross margins improved in the first quarter of 2013, but operating margins continued to deteriorate both sequentially and year over year. The expenses of doing business are simply moving from one line of the ledger to another – but because Amazon calls them “investments,” an unpleasant cost is – once again – made to disappear. Nevertheless investors, like customers, seem happy; the company’s stock has generally outperformed that of more profitable rivals like Wal-Mart
(NYSE:RAX), and even Apple
Kindle and AWS are interesting because, with a little legwork, we can arrive at an idea of their profitability. IDC estimates that, in 2012, Amazon sold 10.5 million Kindle Fires. For converting that into revenue, the company’s online store is more helpful than its earnings reports. If we assume that the number of customer reviews is proportional to sales – for instance, the 7-inch Kindle Fire gets about 1,500 reviews each month, while the 9-inch receives roughly 1,000 – we can arrive at a few (very general) numbers. Currently, the average Kindle Fire sells for $225, the average eReader for $141, and the ratio between them is about 2-to-1. Taken together, this would indicate tablet revenue of $3.2 billion for 2012. Since Amazon has cut prices over the last year, and its product mix has shifted, actual revenue would have been higher. $4 billion is as good a guess as any.
AWS, on the other hand, is lumped into Amazon’s “other” earnings category. It earned some portion of $2.5 billion, shared with other miscellaneous revenues like Amazon’s credit card and its online advertising. Before the introduction of AWS in 2006, this earnings category provided a fairly consistent 2% of sales. That figure now stands at 4.1%, implying – all things equal – AWS revenue of $1.3 billion.
In sum, we’re looking at $5.5 billion in revenue from Amazon’s new products. About half of that has been swallowed by the company’s R&D and marketing budgets, which grew from a combined 8.1% of revenue in 2010 to 12.5% in 2012 –- a growth that coincided with the expansion of AWS and Kindle, and can hardly be attributed to anything else. Factor in the costs to manufacture and other expenses, and Amazon is in the red by well over $1 billion.
Fortunately, we live in a “fundamentally” different world, where the top line matters more than the bottom one. Amazon isn’t the only tech firm driving its growth by selling at a loss. As I wrote several weeks ago, this is routine in the cloud
. We’re told that, when they reach scale, these companies will turn a profit -- and if they’re not turning a profit, well, that’s just because they haven’t reached scale. In this strange, rabbit-hole universe, businesses lose more money as they become more profitable, and heretical concepts like "innovation disruption" become the stuff of mass orthodoxy
. We should not be surprised, then, if “too good to be true” no longer inspires a healthy skepticism. These days, it’s simply another way of saying “too good to pass up.”
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