Amazon earnings: How Jeff Bezos gets investors to believe in him.

With Wall Street’s Support, Jeff Bezos Can Conquer the World Without Earning a Profit

With Wall Street’s Support, Jeff Bezos Can Conquer the World Without Earning a Profit

Commentary about business and finance.
Jan. 30 2014 11:40 PM

The Prophet of No Profit

How Jeff Bezos won the faith of Wall Street.

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Climbing this final hurdle through a viable same-day delivery system is a holy grail for Amazon, driving a range of its activities (including the much-hyped experimentation with drones). But fast drone delivery has a lot of technical and conceptual problems. The grocery model—lots of warehouses, lots of trucks—is in many ways more promising. AmazonFresh doesn’t need to make money. It just needs to bring in enough money to finance its own creation.

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The most staggering thing about the no-profits business model is to contemplate the extent to which rivals are simply helpless in its face. “There is just no way to compete with them on price,” Sarah Rees of the English independent bookstore Cover-to-Cover told the Observer’s Carole Cadwalladr in her Nov. 30 inquiry into the store’s rise in the United Kingdom. The main focus of the Observer story is the working conditions at Amazon’s fulfillment centers (which are not very pleasant—read Mac McClelland in Mother Jones for a great look inside the bleak working conditions in the American warehouses), and it links indie bookstore owners’ inability to compete with Amazon to its brutal exploitation of workers. Higher pay would, of course, increase Amazon’s cost. But their competitors’ dilemma is more fundamental.


A company that’s trying to turn a profit simply can’t compete on price with one that isn’t. What’s more, the mismatch between when your credit card company pays Amazon for the stuff you’ve bought (typically within a day) and when Amazon pays its suppliers (often as slowly as 90 days) gives them free money to play with. This kind of “float” is a tiny edge, but across an enormous volume of transactions, it amounts to an enormous amount of cash to fuel the enterprise. Small firms can’t match that, but may be able to cope by offering intangibles or sentimental value that a globe-striding behemoth by definition can’t match. And, indeed, there is evidence that independently owned bookstores are back on the rise in America, offering yin to Amazon’s yang.

But for other large, impersonal retailers, a match-up with Amazon is a disaster. How do you turn a profit competing with a company that doesn’t?

This is why efforts by Walmart and other incumbent retail chains to get serious about e-commerce are very likely to fail. A zero-margin, same-day nationwide grocery delivery service is a win for Amazon, which currently doesn’t sell groceries in most of the country. But Walmart does sell groceries. Lots of groceries. In a broad and growing set of locations. For Walmart to compete with Amazon via a zero-margin delivery arm wouldn’t just be competing with Amazon—it would be competing with Walmart’s core business. Rather than staving off Bezos’ juggernaut, the plummeting profit margins would be seen as evidence that the company is succumbing to the impact of facing its competition.

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The natural question to ask about the zero-profit juggernaut is where it ends. A common assumption is that Amazon’s long game is to grow at near-zero margins for some period of time and then “flip a switch” to jack up prices and watch the money roll in.

This is possible. But if it happens, it’s more likely to arise as a result of a loss of investor confidence than as a deliberate plan. At the moment, no other company can get away with an Amazon-like business strategy. Wall Street won’t let them get away with it—the princes of finance demand dividends and share repurchases and the profits that finance them. Amazon gets away with relentlessly investing in the future only because, for now, investors have faith in Bezos and his strategy. But that faith has been tested in the past, and it’s likely that some future convulsion in markets will cause it to wane again. If it does, the company will likely need to return to its mid-aughts strategy of increasing profits and even profit margins. That’ll likely mean slightly higher prices for almost everything, the elimination of some hard-to-ship items from Prime eligibility, and a reduced pace of entry into new markets. 

As a result, the pace of growth will almost certainly slow. The question will become whether or not faith can be restored. Perhaps if Amazon transforms itself—even temporarily—into a firm that’s both large and profitable, the piggybank effect will take hold. Once the company has steady profits, the demands to disgorge the cash may become impossible to resist.

A retreat into permanent conventionality is especially likely if Bezos were to turn his interest to other things as he gets closer to 60. Bill Gates, after all, was in his early 50s when he decided to focus primarily on his philanthropic efforts rather than the business world. A company still run by its charismatic founder—especially a charismatic founder who also happens to be the major shareholder—has a much easier time following unorthodox business strategies and keeping an eye on the long term.

In theory, executive compensation schemes linked to stock market performance are supposed to focus managers on the long view. But in practice, the opposite seems to be the case. In an impressive paper published in April 2013, Alexander Ljungqvist, Joan Farre-Mensa, and John Asker found that publicly traded firms systematically under-invest compared to privately held ones. The effect is larger in sectors where stock market swings are more closely tied to quarterly earnings reports, indicating that what they call “managerial myopia” is likely the culprit. In other words, when you pay executives to increase the share price, they focus on increasing the share price—even when that means focusing on headline numbers in the next quarterly financial report rather than on the long term.

Obviously a series of reports featuring diminishing profit margins and fairly frequent years of financial losses won’t serve well in that kind of environment. Amazon has built itself over the years precisely by avoiding that kind of thinking, yet its ability to continue to do so may be very linked to the identity of its founder and CEO.

If the company can stay the course, it has a long way to grow before changing plans and flipping the switch would make sense. In the U.S., e-commerce sales still account for just about 18 percent of retail sales (excluding food service). Another 21 percent or so is motor vehicle parts and dealers, a market that’s generally not accessible under the current legal regime in the U.S. but could certainly be addressed in the future. And at the moment, Amazon is considerably less global than other major American technology companies. They have a large presence in Germany, the U.K., and a few other countries, but they don’t exist in markets ranging from Korea and China to Poland and the Persian Gulf.

In principle, all sorts of things we don’t normally consider “retail” could be sold through the world’s largest online retailer. Car insurance. Plumbing. In some ways, the sky’s the limit.

Even in its wildest dreams, the everything store will never entirely monopolize the marketplace. The company that offers the best price and the greatest convenience will always be vulnerable in market segments where price and convenience aren’t the most important consideration. That especially means higher-end niches where people will gladly pay a penalty to stand out from the pack. But high-end niches are, by definition, niches. The mass market where value conquers all is bigger.

And growth is growth. Amazon hasn’t earned much profit over the past three years, but is there any doubt that today’s much-larger version of the company is a more valuable enterprise than the smaller version of January 2011? Whether shareholders will continue to accept this logic is an open question, but there’s no particular reason they ought to abandon it. For the foreseeable future, the party can—and will—go on, crushing everything in its path and generating mighty gains for consumers.

Correction, Jan. 31, 2014: This article originally misspelled the brand Gillette.