Will diversification into new markets finally turn a profit for
Amazon.com before the dotcom godfather burns through the last of
its savings? Stephen Phillips reports
In five years Amazon.com has built the world's biggest online
store. However, despite generating expected $1bn (£0.67bn) sales
from the Christmas retail season alone, profit has proved elusive.
Despite its profligate sales, business-to-consumer e-commerce's
pre-eminent player is not expected to enter the black until
year-end, according to financial analysts' most-optimistic
forecasts. Meanwhile, a cost-intensive diversification strategy
casts doubt on the prospect of the company ever turning a profit,
according to a growing chorus of company-watchers.
Since spotting the Web's potential as a medium for commerce in
1995, just months after the first browser prised open the Internet
for consumers, Amazon has remorselessly driven home its first-mover
advantage. The trail-blazing Web merchant has carved out a dominant
share of the online book, music and video-retailing market by
leading rivals in delivery speed and reliability and offering a
ground-breaking interface (anchored by its patented 1-Click online
purchase technology), that enables customers to enter payment
details just once for all sales transactions.
If the story ended here there might be a happy-ending in sight.
On its own, this part of Amazon's business recently entered profit
for the first time, with US sales alone worth $1bn (£0.67bn) a
year. However, instead of resting on such laurels, Amazon CEO and
founder Jeff Bezos is eyeing the ultimate spoils of building the
Web's one-stop shop.
To this end, the e-tailer is relentlessly colonising new markets
using pacts with established vendors such as Toys 'R' Us to gain
instant brand cachet and supply chain access. So far Amazon has
diversified into toys, tools, electronics and kitchenware and its
ambition shows no sign of flagging.
With the land grab for Internet retail markets in full flow, the
e-tailer does not have the luxury of being able to wait for
profitability as a platform for expansion, according to Amazon
commentator and venture capitalist Steve Jurvetson, managing
director of Silicon Valley's Draper Fisher Jurvetson. If it digs,
rivals will sew up coveted customers and its "future opportunity is
truncated", he says.
To underpin its bid to become the Web's most pervasive retailer,
Amazon has plunged "hundreds of millions of dollars", says David
Risher, senior vice-president and general manager, US Stores, into
assembling a formidable logistics operation. This spans seven US
warehouses to serve its largest national market, offering storage
space ranging from 200,000 to 800,000 square feet; a 500,000 square
feet warehouse near Milton Keynes to cater for UK customers; plus
facilities in Germany, alongside operations in France and Japan -
its newest national markets.
The company is banking on harnessing the traction it has
developed in its established markets to conquer new ones. The crown
jewel in its quest, according to Jurvetson, is an unparalleled
customer database providing the most-comprehensive glimpse into
consumer buying habits enjoyed by any retailer (online or
physical), opening up multifarious cross-selling opportunities.
However, away from the risk-friendly culture of Silicon Valley,
the financial community takes a decidedly less bullish stance on
the prospects of Amazon pulling off what Jurvetson dubs its
"monopolist's gamble". Many Amazon-watchers believe diversification
will saddle the company with an unsustainable cost burden. "There
is an incompatibility between its brand proposition of offering a
dominant breadth of assortment and achieving profitability," says
Lauren Cooks Levitan, managing director, research at San Francisco
investment bank, Robertson Stephens.
What could prove Amazon's undoing are so-called split shipments
- multiple deliveries to fulfil a single customer order - says
Levitan. This is a keenly-felt problem in the US, the source of
two-thirds of the company's revenue, where far-flung population
centres necessitate a network of distribution centres for product
shipments. By extending its product range, Amazon will have to
source items in a single order from multiple locations, according
to Levitan, ratcheting up costs from postage and labour to picking
and dispatching goods. Meanwhile, the alternative of stocking every
product at all distribution centres is financially prohibitive.
Recent anecdotal research by Robertson Stephens found that
Amazon took an average 3.67 shipments to fulfil each order. The
e-tailer says orders placed by the bank were atypical and denies
split shipments are a function of diversification.
Nevertheless, Risher admits Amazon will lose money on shipments
if split deliveries become "a major problem". To avoid this outcome
Amazon is working to match inventory distribution to geographical
demand patterns, he says.
To ease such fulfillment headaches, Jurvetson proposes
uncoupling Amazon's logistics operation from its Web storefront.
The company should spin out its distribution arm as a separate
money-spinner, he advises, while farming out fulfillment to a
specialist to shed costs and focus on selling. Outsourced
e-fulfillment - spanning warehousing and dispatch of items ordered
online - is expected to be worth £5bn ($7.15bn) a year in the UK
alone by 2008, according to research from consultant E-Insight.
However, Amazon has shown no inclination to relinquish internal
control over operations. As a legacy of its first-mover status, the
firm has historically developed its software in-house, reflecting
the absence of external products when it started out. Even though
suppliers have since sprung up to service the burgeoning online
retail market, Amazon has stuck to a proprietary approach that
seems increasingly like an expensive anachronism.
Another challenge of diversification is the higher marketing
costs attached to many of the new offerings, which unlike books
need to be 'sold'. Last summer, investment bank Lehman Brothers
ascribed Amazon's second-quarter sales shortfall to what it
calculated as a reduction in marketing costs as a proportion of
sales to 7.3% from 12.3% during the first half of 2000.
"To us this is an indication that new categories do not just
sell themselves to existing customers and that without stores to
drive traffic or catalogues to remind shoppers, pure-play online
retailers like Amazon may need consistently higher marketing
support," concludes a Lehman's research note.
As well as needing more merchandising, many of the new items are
bulkier than books, CDs and videos, carrying correspondingly higher
storage overheads. Meanwhile, the consumer electronics market is
currently gripped by punishing price competition as new entrants
such as grocery stores aggressively undercut established players,
leading to crimped profit margins.
Share-price plunge
Amazon shows no sign of scaling back its ambition. However, its
focus on 'sales before profit' is distinctly out of step with
prevailing investor priorities in the wake of last year's dotcom
downturn - raising implications for its continued ability to raise
funds to bankroll its capital-intensive strategy.
Amazon's expansion was funded by a public investment market that
eagerly snapped up its shares in endorsement of its singular
pursuit of market share. But the estimated 16% failure rate of US
dotcoms since last spring has left chastened investors demanding a
clearly-plotted path to black ink as an assurance of return on
investment. Shaky confidence in Amazon's ability to deliver the
goods has seen the e-tailer's share price plunge 75% since the turn
of 2000, before December's retail bonanza dealt a customary fillip
to its stock.
As of last November, Amazon was reckoned to have $830m (£556m)
in ready cash, a sum expected to sustain operations until late this
year at present rates of consumption. However, unforeseen events or
the failure of profit to materialise as expected may force Amazon
to go cap in hand to a hostile market in order to stay afloat.
Despite his support for Amazon's expansion strategy, Jurvetson
acknowledges that the company is treading a tightrope as it bids to
generate cash from operations before burning through its savings.
"The ideal way to run Amazon is to turn cash-flow positive when you
run out of money and people are no longer prepared to give it to
you cheaply," according to Jurvetson. He concedes, however, that no
firm enjoys such foresight.
Meanwhile, there are a number of clouds on the horizon. The
allow-ability of part of what Amazon counts as revenue is under
question. The company's practice of accepting part-payment in stock
for advertising space on its website, under its Amazon Commerce
Network (ACN), is the subject of an unofficial probe by US public
company watchdog, the Securities and Exchange Commission (SEC).
Amazon's November filing with the SEC revealed that 64% of the
$166m (£111m) it received from ACN partners for the nine months
ended 30 September was stock-based. The firm claimed $94.8m
(£63.5m) of this as revenue, within $1.8bn (£1.2bn) total revenue
for the period.
This is entirely in accordance with generally accepted
accounting principles (GAAP), while accepting equity for services
is long-standing US corporate practice. However, its use has become
a bone of contention for loss-making Internet businesses such as
Amazon, whose shares are valued as a multiple of revenue not
profit. At issue is the 'quality' of such revenue - crystallised in
the plunging stock valuations of many of the dotcoms paying to
advertise on Amazon's site.
Much of what the e-tailer booked as revenue from ACN partners
last year, based on their share price when the deal was struck, was
subsequently wiped out amid the dotcom downturn. When stock
recorded as revenue changes in value Amazon is not required to
restate previously-reported figures. While the firm vows it will
insist on a greater hard cash component to future ACN deals, the
ability of struggling dotcoms to cough up currency is also in
doubt.
Clouds on the horizon
While the threat from dotcom upstarts has receded with their
reduced ability to raise funds on the investment market, the
challenge from bricks and mortar retailers adding online stores is
getting fiercer. As well as wielding generous Internet war chests
from established profitability, physical retailers will benefit
from a maturation of the online market, says Ken Cassar, senior
retail analyst for Internet market watcher Jupiter Research.
This can be seen in a change in the demographics of online
shopping from early adopters - typically wealthy, IT-literate young
males who tended to surf exclusively pure-play dotcom websites -
toward a customer base more representative of the population at
large. "They will have a proclivity toward the stores they do
business with in the real world," predicts Cassar.
The advent of digital wallets poses another potential threat to
Amazon's ascendancy. By dispensing with onerous online form
filling, the online payment system would eliminate one of the
barriers to consumers' browsing smaller, less-sophisticated
e-tailers' wares.
In the run-up to Christmas, Amazon senior executives convened
daily summit meetings to micro-manage operations during its busiest
season, and dispatching 450 head office staff from Seattle to swell
the ranks of over-worked warehouse staff. The e-tailer will need to
summon every ounce of this vigilance to rise to the challenges it
can expect to face during the coming year.
Risky Business: Amazon's one-stop web shop
Amazon's vision of a one-stop Web shop faces the following
reality checks:
- Spiraling costs from split shipments of single orders
- Increasing marketing demands of new wares, which unlike books
need to be 'sold'
- Investment market hostility to its sales-before-profit business
model could make it hard to raise funds if the e-tailer burns
through savings
- Stiffer competition from well-heeled bricks-and-mortar
retailers adding online stores
Vital Stats: Amazon.com
- Headquarters: Seattle, USA
- Headcount: 8,700
- Sales (1999): $1.64bn; $4bn expected for 2001
- Net loss (1999): $720m
- Sales (2000):2000 figures unavailable at time of
publication