Is Profit No Longer the Motive of Business?

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Today, there are a few companies making me rethink everything I thought I knew about business. I thought a business's purpose was to provide a good or service to society, something that people would pay for and make a profit for the owners.

For years, this is the way the U.S. and the stock market worked. We looked at metrics like return on capital and net income to judge how a business was performing and the companies that made the most money were worth the most money. But Amazon's (NASDAQ: AMZN  ) results along with a no-margin trend in other businesses has me wondering whether the market has flipped the script. 

My world turned upside down
The transition to lower-margin businesses begins (in my eyes) in China, where the goal isn't profit -- the goal is employment. Foxconn can make computers, televisions, and just about every other electronics device for less than U.S. manufacturers not only because it have cheaper labor, but it has free money from the government and doesn't care about margins. The company is down to about a 2% margin, what most manufacturers would consider unacceptable. 

But Foxconn can get cheap money from state-run banks in China -- money that fuels expansion. If U.S. banks handed out billions of dollars to companies to make 2% gross margins, we would be stealing manufacturing from other countries like crazy. Foxconn is the headline maker today, but 20 years ago China started this trend in the PC business. 

It took a long time for the PC business to be overtaken by the Chinese. Dell held its own with efficient operations for a long time, but now it's in a world of hurt and may be going private to try to turn the ship around. IBM saw the writing on the wall before others and sold its PC business to Lenovo in 2004. Since then, we've seen most brands outsource manufacturing to China, if not throw in the towel altogether and capitulate to Chinese brands.

The smartphone and tablet business didn't even have a shot at escaping the low-margin manufacturers in China. Apple (NASDAQ: AAPL  ) has outsourced all of its manufacturing since Tim Cook took over operations, choosing the make margin by designing and selling electronics instead of actually making them. 

But Apple has come under pressure from competitors who don't seem to even care about making money selling devices. Amazon uses low-margin suppliers to make a Kindle tablet that Jeff Bezos has said will be a no-margin device. What a great deal for consumers. 

This same trend has destroyed the solar market, where easy money in China and manufacturers selling below cost destroyed the U.S. solar market. You see it in wind, too, where giants like GE and Vestas have been overrun by companies running razor-thin margins. The examples of low-margin businesses taking over China go on and on. 

Moving beyond China
If the low-margin business is working in China, why not expand it in the U.S.? Amazon is using a no-margin strategy to kill competitors and dominate online retail as we speak. Best Buy has been relegated to a showroom for Amazon and investors have thrown the company out with the bathwater despite a valuation that looks far better than Amazon from a profit standpoint. 

How can Best Buy possibly compete? Jeff Bezos has literally says that he doesn't care about margins, calling his competitors' margins his opportunity. The Kindle sells at cost, Prime users get two-day shipping and streaming content that has no proof of being profitable. Amazon has redefined retail as a zero-margin business and the market is applauding the results, despite no proof that it will ever turn a profit.

In tech, Google doesn't even try to make money selling an operating system for smartphones and tablets -- it just gives it away. How are Apple or Microsoft supposed to compete with that pricing? 

The only thing that stops the wave
I have been questioning everything I thought I knew about business, especially since I'm short Amazon. How can my thesis that Amazon's operations will continue to struggle be so correct and the stock still be moving higher?

The only answer is that investors will have to demand more from companies, or they'll be more than happy to sell at no profit. Right now that isn't happening for Amazon, and Google is happy making money on search and giving away a plethora of other products.

The transition in China will be interesting to watch as the country becomes an ever larger part of the world's economy. Will state-run banks begin requiring larger profits from manufacturers, or are razor-thin margins enough to satisfy them? What happens if some of these banks are turned over to the private sector -- does the dynamic change?

Foolish bottom line
I'm an investors who likes companies who make money and the trend of no-margin businesses have left me scratching my head at times. But as investors try to justify no-margin businesses by moving targets to cash flow or revenue growth or whatever metric is doing well at the time, I'm reminded of the last time we tried to redefine business. The Internet bubble of the late 1990s was built on a notion that clicks or page views were more important than profit. We all know how that ended, and long-term investors who stuck with profitable companies that traded at reasonable multiples were rewarded for their patience. Maybe the same thing will happen again, or maybe we're entering a new no-margin business world? 

Everyone knows Amazon is the big, bad wolf in the retail world right now, but at its sky-high valuation, most investors are worried it's due for a correct. We'll tell you what's driving the company's growth, and fill you in on reasons to buy and reasons to sell Amazon in our new premium report. Our report also has you covered with a full year of free analyst updates to keep you informed as the company's story changes, so click here now to read more.

Read/Post Comments (7) | Recommend This Article (15)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On February 01, 2013, at 12:46 AM, lakawak wrote:

    Give me a break...China's business goals are not profit? Yes they are...they are just about VOLUME, not high profit margins. BIG difference.

    If a business in China was not profitable at all, it would cease to exist. Similarly, if they really ddn't care about profit, they would pay their slaves more. Their business is not about "employment" they employ a lot of people because they can pay them pennies a day. And there are plenty of replacements whenever one of them kills themselves.

  • Report this Comment On February 01, 2013, at 12:48 AM, lakawak wrote:

    Also...trying to say that since Google "gives away" some products that they don't care about profit is as stupid as saying that Gillette doesn't care about profit since you can buy a new Fusion razor that comes with one cartridge at 25 cents or so what the catridge alone costs. Or that printer manufacturers don't care about profits becuase htey sell new printers for 30.

    To Google, Andoird is not a product. the USERS are.

  • Report this Comment On February 01, 2013, at 3:23 AM, ThomasPaine9 wrote:

    I'm rushing out to sell MCD. Clearly they've lost sight of the profit motive since they don't charge kids to play in their playgrounds.

  • Report this Comment On February 05, 2013, at 10:44 PM, crca99 wrote:

    Very interesting. I've never thought about no margin businesses in that light.

  • Report this Comment On February 06, 2013, at 2:08 PM, WhidbeyIsland wrote:

    For generations humans have battled about "free enterprise" vs "socialism." We stopped most of our "natural selection" evolution thousands of years ago. Now our culture is evolving into a new kind of "social being"; perhaps we are becoming a kind of "hive mind." In that frame of reference, the Internet and World Wide Web, Amazon, Ebay, Craig's List, and similar social changes are all early harbingers of a "new" social entity, something like intelligent ants and bees.

  • Report this Comment On February 06, 2013, at 2:28 PM, SkepikI wrote:

    Bubble Bubble, toil and trouble, just another bubble in the making..... how long? who knows, inertia is a strange and perplexing thing in finance, unlike Physics. Hard to measure, harder still to anticipate, but history says it ends ugly. As long as housing prices continued to escalate, it was classic wisdom that affordability no longer mattered, you could just keep flipping your house to something more expensive and then downsize at a profit...until you couldn't. Profits? Doan need no steeking profits...until the well runs dry and the bankers, government, shareholders, whoever says "no more" when? one year? two? ten? it took about ten for some well known scams, but it always, always comes crashing down.

  • Report this Comment On February 07, 2013, at 2:54 AM, maniladad wrote:

    China, or the Chinese government, has been at war with the United States for more than a decade. Recognizing that they lacked the sophisticated military power of the US, they have resorted to non-military tactics, particularly economic, and they have a long, long-term approach. Undermining US production capacity by underselling is just one aspect of the attack. Buying up US debt is another. Cyber attacks may well be part of the preparation for another aspect of the assault. In addition, there are suggestions that some of the electronic equipment that they have produced and which has been used in military applications may have embedded capacity to respond to transmitted signals or to send information, raising the possibility of massive failure of sophisticated hardware during a military operation. (This last possibility borders on paranoia but should not be discarded out of hand. Is it not the height of stupidity to trust your enemy to supply you with reliable equipment?) It is possible that the speculation that drove the rapid rise of oil that damaged the US economy was in part carried out not merely for profit but for political purposes.

    In “Unrestricted Warfare,” written in 1999 by two Chinese colonels, they explained that “a single manmade stock-market crash, a single computer virus invasion, or a single rumor or scandal that results in a fluctuation in the enemy country’s exchange rates, or exposes the leaders of an enemy country on the Internet, all can be included in the ranks of new-concept weapons.”

    They also included this statement, “The Americans have not been able to get their act together in this area. This is because proposing a new concept of weapons does not rely on the springboard of new technology; it just demands lucid and incisive thinking. However, this is not a strong point of the Americans ...”

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