3 Companies Becoming Better as They Become Bigger: Netflix, Amazon, and Priceline

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As a company grows over time, chances are it may need to face all kinds of challenges and difficulties. For some special businesses, however, a bigger company means a more valuable product or service. Netflix (NASDAQ: NFLX  ) , (NASDAQ: AMZN  ) , and  (NASDAQ: PCLN  ) are part of that privileged group, and this says a lot about their ability to generate sustained growth for investors over the years ahead.

Netflix: Growing value and increased profitability
Netflix has recently announced a price increase, raising the subscription price for new customers from $7.99 to $8.99 monthly. This has raised some concerns among investors, as the company made a big mistake in 2011 when it tried to excessively raise prices, annoying many customers in a decision that was later reversed.

But things are remarkably different now. The company has added a lot of valuable content to its library, including widely successful titles such as original production House of Cards. More content means more value for subscribers, and $1 extra per month sounds like a reasonable increase considering how much the quality of the service has increased over time.

Netflix benefits from a very efficient and convenient business model in terms of scale advantages and competitive strengths. When the company increases revenues, be it via price increases or new subscribers, the extra money flows almost directly to the bottom line, since costs are pretty much fixed.

Profitability has been consistently increasing over the last few quarters, and contribution margin was 15.6% of sales during the first quarter of 2014, more than double the contribution margin of 7% reported in the same quarter of 2013. Furthermore, management forecasts a contribution margin of 18.5% for the second quarter of 2014 versus 10.2% in the second quarter of 2013.

More customers mean more profitability for Netflix, and the company puts that money to good use by investing in additional content to increase the value of the service. As Netflix gains more subscribers over the years, it also gains financial muscle to reward those subscribers with a growing library of titles.

Amazon and the power of scale
Amazon is all about offering competitively low prices for different kinds of products, even if that means operating with minuscule profit margins. The online retailer has been enormously successful in terms of gaining market share in several retail categories over the last several years, and growth rates are still amazing for a company of its size.

Amazon generated $19.74 billion in sales during the first quarter of 2014, a whopping increase of 23% versus $16.07 billion in the same quarter of the prior year. This performance is nothing short of impressive, and a clear indication of the fact that Amazon continues gaining market share versus brick-and-mortar retailers at a considerable speed.

Amazon enjoys costs advantages versus traditional retailers in areas such as inventory, real estate, and payroll expenses, and the company becomes more competitive as it grows in size. All else equal, selling more products means lower fixed costs per unit, which Amazon translates into lower prices for its products.

In Amazon's particular case, fixed costs are actually rising as the company invests in initiatives like building its distribution network, digital content, hardware, and several other projects. But this is due to the company's strategic decision to actively invest for long-term growth; the business model still allows for falling costs as the company grows in size.

Priceline: A network of growing profits
Online travel agencies are a textbook example of an industry benefiting from the network effect, and Priceline is a profitable growth leader in such a compelling business. Travelers want to go to the platforms where they can find more and better options, and companies like hotel operators, airlines, and car rental businesses choose to partner with the online travel agencies that can bring in more customers.

Priceline is truly firing on all cylinders: Sales during the first quarter of the year increased by 26% to $1.64 billion versus $1.3 billion in the same period of 2013. Gross travel bookings were $12.35 billion during the quarter, a big annual jump of 34%, and Priceline booked more than 83 million hotel nights during the quarter, an increase of 32% over the first quarter last year.

The company is mostly focused on the agency business model, which means allowing hotels and other service providers to list their own offers, paying the company a commission for every transaction.  As opposed to the merchant model, which means buying blocks of rooms and selling them at a markup to travelers, the agency model has no associated cost of revenue, and this should allow for increasing profit margins over time.

Both travelers and industry operators benefit from a more valuable service as Priceline becomes bigger, and the company gets to expand its profit margins as sales grow over the years. This is quite a convenient business model for long-term shareholders in the company.

Foolish takeaway
In business, as in life, growth is seldom easy. But companies such as Netflix, Amazon, and Priceline enjoy a particular advantage, since their customer proposition becomes more valuable as they grow in size. This is a crucial aspect to consider when evaluating the long-term growth prospects of these companies.

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Andrés Cardenal

Andres Cardenal, CFA is a tenacious researcher of the best investment opportunities around the world. Andres is an economist and CFA Charterholder living in Buenos Aires, Argentina. Naturally flavored. Follow me on Twitter for more investment ideas:

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8/28/2015 4:00 PM
AMZN $518.01 Down -0.36 -0.07% CAPS Rating: ***
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PCLN $1259.39 Up +7.38 +0.59%
Priceline Group CAPS Rating: ****