A Vote for Amazon.com
Rob takes on Al on Microsoft
by Rob Landley (landley@flash.net)

Austin, TX (Oct. 21, 1998) -- Al will probably be a little disappointed in today's column, especially since he expected me to express "a whole lotta love" for Amazon. While I admire the company, it's not one of my personal holdings. And I simply don't follow Amazon.com (Nasdaq: AMZN) closely enough to trust it any farther than I can throw it. That said, I still trust the online retailer way more than I do Microsoft (it's smaller, so I can throw it farther), and I definitely don't consider Microsoft the "obvious" choice between the two.

While I'll concede to Al that Microsoft will probably beat the market over the next ten years, I don't think Mr. Softy will offer the sort of smooth sailing that many people seem to expect (my fellow CK managers included). Today and tomorrow represent my regularly scheduled attempts to knock Microsoft down off of that pedestal, and remind everyone that an investment in any company, even Microsoft, is not a "sure thing." (The fact that I intend to enjoy this is just a fringe benefit.) I hope you enjoy it.

My main argument is, predictably, against Al's assertion that Microsoft has one of the best business models of all time. Microsoft certainly has had a lucrative approach to commerce, but its success has primarily relied on a ruthless leveraging of monopoly positioning in the PC industry. Remember, Fools, that the $17 billion cash on Microsoft's balance sheet won't look so great if they've earned it illegally. There are rules to this game of business, just like there are rules to the sport of boxing (i.e. you can't stuff a metal object in your left glove before the opening bell).

Because I think Microsoft has unfairly used its monopoly position in operating systems, I believe that Amazon's business model is, in several ways, superior to that of Mr. Softy today. For one thing, Amazon naturally has a repeat-purchase quality to its business that Microsoft lacks. Book buyers tend to buy lots of books, which is why we have bookshelves. We also prefer to read new books (buy, buy, buy). And even when buyers hunt used books, Amazon can sell them.

Microsoft's model is very different. They have to spend a lot of money on R&D, then they have to rely on the personal computer makers (Dell, Compaq, Gateway, IBM) to pay up to run their operating system. With the Justice Department poking around, Microsoft may well end up losing the stranglehold it has over the PC makers today, or it may have to forego linking its operating-systems business to their applications, like Microsoft Office and Internet Explorer. If that happens, the PC makers may well choose the best new applications rather than the most financed applications coming down the pike. Imagine that. Innovation.

Now as for competition, let's start with Amazon.com. I'm not quite as worried as Al is about the combination of Barnes & Noble with Bertelsmann. Amazon was first into the niche, which is a major advantage, as countless consumer companies can attest. This sort of game is generally the winner's to lose. Let's remember also that Amazon is not "losing money" because of fierce pricing competition. Hardly. In place of short-term profits, Amazon is making investments in its future. Why, with so many opportunities out there, would Amazon choose to show a taxable profit now? Let's remember that Amazon's gross margins actually increased over the past year, and that revenues were up around 300%. The company may not be a Cash-King, or even a Merchant-King yet, but it's doing something right.

On the other hand, in many ways, Microsoft's competition is really cooling down. Yes, that's bad news. Historically competition has been a great thing for the software giant, since you can't copy your smaller competitors if they don't exist. In fact, when Microsoft has tried to innovate, they've run into a lot of bad news (anybody remember "Microsoft Bob"?). Let's remember that Microsoft even bought the original version of DOS from another company. Make no mistake about how they've built this monopoly -- it's been a heavily legal and financial effort out of Redmond, Washington. By focusing on profitable duplication and aggressive marketing, Microsoft has built an advantage that allows it to methodically tap its existing monopolies as a means for heavily funding failures, and duplicating their way into success.

Microsoft used these tactics in its battle against Netscape Navigator. First it gave away Internet Explorer for free, then it bundled Explorer with Windows 95, then it made it extremely difficult to uninstall Explorer from Windows 98. It's a step by step process. Here it is:

  1. Champion how much competition there is in this chaotic new world.
  2. Wound the competition by giving away a duplicate version of their stuff for free.
  3. Choke the competition with convenience, by integrating your applications into your platform.
  4. Lock out the competition by making your stuff the absolute default.

For a long while, yes, monopolies like this make for great investments because, in effect, as they grow more dominant they actually hunger for competition. They're starved for new ideas. However, once Mr. Softy has convinced no one to compete with them, and they're very close to this status today, what you have is a pure consumer monopoly.

And that monopoly position will prove an inhibitor to Microsoft over the next decade. I don't think it'll so slow down Mr. Softy that the company's stock will underperform the market. But I do think that, in this odd battle between Seattle companies, Amazon.com has the small cap's advantage of facing virtually unlimited room to grow. Microsoft, on the other hand, is one of the largest companies in the world. Today, after rising $6 1/4, Microsoft's outstanding shares are priced at a quarter trillion dollars. How many more doubles are left in this giant? If Amazon ends up being the Wal-Mart of online, they'll have plenty of two-baggers ahead.

I don't want readers of this column to think that I expect Microsoft to heave and stall like an old tractor. I believe the company will beat the market over the next ten years. And I believe that if the Justice Department steps in and breaks them up (which I think is a virtual shoe-in over the next fifteen years), Microsoft's components will grow even faster. But, in the battle in Seattle, I can see a number of strong arguments in support of Amazon.com. They have more room to grow, less obstacles to that growth, and a brandname that customers actually embrace.

Tomorrow I'm going to continue in this vein, talking about Microsoft's role within its industry, including its relationship with Intel, Dell, Compaq, Oracle and IBM. I might also point out some of Microsoft's strengths, and how it could use them more effectively. Finally, if you haven't voted in the Fool's online poll about the Microsoft-DOJ case, cast your vote here.

Fool on, Fools.

- Oak

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10/21/98 Close

Stock  Change    Bid 
 AXP   -2 5/8    87.06 
 CHV   -  1/2    87.25 
 CSCO  +3 1/2    57.63 
 KO      ---     66.94 
 GPS   -  1/16   57.00 
 EK    +  7/8    76.50 
 XON   -1        75.56 
 GM    -  11/16  60.94 
 INTC  +2 1/2    87.06 
 MSFT  +6 3/16  106.44 
 PFE   +1 7/16   98.00 
 SGP   +2 3/8   100.88 
 TROW  -2 3/16   32.13 
                  Day     Month   Year    History 
         C-K      +0.92%   2.32%   8.08%   8.08% 
         S&P:     +0.56%   5.20%   6.35%   6.35% 
         NASDAQ:  +2.17%  -1.13%   0.50%   0.50% 
 Cash-King Stocks 
     Rec'd    #  Security     In At       Now    Change 
     2/3/98   24 Microsoft     78.27    106.44    35.99% 
     2/3/98   22 Pfizer        82.30     98.00    19.08% 
     5/1/98   37 Gap Inc.      51.09     57.00    11.57% 
    8/21/98   22 Schering-P    95.99    100.88     5.09% 
    2/13/98   22 Intel         84.67     87.06     2.82% 
    6/23/98 34.5 Cisco Syst    57.56     57.63     0.11% 
    2/27/98   27 Coca-Cola     69.11     66.94    -3.14% 
     2/6/98   56 T. Rowe Pr    33.67     32.13    -4.60% 
    5/26/98   18 AmExpress    104.07     87.06   -16.34% 
 Foolish Four Stocks 
     Rec'd    #  Security     In At     Value    Change 
    3/12/98   20 Eastman Ko    63.15     76.50    21.14% 
    3/12/98   20 Exxon         64.34     75.56    17.45% 
    3/12/98   15 Chevron       83.34     87.25     4.69% 
    3/12/98   17 General Mo    72.41     60.94   -15.84% 
 Cash-King Stocks 
     Rec'd    #  Security     In At     Value    Change 
     2/3/98   24 Microsoft   1878.45   2554.50   $676.05 
     2/3/98   22 Pfizer      1810.58   2156.00   $345.42 
     5/1/98   37 Gap Inc.    1890.33   2109.00   $218.67 
    8/21/98   22 Schering-P   2111.7   2219.25   $107.55 
    2/13/98   22 Intel       1862.83   1915.38    $52.55 
    6/23/98 34.5 Cisco Syst  1985.95   1988.06     $2.11 
    2/27/98   27 Coca-Cola   1865.89   1807.31   -$58.58 
     2/6/98   56 T. Rowe Pr  1885.70   1799.00   -$86.70 
    5/26/98   18 AmExpress   1873.20   1567.13  -$306.08 
 Foolish Four Stocks 
     Rec'd    #  Security     In At     Value    Change 
    3/12/98   20 Eastman Ko  1262.95   1530.00   $267.05 
    3/12/98   20 Exxon       1286.70   1511.25   $224.55 
    3/12/98   15 Chevron     1250.14   1308.75    $58.61 
    3/12/98   17 General Mo  1230.89   1035.94  -$194.95 
                               CASH     $48.07 
                              TOTAL  $23549.63 
 *Please note: On 8/4/98 $2,000 cash was added to the
portfolio. $2,000 will be added every six months.

*The year for the S&P and Nasdaq is as of 02/03/98