Post of the Day
June 11, 1999
Posts selected for this feature rarely stand alone. They are usually a part of an ongoing thread, and are out of context when presented here. The material should be read in that light.
Personal Business Experience
We were a small company re-selling computer hardware and software to government and commercial customers ($18M in revenue, 8% profit). We had a favored status in the business (minority-owned). We got deeper discounts than our competitors. We had excellent inside sales people and fulfillment people. They worked cheap. We had online ordering and even internet-based ordering. We had all virtual inventory. We managed our payables (read slow-pay). We managed our receivables (read discounts). We gave up after 4 years and a lot of losses. Why?
First, the prices we had to sell at did not cover expenses unless our volume was extra-ordinary. Having extra-ordinary volume meant having to float extra-ordinary amounts of receivables (all low-risk receivables fortunately), which added to expenses. Second, there were a lot of competitors that were in the same business, all operating off the same business model, so the competition among resellers lowered the effective spread from about 6-8% to 1.5-3% when we got out. Third, the wholesalers began consolidating and started controlling their negotiated margins to the resellers better (we won't call it price-fixing of course but with fewer sources you get fewer options). Fourth, the manufacturers that used the supply chain bypassed the chain to cut better deals with major customers to preserve their margins. Then fifth, the manufacturers that sold direct and just-in-time began to seriously cut into the market share of the companies that were using the traditional supply-chain, so the large traditional sales model became irrelevant (manufacturer, wholesaler, reseller). In fact, even the wholesalers began competing with the resellers because their margins from the manufacturers were being squeezed so much (which made us re-re-sellers).
Does this Relate to Amazon?
Now I do not understand all of the valuation issues surrounding Amazon. I am a mere tadpole swimming in the Sea of Investing. I look at Amazon from my own operational business experience. So I see three salient points about them that have some parallel in my past experiences. First, they are internet-based with not much competition and that excites investors and allows a business person to make some money (although they haven't yet made money). That is obviously good for investing potential.
Second, there are no large manufacturers in the book business in the same way there is in the computer goods world. In a very real sense, manufacturers are authors-and-publishers, not just publishers, and authors are fickle. Until authors sell their own books direct by contracting to a publisher (or Amazon) for services there will not be the supply-chain bypassing that has occurred in the computer hardware field in the last 5 years. (In fact, if such a model were to occur the publishers might be the endangered species, not an Amazon.) That says pretty good things for the investor community since the margins will not be suffering the same compression that has occurred in the computer hardware field between the supply-chain elements.
Third, electronic books and new printing technology make it quite practical to begin just-in-time techniques to use in the supply chain. That will reduce cost, which will reduce price, which will reduce gross margins. The capital and knowledge barriers to get into the book-publishing business will probably be all but gone in 5 years, so there will be more competition, which means more people chasing fewer dollars. That does NOT say good things for the current investor crowd.
So in my view, Amazon is a market-timing issue, not a valuation issue at all. In five years, there either will be 157,383 other internet-based book-and-other-selling enterprises or none. Whether any of them will actually make money is a fine point for debate. At that time, it will be a valuation issue for investors. Until then, it's a roller-coaster ride and that can be a lot of fun!