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October 17, 2000

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Subject:  Re: ETYS: Gordo's Crisvinesque Lapses
Author:  albaby1

NemEd wrote:

I think you're quibbling over what you alone think constitutes economies of scale. I don't think you can make up your own rules and say ad costs don't count in this evaluation.

Sigh. I'll borrow Reagan's line: "There you go again." I just got done complaining that you were attributing positions to me that I had not taken. Now you're claiming that I said that ad costs don't count? Where did I say that, exactly?

My point is that declining percentage costs of any operating component do not, in and of themselves, demonstrate economies of scale - particularly when you examine expenditures and/or revenues on a quarterly basis. To quote my earlier post:

"However, when a company is growing its infrastructure (as Amazon still is) in advance of sales to use that infrastructure, declining costs as a percentage of sales do not have to indicate the presence of economies of scale. When a company front-loads capacity, we expect that percentage costs will start out high, and decrease as capacity is utilized."

http://boards.fool.com/Message.asp?mid=13419646

Thus, we have no way of knowing whether a percentage decline in a particular operating cost represents: a) growing utilization of a front-loaded investment in capacity or demand generation; or b) greater efficiencies through scale. I don't think my arguments are similar to predictions of whether Amazon will be profitable one day; I was merely rebutting your implicit suggestion that current expenditures demonstrate economies of scale.

Continuing on, you note:

Your NYT example, which I am quite familiar with, while appealing to you in its sentimental, little-guy novelty, is not very useful, in the end. It's become a kind of quaint, though less than instructive cliche. They don't have marketing expenses for one.

You might not be as familiar with the example as you suggest, particularly since you appear not to know the ending. Mr. Bowlin tried to scale up from his profitable mini-store into a larger on-line presence, and got mushed. I was actually citing it for the opposite of what you suggest: not a feel-good story of David.com vs. Goliath.com, but rather an illustration of the hazards of growing beyond a certain scale.

Which brings us to:

To coin one of your favorite phrases back at you, the hobbyist example is just that, a "trivial" example, with no impact on the larger industry we speak of. It was good for a little luddite article in the NYT and some nifty little human interest story for the bears to share around the campfire, but unless you're willing to do a follow-up and tell me how this guy has quit his job and is making a killing in his little vanity business (selling to a relatively small circle of family and friends), I think you can put it to rest.

Your perjorative dismissal of "hobbyists" misses the mark a bit, but I have to admit I was not abundantly clear in my earlier posts. Mr. Bowlin's experience is not an example of the profitable small business; I refer you more directly to my earlier posting about the success of small retailers that use Ebay as their primary marketing tool:

http://boards.fool.com/Message.asp?mid=13163955

That posting discusses an article in the NYT about Ebay's strong B2C component, distinct from the C2C model wherein Aunt Ida (not her real name) clears out her attic:

http://www.nytimes.com/library/financial/sunday/082000biz-ebay.html

Using the figures cited in that article, we can draw some conclusions about smaller on-line businesses. Ebay has between 20K-25K registered "power sellers," who have minimum monthly sales of $2K, $10K, or $25K to qualify for different levels. Taking the most conservative of those figures, 20K sellers at $2K per month yields approximately $480 million in annual sales - pretty good for alleged "hobbyists." 25K worth of power sellers at the minimum dollar level would clock in at $600M.

More likely the total B2C sales logged through Ebay is larger, since that's the most conservative estimate and not all businesses choose to register as "power sellers." The article also notes that the top 10% of sellers accounted for about $1B of Ebay's $1.3B of total sales last quarter - or half again as much as Amazon did over that time period. Plus, Ebay small businesses also have sales that are generated on-line outside of their auction listings, so their total on-line revenues are actually higher than just those sold through Ebay.

Those businesses are small, and they are profitable, by and large - the article reports a study showing profit margins averaging about 40%. Their profitability vs. Amazon can't all be due to lack of advertising expenses, either. Not only do those firms have to pay Ebay listing fees, but Amazon wouldn't be profitable even if marketing expenses fell to zero.

This is hardly conclusive, of course. But there is at least some evidence that suggests small-scale e-tail operations have been able to sell and fulfill at significantly lower operating costs (as a percentage of revenue) than any of the big companies, including Amazon. That doesn't comport with the suggestion that being bigger translates into more efficiency.

But I return to my earlier position: I do not assert that economies of scale in e-tail do not exist. In fact, I think it's pretty likely that they do at some level. However, I think that the percentage figures that you cite do not necessarily support the conclusions that you draw from them.

Best regards,

Albaby


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