During the peak of the COVID-19 pandemic, technology companies in particular experienced unprecedented demand. Amazon (AMZN 0.58%) witnessed a striking inflow of business across both of its core segments: e-commerce and cloud computing. Consumers were ordering household staples, office supplies, and more, while corporations were buying up more cloud instances from Amazon Web Services (AWS).

As a result, Amazon's top-line revenue was surging and its profitability and cash-flow profile were flourishing. In an effort to keep up with demand, Amazon hired loads more employees and invested in its fulfillment centers. However, as pandemic concerns waned and some workers returned to the office, Amazon began to see its business slow down.

At the end of 2022, the company followed its big tech cohorts by announcing layoffs. About a week ago, Amazon's CEO, Andy Jassy, announced that the company is doubling down on these cost reduction initiatives and plans to lay off an additional 9,000 employees.      

How much is enough?

As of Dec. 31, 2022, Amazon had approximately 1.5 million employees. During the company's fourth-quarter and full-year 2022 earnings call in early February, management announced that Amazon would be reducing headcount by 18,000 employees to optimize the cost structure. 

However, in late March, Jassy published a note to Amazon employees saying that the company plans to reduce headcount by an additional 9,000 employees. While this may have initially caught employees and investors off guard, Jassy explained the rationale. He stated:

Some may ask why we didn't announce these role reductions with the ones we announced a couple months ago. The short answer is that not all of the teams were done with their analyses in the late fall; and rather than rush through these assessments without the appropriate diligence, we chose to share these decisions as we've made them so people had the information as soon as possible. The same is true for this note as the impacted teams are not yet finished making final decisions on precisely which roles will be impacted. 

Investors can see that this second round of layoffs is really just an extension of the initial 18,000 impacted employees. Stated differently, Amazon was planning to capture all layoffs in one swing, but some departments took longer than anticipated to figure out its organizational structure.

People working in a warehouse.

Image source: Getty Images.

A cloudy picture is ahead

Per Jassy's note, the majority of impacted employees will come from reductions in the AWS, people experience and technology (PXT), advertising, and Twitch segments.

When it comes to AWS in particular, these cost reductions should not be too surprising. Although digital transformation remains a core pillar for businesses of all sizes, and cloud computing applications are increasingly important investments, Amazon's CFO, Brian Olsavsky, shared an interesting perspective during the Q4 earnings call. Specifically, Olsavsky cited his inability to forecast the growth rate form AWS, given the current "uncharted" territory for the economy. Olsavsky is more or less admitting that demand is slowing down; moreover, the cloudy economic environment and rising concerns over a recession have made near-term forecasting a challenge.

Although this is a tough reality, Olsavsky is spot-on in his assessment. Companies like Microsoft, Alphabet, and Meta Platforms have also announced major reductions in force. In fact, Meta recently announced its own second round of layoffs. 

Cash is king 

The table below illustrates Amazon's trailing-12-month free cash flow over the last several quarters:

Metric Q4 2021 Q1 2022 Q2 2022 Q3 2022 Q4 2022
Free cash flow (in millions) ($9,069) ($18,627)  ($23,487) ($19,686) ($11,569)

Data source: Amazon Q4 earnings release.

The table above shows that for the last 12 months Amazon's free cash flow has consistently been an outflow, or negative. Furthermore, the company's outflows have grown larger since Q4 2021. To put this into perspective, the last time Amazon generated a net inflow was the third quarter of 2021, when the company reported $2.6 billion free cash flow.

During the periods shown above, Amazon's headcount became bloated and operating expenses ballooned. Now, as business normalizes, coupled with operational hedges to lingering inflation and a potential recession, the company is relying on headcount reductions to decrease costs quickly and turn cash outflows back to inflows.

Although Amazon has not guided toward an explicit cost savings target, it's safe to assume that the company is looking to eliminate several billion dollars in costs. Should the company execute, the long-term growth picture is still intact. People will continue to use Amazon as their primary storefront, and AWS will likely continue to be a leader in cloud network solutions.

As a result, Amazon's management has identified a clear, albeit disorienting, path back to profitability. Although layoffs can be rather uncomfortable, management has admitted that the company grew too quickly and overhired during the height of COVID-19. Now, Jassy and his team must create a leaner organization, without compromising long-term growth.

Prudent investors should keep an eye on Amazon's free cash flow and total headcount figures, both of which are publicly reported. If headcount decreases, then there should be signs of smaller outflows. As the company inches back toward free-cash-flow positive operations, Amazon could be worth a look for your portfolio.