Amazon's Insane Plan to Destroy All Rivals

The e-tailer's willingness to slash its own margins is so crazy, it just might work.

Nathan Alderman
Nathan Alderman
Sep 6, 2012 at 12:00AM
Other's (Nasdaq: AMZN) newest video content deal looks disastrous for struggling streaming-video service Netflix (Nasdaq: NFLX) -- and, honestly, not that great for the e-tail giant, either. Why, then, did Amazon cut Netflix off at the knees?

Apparently, just because it can.

Development, arrested
After losing rights to Disney and Sony films in the past year, Netflix got recent hit movies for its streaming service almost entirely from cable network EPIX. The joint venture of Paramount Pictures, MGM, and Lions Gate has charged Netflix $200 million a year since 2010 for exclusive rights to flicks from the Marvel Universe and Transformers series, among other blockbusters. With that exclusivity now ended, EPIX has wasted no time cashing in.

On Sept. 4, EPIX also licensed its films to Amazon's Prime service. Throw in another recent deal that gives Amazon rights to NBC Universal TV shows, and its lineup looks eerily similar to Netflix's. But Prime's cheaper on a monthly basis, and includes free two-day shipping on all Amazon orders.

As competitors duplicate more of its streaming catalog, Netflix must rely all the more on original content like next year's new season of Arrested Development. But while its 2013 lineup of original shows looks promising, life as just another HBO-like premium channel seems like an awfully steep slide from Netflix's glory days as the undisputed ruler of DVD rentals. And it likely won't offer investors the same kind of margins or growth opportunities.

What is Amazon thinking?
In its latest quarter, Amazon earned just $7 million – yes, with an "m" -- in net profit, on sales of $12.83 billion. Its quarterly net margin shrank from 1.9% to a microscopic 0.05% year over year.

Don't assume that the annual $79 fee Prime members pay will help stem those shrinking profits. Amazon's fulfillment expenses rose 58% year over year in fiscal 2011. As a percentage of sales, shipping costs climbed from 8.5% to 9.5% in the same period.

So why is Amazon burning tens of millions (or more) each year, just for one of several streaming movie sources? Especially when Amazon Prime video is essentially a freebie extra to entice people to pay for an already unprofitable shipping discount?

Jeff Bezos, honey badger
Like the African honey badger, whose astonishing indifference to bee stings and cobra bites has earned it Internet infamy, Amazon CEO Jeff Bezos just doesn't seem to care.

Shrinking margins? That's short-term stuff, and Bezos seems to take the long view. In everything from retail to book publishing to streaming video now, he's proved willing to cut margins past the fat, through the muscle, and deep into the bone, just to crush his rivals and drive them out of business. Perhaps Bezos envisions an uncontested reign for Amazon as the king of everything the world wants to buy. If so, I'm not sure how much of that dream will pass muster with antitrust authorities. But I can't see any potential outcome that ends too badly for Amazon.

In addition, when Amazon entices customers into paying for Prime, those shoppers have a greater incentive to buy more stuff from Amazon, and less from its rivals. That not only steals market share and slowly starves other retailers, but also brings an ever-rising tide of revenue into Amazon's coffers. In its latest quarter, Amazon's product sales grew more than 25% year over year. However little of that cash makes it down to the bottom line, the extra revenue fuels Bezos' plans for new shipping centers and cloud server farms, in furtherance of his competitor-crushing aims.

Don't assume Amazon will go broke in this pursuit -- at least, not yet. While its cash reserves dropped by nearly $3 billion year over year in its latest quarter, it still has $2.3 billion in the bank, plus another $2.6 billion in marketable securities. That's enough of a stronghold to keep the company in business for a while yet.

Rivals of any stripe should think twice about crossing Amazon in any market segment. This company is quite frankly insane. It will spend many millions of dollars each year to destroy your entire business, just so that it can make one free side benefit of its money-losing subscriber service even slightly more enticing.

That's dismal news for Amazon shareholders in the short term, especially given its mind-boggling forward P/E of more than 100. But Fools who stay focused on the long term -- as Bezos seems to -- may be rewarded if and when Amazon outprices, outspends, and outlasts all who dare oppose it.

Want to learn more about this fearless, ferocious honey badger of online retail? Get a complete breakdown of's strengths, weaknesses, and areas investors need to watch in our Fool analysts' new premium report.