Many companies, in an effort to continue growing, diversify into new businesses. Sometimes this makes sense, specifically when the new business is somewhat related to the mature core business. But often this diversification is nothing more than "deworsification," a term coined by legendary investor Peter Lynch. When a company expands into areas where it has no experience or advantages, it is guilty of deworsification.
The shotgun approach
Amazon originally started out as a bookseller, and eventually started to sell all sorts of things through its website. This diversification made sense, since the company's core competency was selling products online. But over the past few years, Amazon has been expanding into an array of different industries, and the company's complete lack of profitability should be troubling for investors.
In 2006, Amazon launched Amazon Web Services, a set of cloud services for websites and applications. This includes cloud-based storage, virtual machines which can run applications, and various database services, among other options. Amazon Web Services has grown extremely fast, and many large websites use the service. Examples are Pinterest, Reddit, Foursquare, Netflix, and Spotify, to name a few.
You could argue that because Amazon had to build the infrastructure to support its own website, the company has experience in this type of business. Indeed, web services make at least some sense for Amazon. What doesn't make much sense, though, is hardware.
Amazon makes both e-readers and tablets with the goal of selling content to customers using the devices. Prices are extremely low, and Amazon makes no money at all from selling the hardware. The only real money is in the high end, dominated by Apple and Samsung. Low-end manufacturers are left with razor-thin margins.
Recently, reports have surfaced that Amazon is working with HTC on a smartphone, presumably with the goal of making it even easier to buy products through Amazon. Another report, this one from the Wall Street Journal, states that Amazon will be selling a set-top box this holiday season. Another initiative is a new PayPal rival, Login and Pay with Amazon, which will allow shoppers to pay on third-party sites by logging into Amazon.
What exactly is the goal here? What is Amazon aiming to be? Certainly not a profitable company, that's for sure. Amazon has no advantages in hardware. Most set-top boxes, like the Roku for example, support every major video service, including Amazon, not to mention the game consoles. Unless Amazon plans to give this thing away for free, I don't see the point.
It seems that Amazon is getting into every low-margin business even remotely related to e-commerce. If the goal is to simply grow revenue, then mission accomplished. But there is no discernible path to profitability, and eventually Amazon needs to prove that it can actually make money. All of this deworsification makes that harder.
When I first read that Intel was planning to revolutionize television with its own web TV service, I was baffled. As I read more about it, my state of bafflement only increased. It seems that Intel, which is the dominant chipmaker for PCs and servers and is just starting to break into the mobile processor space, decided that launching a TV service made sense.
Of course, the effort has so far gone nowhere. Intel has been unable to secure any major content deals, and now the company is seeking a partnership to get the service off the ground. Intel's core competency is semiconductor chips, and the company has no experience with media distribution. It amazes me that this idea got as far as it did.
Intel needs to dump the program and refocus on getting its chips into mobile devices. To some degree, this is already happening, as new CEO Brian Krzanich has slowed the TV efforts. This is the quintessential example of deworsification, and investors better hope that Intel hasn't wasted too much money on the effort.
The bottom line
When a company launches new initiatives in order to diversify, it's important for investors to make sure that the company is sticking to what it knows. Amazon getting into every business under the sun isn't going to lead to profitability, and Intel trying to "revolutionize TV" is only going to tarnish the company's image. When a company starts deworsifying, it may be a sign of desperation to grow revenue.
Timothy Green has no position in any stocks mentioned. The Motley Fool recommends Amazon.com and Intel. The Motley Fool owns shares of Amazon.com and Intel. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.