Amazon.com turned 20 years old this year, but you'd never know that by looking at the company's bottom line. For all intents and purposes, the e-commerce giant is still being run like a start-up, albeit one with more than $80 billion in revenue over the past 12 months.
The company's decision to forgo profits in favor of low prices led former Slate contributor Matthew Yglesias to characterize the Seattle-based company as a "charitable institution being run by elements of the investment community for the benefit of consumers." And, just to be clear, this isn't an unusual sentiment. The argument is that investors have excused Amazon's paltry profits because they've bought into founder and CEO Jeff Bezos' philosophy. But according to this line of thinking, this faith won't last forever; at some point the company will have to turn its attention to actually making money.
It's impossible to deny that there is something to be said about this. Ultimately, investors will demand that Amazon do something about its anemic profit margin. At the same time, however, it also seems impossible to deny that a move in this direction anytime soon would be premature -- not to mention unlikely given Bezos' continued reign. Bezos has a vision. He's delivered on that vision over the past two decades. And the scale of Amazon's potential remains so breathtaking that one would be excused for concluding that the company is still in its infancy.
A gaping divide between revenue and earnings
Amazon's preference for growth instead of profits is without precedent. Over the past decade, its net income increased from $35 million in 2003, its first year in the black, to $274 million last year. On the surface, this looks pretty good -- after all, it equates to a nearly eightfold increase. Yet over this same time period, its annual revenue went from $5.2 billion all the way up to $81.8 billion in the four most recent quarters. The net result is that Amazon's profit margin has plummeted from 5% down to just 22 basis points -- that is, 0.22%.
This is an unusually thin margin relative to other now-established companies at Amazon's age. As Daniel Gross observed last October:
By the 1920s, 20 years after Henry Ford founded the Ford Motor Company, Ford was racking up profits of about $90 million per year. Between 1893 and 1901, John D. Rockefeller's Standard Oil threw off $250 million in dividends alone. The company was so profitable that Rockefeller didn't know what to do with the profits and was forced to invent modern philanthropy just to get rid of it.
Some more recent examples: Intel was founded in 1968 and operated in a highly competitive, capital-intensive industry. Yet in 1988, Intel earned $452.9 million on $2.87 billion in revenues -- a fat 16% profit margin. The first Wal-Mart opened in 1962. In 1982, 20 years into its life, Wal-Mart had sales of $2.4 billion and profits of $55.7 million, a razor-thin 2.5% margin but a profit nonetheless.
The growing divide between profit and revenue at Amazon is even more extraordinary when it's compared to other technology giants. In 2013, Google earned $12.9 billion from revenue of $59.8 billion, Microsoft generated $22.1 billion in net income from $86.8 billion in revenue, and even Facebook cleared $1.5 billion even though its top line was a comparatively paltry $7.9 billion. These equate to profit margins of 22%, 26%, and 19%, respectively.
To this end, Amazon has cultivated a vast stable of unprofitable services. It's piloting an almost certainly unprofitable grocery delivery service in Seattle, San Francisco, and Los Angeles. It breaks even on its Kindle e-readers and tablets. And it offers free two-day shipping to Amazon Prime members, its highest-volume customers. Even though the price of an annual membership increased this year from $79 to $99, analysts still believe that it yields a deficit. "While raising Prime pricing and pitching 'drone delivery' solutions make good headlines, shipping losses remain a burden on profits," BGC Financial's Colin W. Gillis told Wired Magazine.
Underlying all of this is Bezos' philosophy that delighting customers with the lowest prices and best service possible is intimately intertwined with creating long-term value for shareholders. "Proactively delighting customers earns trust, which earns more business from those customers, even in new business arenas," Bezos wrote in his 2012 letter to shareholders. "Take a long-term view, and the interests of customers and shareholders align."
Amazon's dominance of e-commerce
With two decades' worth of performance under its belt, it's safe to say that Bezos' vision has been borne out by the facts. Since the turn of the century, the online retailer's revenue has increased by double digits every year. And while there are whispers that this is starting to moderate, as one would expect from a company approaching $100 billion in annual sales, it's still growing at an incredible pace. Sales in the most recent quarter were up by 23% compared to the same period last year.
Even more impressive has been Amazon's ability to capture a growing share of the rapidly expanding e-commerce market. In 2000, the first full year the Commerce Department tracked online retail sales, Amazon's $2.76 billion in revenue equated to 10% of total e-commerce sales. Fast forward to today and the figure is 28.3%.
It's important to appreciate, moreover, that this estimate dramatically understates the breadth of Amazon's actual influence. This is because the company also operates an online platform for third-party retailers. Amazon doesn't disclose this channel's sales volume, but Scott Wingo of Channel Advisor, a company that provides consulting services to online retailers, believes it added up to $24.6 billion in the fourth quarter of last year alone. That's roughly $1.5 billion more than Amazon generated directly from its own e-commerce sales.
After taking third-party sales into consideration, one gets a clear view of Amazon's dominance. Using Wingo's research as well as assumptions about Amazon's international sales derived from its latest annual report, the company's market share in the fourth quarter of last year amounted to an estimated 46% of U.S. e-commerce sales. Add in eBay's domestic sales, and the two companies control a majority of the market, leaving only 42% to be split between thousands of other retailers. By comparison, Wal-Mart's share of the entire domestic retail market (excluding automobile-related sales) topped out at 12% in 2009.
On top of this, there's little reason to believe that Amazon's sales are anywhere near their long-term potential. You can infer this from the fact that total e-commerce sales, while growing rapidly, are still only a fraction of overall retail sales in the United States. According to data curated by the Federal Reserve Bank of St. Louis, online sales accounted for a mere 6.4% of domestic retail sales in the most recent quarter. It's no exaggeration, in other words, to characterize Amazon's potential as breathtaking.
The Catch-22 in Amazon's business model
After two decades of waiting for Amazon to turn a meaningful profit, investors would be excused for wondering when it will flip the switch and begin doing so. Just matching Wal-Mart's meagerly profit margin of 3.3% would have added $2.2 billion to the e-commerce giant's bottom line in 2013. But the truth is that the stakes are too high to risk such a move just yet -- or, for that matter, anytime in the foreseeable future.
Is there any doubt that Amazon could someday generate $500 billion in annual revenue if it continues on its current trajectory? Is there any question that it has the potential to become America's biggest retailer by sales volume? Or that it will continue to play a starring role in the digital marketplace as well as cloud computing? In my mind, there's isn't. To Bezos' point from two years ago, "long-term thinking squares the circle."
