Shares of Amazon.com (AMZN +3.23%) tumbled recently after the company reported a huge loss during the third quarter and guided for an unprofitable holiday season. The massive investments Amazon has been making are taking their toll on the bottom line, but even revenue growth, which has remained impressive for so long, is expected to slow during the fourth quarter.
The story has always been that Amazon is investing in its future, eschewing the profits of today for the eventual profits of tomorrow. But this strategy, while pushing the stock to huge gains over the past decade, may now be hitting some resistance. Here are three massive risks facing Amazon that investors should be aware of.
The competition isn't standing still
Amazon has built its e-commerce empire by being able to offer the lowest prices, but this now seems to be changing. A recent study found that both Wal-Mart and Target offered lower online prices than Amazon in a few major categories, and although the cost of shipping isn't considered, this marks a distinct shift from the general perception that Amazon is always the cheapest option.
Many retailers now employ software that automatically adjusts prices to better compete with Amazon, and companies like Staples (SPLS +0.00%) and Best Buy also price match Amazon both in-store and online. And with Amazon charging sales tax in an increasing number of states, any price advantage the company once had appears to be vanishing.
Amazon Prime, which gives those willing to pay $99 per year free two-day shipping on all orders, is also under attack. Services like ShopRunner, which partners with various retailers and offers free two-day shipping for $79 per year, is essentially a non-Amazon version of Prime, without all of the extras that come with Amazon's service. Google Express, although only in a few locations so far, is another potential threat. Google Express offers same-day delivery from a variety of stores, like Target, Costco, and Whole Foods, by employing couriers to make the deliveries.
Along with these services, some retailers are getting far more aggressive with shipping. One example is Staples, which offers free delivery on all orders to members of its free rewards programs, and on many items, it offers free next-day delivery. This is possible because Staples already operates its own fleet of trucks for its commercial delivery business, allowing it to eliminate the middleman on many occasions.
Amazon is still the default option for many consumers, but competitors are getting better at fighting back. Whether consumers are actually loyal to Amazon, or simply loyal to low prices and free shipping, remains to be seen.
The cloud could eat Amazon alive
Amazon had the benefit of being the first mover in the infrastructure-as-a-service market with Web Services, and it still maintains a leading market share. But prices for basic commodity services like storage and virtual machines have been continually slashed by both Amazon and its competitors, and it's becoming difficult to see how Amazon can maintain profitability from its cloud computing business in the long run.
Both Amazon and Microsoft are investing billions of dollars per year building out their respective data centers, but while Microsoft has various cash-cow business that are wildly profitable, Amazon has a low-margin retail business with which to fund its cloud investments. With an operating loss of more than $500 million in the third quarter, and the low end of Amazon's guidance calling for an operating loss of the same magnitude next quarter, it's questionable whether Amazon can continue to compete in the cloud computing market in the long term against rivals that are drowning in both cash and profits.
A first-mover advantage only goes so far, and Amazon may be reaching the point where its cloud computing lead is in serious jeopardy. Without the resources of a company like Microsoft, Amazon may not be able to defend its position, and the huge investments the company is making could ultimately be for naught.
Big bets are backfiring
Amazon has gotten into a lot of different businesses over the past few years. It started selling its own tablets, with moderate success, as well as the Fire TV streaming box. It began delivering groceries to people's doorsteps in a few cities through Amazon Fresh. It paid nearly $1 billion for Twitch, a website where people stream themselves playing video games. And, of course, it invested heavily in its cloud computing business.
Sometimes, these big bets on new businesses backfire, and one needs to look no further than the Fire Phone for a perfect example of such a failure. I wrote in June that Amazon's foray into the smartphone market would be a massive failure, and the company's third-quarter earnings report has confirmed my opinion. Amazon took a $170 million write-off related to poor sales of the Fire Phone, even after the company slashed the price to $0.99 with a two-year contract in an effort to spur demand.
Amazon's tendency to enter markets where it has no competitive advantage poses a big risk to the company going forward. Famed mutual fund manager Peter Lynch coined the phrase "deworsification" to describe a company diversifying into areas beyond its core competency, and this appears to be exactly what Amazon is doing. Amazon investors should be questioning whether the company is making sound investments in the future, or instead simply throwing money away.
