When Amazon.com (NASDAQ:AMZN) recently reported another poor quarter with higher-than-expected losses it created a frenzy of news stories, social media posts, and other hubbub questioning the viability of its business model.
Former Microsoft CEO Steve Ballmer took that a step further during an appearance on The Charlie Rose Show last week, telling the host that he did not believe in the online retailer.
"They make no money, Charlie," Ballmer said. "In my world, you're not a real business until you make some money. I have a hard time with businesses that don't make money at some point."
That's a pretty harsh statement, but Ballmer is voicing the concerns of some of the company's critics who wonder if heavy competition and expensive infrastructure, along with research and development costs and razor-thin margins make it impossible for Amazon to actually make money.
How bad was the quarter?
Amazon grew its sales by 20% to $20.58 billion in the third quarter of 2014 compared with $17.09 billion in third quarter 2013. That would be good news if it were making money on those sales, but the company's loss climbed by an even higher percentage. Amazon lost $437 million in the third quarter, up from $41 million during the same period last year. That's a more than 1,000% increase, but CEO Jeff Bezos does not seem discouraged and in the earnings press release, essentially said he planned to stay the course:
As we get ready for this upcoming holiday season, we are focused on making the customer experience easier and more stress-free than ever. In addition to our already low prices, we will offer more than 15,000 Lightning Deals with early access to select deals for Prime members, hundreds of millions of products across dozens of categories, curated gift lists ... new features like #AmazonWishList [which lets you add products to your Amazon wish list by tweeting], and a great new lineup of products like Kindle Voyage and Fire HD Kids Edition. And if you order your gifts on AmazonSmile, we'll donate a percentage of your purchase price to your favorite charity.
So, prices will stay low, Amazon will give some of its scant margin away to charities, and it will continue to build market share while losing money. In the same release the company predicted Q4 sales of between $27.3 billion and $30.3 billion, up 7%-18% compared with fourth quarter 2013, and losses between $430 million and $570 million, compared to $510 million in Q4 2013.
Bezos appears to be playing the old retail game of selling $20 bills for $19 and trying to make up the loss on volume.
Why is Ballmer skeptical?
Losing money while you build market share is a tried and true start-up tactic, but Ballmer thinks Amazon should be beyond that phase of its growth.
"I get it if you don't make money for two or three years," he told Rose, "but Amazon is what, 21 years old? And they're not making money."
Ballmer also questioned if the company, which had a market cap of around $150 billion at the time of the interview, would ever turn a meaningful profit (it has had profitable years).
"If you are worth $150 billion, eventually somebody thinks you're going to make $15 billion pre tax," he said. "They make about zero, and there's a big gap between zero and 15."
Is Amazon doing the right thing?
Bezos is building his customer base and growing sales, but he's doing so by offering low prices, which might not be sustainable. That would be OK if the company was still primarily a bookseller and the only other major player (Barnes and Noble (NYSE:BKS)) could be forced out business, but books are a tiny part of the Amazon puzzle these days. Wal-Mart (NYSE:WMT), Google (NASDAQ:GOOG) (NASDAQ:GOOGL), and Target (NYSE:TGT), the company's biggest rivals, can't be low-priced out of existence.
Amazon is also spending heavily on technology and building its locked-in user base via Prime membership. In theory, having people use Amazon devices and/or tying them into a loyalty program makes them more likely to buy from the company. But if those sales aren't profitable and developing the tech and keeping people paying for Prime by spending big on its free video and music services makes them even less so, then getting bigger just increases losses.
Ballmer may well be right that Amazon isn't a business. It's the weird kid at school who gets everyone to come to his birthday party by handing out lots of free stuff but discovers that he has no real friends once the pizza, cotton candy, and goodie bags are gone.