How We'll All Be Amazon.com Customers Eventually

By Greg McFarlane AAA

Some companies have a small clientele and a huge capacity for making money. Others have an enormous customer base coupled with a long-term plan that goes beyond making as much money as possible as quickly as possible. Amazon.com Inc. (AMZN) is unusual among the largest companies in the United States ranked by market capitalization, in that its profit margins are tiny, but its stock is phenomenally expensive. For years and years, Amazon lost money without apology.

Predating even its contemporaries eBay Inc. (EBAY) (founded 1995) and Google Inc. (GOOG) (1998), Amazon opened for business in 1994 in a small West Coast office with a skeletal staff and a tight budget. Since then the company has focused on growth almost exclusively, showing just enough profit to keep shareholders happy. The existing ones should be ecstatic: the stock trades at more than 500 times earnings. Large short-term payables are a necessary part of Amazon’s business model, meaning that the company’s book value is somewhere south of $10 billion, barely one-twentieth that of America’s biggest banks and petrochemical corporations. (For related reading, see What's At Stake As Google Takes On Amazon.)

It’s hardly worth mentioning that Amazon founder Jeff Bezos, the only chief executive officer the company has ever had, loves and lives to defy convention. If he didn’t, Amazon would be an unremarkable bricks-and-mortar bookstore in downtown Seattle, rather than the one company most responsible for the demise of that type of business.

Revolutionizing Retail

Amazon seems to be the one company most beholden to the idea of trying something novel and worrying about its impact on finances later. In Bezos’s own words, “nothing gives us more pleasure at Amazon than ‘reinventing normal.’” The company breaks even on Kindles, instead making money on the content delivered to each unit. Amazon does this while simultaneously revolutionizing the way books are read, no less – turning them from fragile physical objects into easily transportable digital files.

Take Amazon’s unmanned drone experiment, which is still in the research-and-development stages. If it succeeds, not only will Amazon make the idea of two-day delivery sound glacial, the company will do the impossible – attach a positive connotation to the word “drone.” Amazon recently introduced grocery delivery (in the San Francisco, Los Angeles and Seattle areas) for $300 annually, apparently undaunted by the profound failure of that venture when attempted by others in the late 1990s. Will it be sustainable this time around? If any company is qualified to answer that question, it’s the one that popularized annual flat-fee delivery for non-perishable items in the form of its Amazon Prime membership program. “I already paid, I might as well order some more stuff” is the rallying cry of Amazon’s best customers.

Primed For Profit?

For a literal answer to the question “How does Amazon make money,” it’s not that simple. Revenue is one thing, profits (on famously low margins) something else. Last year’s $274 million in net income came from incalculable little sources: a pillow sham here, a pair of pumps there (in 2009, Amazon purchased Zappos.com). But perhaps Amazon’s most profitable endeavor to date is something blessedly low-tech – the one-price shipping (and related benefits) of Amazon Prime. (For more on this topic, see Is Amazon Prime Still The Best Deal In Tech?)

For the unfamiliar, buying a Prime subscription includes access to digital content unavailable elsewhere – TV shows watchable on certain versions of the Kindle, for instance. In a world in which certain services couldn’t subsidize others, Amazon would be losing money on such an offer. According to a Time magazine report, the average Prime subscriber gets $55 worth of shipping and $35 worth of digital content for the $79 price. The math doesn’t appear to work out.

Why 244M Customers Just Isn't Enough

To quote David Letterman, “We lose money on every sale, but we make it up in volume.” Well, Amazon actually does. That average Prime customer is costing the company $11 a year, but in return is buying an extra $719 in merchandise when compared to the average non-Prime customer. It’s $1,224 annually for the former, $505 for the latter, and even with Amazon’s slim profit margins that’s still money in the bank. At least one analyst believes that the correlation between Prime price and money subsequently spent is perfectly inverse, and that if Prime were free, Amazon’s creative devastation of the physical retail realm would accelerate. The company claims at least 20 million of those high-volume Prime customers, an ever-growing proportion of the whole. Which, by the way, is 244 million customers. That total likely makes Bezos cringe – after all, it means 97% of the planet isn’t buying from Amazon.

The Bottom Line

Apple has the celebratory product releases and slavish devotion. Google has the ubiquity, its tentacles all over our online lives. But only Amazon is the company that – more than any other – redefined commerce for a world no longer content to shop in person when there’s no compelling reason to do so. Leveraging itself into a position of market dominance, Amazon has done so to the extent that it’s now practically synonymous with online retail. With unparalleled convenience and famously receptive customer service, Amazon seems bound to continue its prosperous growth in its third decade of existence and beyond.

 
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