Amazon.com, Inc. [NASDAQ:AMZN] briefly surpassed the $1 trillion ceiling this week to become the second company ever to do so (following Apple’s historic moment a few weeks ago).
$1 trillion! What a time to be alive.
And as an Amazon-fanatic, I’m happy to see them do it.
I’ve used their services on a nearly weekly basis over the past decade or so… I’m a Prime member. I’ve got the whole Echo setup in my home. I’d even get the logo tattooed on my thigh if it gave me some elevated Amazon status.
When I lived in Baltimore, near Washington DC, Amazon had a fulfilment centre nearby…and offered Prime Now — two-hour delivery. We also had AmazonFresh — fresh groceries delivered straight to your door.
So, picture this — you’re baking a cake and you realise you’re out of eggs. Instead of getting in the car, driving to the store, buying the eggs and driving home…you just pull out your phone and order a half-dozen eggs. Within the next hour or so, a delivery guy appears at your door, eggs in hand.
Unfortunately, New Zealand’s Amazon experience couldn’t be more different. If you’re lucky enough to find a vendor that ships here, you might get your stuff this month…if a typhoon doesn’t blow the cargo ship off course.
Sadly, that’s meant that I’ve had to rediscover what the inside of a grocery store looks like…
And despite my most sincere efforts, Amazon’s online sales are not their main driver of profits. Surprisingly, that crown belongs to Amazon’s Web Services — its cloud-hosting arm.
Why is that?
Well, it’s because Amazon’s ecommerce business runs on razor-thin margins, even negative in some cases. Last year, the company’s margin was 1.7%…and that includes the far more profitable contributions from the Web Services branch. The ecommerce side is much lower.
For reference, consider Wal-Mart. The company has built its dynasty on beating everyone on price. It’s managed to push out smaller retailers by squeezing its margins down to nothing…and then surviving by selling half a trillion dollars’ worth of product. Wal-Mart’s margin? 2.8%.
So, Amazon is nearly halving Wal-Mart’s famously low margins…and for what? Just $3 billion in net profit.
Super-high market capitalisation. Super-low profits. A 2017 P/E of…drumroll please…418.
That’s finance-speak for ‘pricey as’.
Frankly, it’s hard to justify that sort of premium. Even coming from Amazon’s biggest groupie. [openx slug=inpost]
So, let’s play devil’s advocate for a second…how could we convince ourselves that Amazon’s astronomical P/E ratio is worth it?
For one, we could be banking on the idea that Amazon’s predatory pricing strategy pays off one day.
Eventually, it could oust your neighbourhood mom-and-pop shop…your grocery store…even other low-costers like Wal-Mart or The Warehouse.
Once it’s taken over the whole game board, it has the full ability to raise prices as it wishes.
That’s the idea, right?
Well, the von Mises in me thinks that there’s no way Amazon could knock out all of the competition, raise prices, and manage to keep the monopoly.
No, the second Amazon raises prices back to — or above — the cost of goods sold, I expect you’d see a flood of new businesses happy to fight for your dollar. We’d be right back to where we started.
And I think Jeff Bezos, Amazon’s head honcho, knows that too.
My guess is that this microscopic-margin strategy isn’t to take over market share…it’s to grow the business and improve the economies of scale so that the cost of goods drops.
When Amazon benefits from a lower cost of goods, it will have some room to play with the margins, while still holding onto a good slice of the market pie.
Add in the factors of improved supply chain efficiencies and logistics, and Amazon’s margin can continue to fatten.
Basically, now that Amazon has the market share it wants, it’s focusing on getting that product into your hands as cheaply as possible.
It’s effective. Now it’s time to get efficient.
For consumers like you and I, this is good news. It means more eggs delivered to my doorstep — for a reasonable price.
It means that Amazon’s new focus on moving product efficiently could lead to previously hard-to-reach places like New Zealand being able to tap into Amazon’s new-and-improved supply chain.
But for producers not selling via Amazon, it means that you’re going to have to deal with the low-cost giant for a long time to come.
You might keep your market share, but only because Amazon wills it. And you can be sure that they’re going to be doing it a whole lot more efficiently than you.
For investors, there’s an obvious opportunity here — automation.
The whole cornerstone to Amazon’s phase two is automating its current processes to be more economic.
That means automation engineering companies like Scott Technology Limited [NZX:SCT] are likely to be in high demand. Getting products made and in customers hands as quickly and cheaply as possible is their game…and when Amazon comes around to our neck of the woods, my guess is that Scott will be their first appointment.
It’s a power-play and I tip my hat to them. Maybe the investors behind the $1 trillion market cap have the right idea. And maybe we’ll all have matching Amazon tattoos soon enough…
Best,
Taylor Kee
Editor, Money Morning New Zealand