יום רביעי, 2 באוגוסט 2017

Amazon: becoming the market

by Eds.

Most people have heard of Amazon.com, at least most in the richer countries. [1] People like it for its low costs and the efficient delivery of consumer goods; people hate it for its ruthless cost cutting, with the impact on warehouse workers, delivery drivers and any business that competes with it, from bookshops to electrical goods stores and many others. But the key thing about its business is not that Amazon aims to move into all markets for goods and services. Amazon’s business is to be the market. Looking for something? Check the price on Amazon!

Exploitation aside, Amazon is an unusual company. It is very big, with a market capitalisation just over $500bn on 25 July, so putting it within the top five corporations on world stock markets. Yet it hardly makes any profit. In the five years from 2012 to 2016, it made a loss in two of those years; in 2015 its net income was a mere $596m, although in 2016 that rose to $2.4bn. While these are big numbers to have in your personal bank account, they are peanuts for a major corporation. The 2016 net income was only around $5 per share, when the average price of a share in that year was $700, giving a return of less than 1%. Even this potential return was negated by the fact that Amazon has never paid any cash dividends on its common stock.[2]

But don’t shed any tears for Amazon’s capitalist investors. Despite the lack of dividend payments, they will have found the price of the shares they held rising rapidly. So they could turn a blind eye to the lack of regular income from the shares and instead marvel at the fact that Amazon’s share price has risen from less than $100 ten years ago, and less than $240 five years ago to over $1000 now. The capital gains from these moves have been dramatic, increasing the wealth of shareholders, if not directly their incomes.

What has made Amazon attractive in stock markets is that its business has also been growing rapidly, recently at some 20-25% per year, with net sales of $136bn in 2016. Still, a big business with little profit now can only remain in favour if the capitalist market’s implicit bet on Amazon’s future turns out to be true. That bet is whether Amazon can gain a stranglehold on the markets it has chosen and be the market to which everyone goes, even just to check prices. In other words, it would be a bet on how far Amazon can own the arena in which millions of companies sell to consumers.
Scaling up

From the outset in 1994-95, Amazon’s founder Jeff Bezos had planned that it would become a major commercial enterprise. Its rapid expansion from bookselling into each new market was always seen as a small step to bigger things. Bezos was able to use his previous financial connections and his links into a network of wealthy individuals, including family and friends, to help fund his ambitions. The company had its stock market listing on Nasdaq in 1997. Despite the need for ever more funds from investors and the postponement of any profit at all appearing on these in the early years, he was able to use his model of being an online innovator in consumer markets to gain both market share and investor confidence.

The business logic of Amazon is to scale up, as it is for any major commercial company. This strategy is only avoided if a company aims to become only a niche player, for example in luxury goods. That is far from being Amazon’s perspective, and it depends upon many benefits of scale:
Consumers pay for products before Amazon has to pay suppliers, so the rising volume of sales also gives Amazon a rising volume of available revenues.
A huge volume of business, even at a low rate of return, can still generate a high amount of profit to fund investments and also to cross-subsidise new areas of business.
Once Amazon becomes a major route through which other companies sell their products, then it is able to negotiate lower supply prices, part of which goes into lower consumer prices, building more business volume, and the rest becomes potential profit for Amazon.
Economies of scale are also a key feature of its many warehouse ‘fulfilment centres’, in which a surprising amount of technology is used to speed up shipments and reduce costs.
High volumes of package deliveries to consumers also enable Amazon to negotiate lower rates with postal service and delivery companies.
A large and growing business also boosts Amazon’s brand recognition, both in consumer markets and in the stock market, where its size makes it a major corporation with full access to financial markets, and one in which the big investment funds are encouraged to invest.

Another aspect of Amazon’s business is to cut down on its fixed investment costs. Not surprisingly, being principally an online seller means that it can avoid the costs of setting up physical stores in convenient locations for consumers. Although it has begun recently to move into the latter area, as a major commercial company it held a relatively minuscule footprint of just under 180,000 square feet for office space, fulfilment centres and data centres in the US and other countries in 2016. Only four percent of this space was actually owned, the rest was leased. This gives it some extra flexibility for threatening a local state that it will move if conditions are not favourable, as well as working out as a cheaper option or one where costs are balanced better against the flow of revenues.

Understanding capitalist companies demands attention to how they operate. Especially for companies involved in buying and selling, scale is clearly an important factor for their viability. In Amazon’s case, the rapid growth of the size of its business has also been able to overcome what has been traditionally seen, by Marxists at least, as the real hurdle for capitalist companies: profitability. The dramatic growth of business volume has generated a higher share price for investors in the company, even if they do not benefit from dividend payments, ones that would have been difficult to finance from the relatively small volume of profits available.
Commercial power

A starting point in the huge US market cannot be overerestimated as a key advantage for Amazon. Home to numerous millionaires and billionaires with spare cash to invest, a pool of skilled technicians and a large supply of pliable cheap labour, a relatively uniform system of commercial laws and secure property rights, and a population of over 320 million people with one of the highest per capita incomes in the world, it is no wonder that the US is home to most of the commercial behemoths today. Competition may be fierce, but success in this market can be a springboard for gaining commercial power worldwide.

There are many ways in which to measure the relative size of companies, but one simple measure of size is stock market capitalisation: the total market price of the company’s outstanding shares. Although based upon the latest prejudice of capitalist investors, it has the advantage of being a clear vote, though a changeable one, on how a company ranks in Mammon’s beauty contest. Amazon’s claims to capitalistic beauty are dependent upon the image it projects for future market domination. The reason that, at around $500bn, it has more than double the market capitalisation of US retail giant Walmart is that it has a potential commercial power lacking in the latter company that is much more focused on its physical stores.

There are three dimensions of Amazon’s commercial power. One is how Amazon’s US-based business has subsidised its expansion into foreign markets. Another is how it uses its position in the US domestic market and elsewhere to exert pressure on suppliers. The third is how it manages to use its resources to expand into new business areas, the promise from which has so far kept the accumulation machine running.
The American base

Of Amazon’s business in North America, the US accounts for very much the largest chunk. The growth of the US market has been most important for the company and, even in more recent years when it has expanded overseas, the pace of American growth has been fastest. Amazon Web Services (AWS), an important and rapidly growing area of business ‘which offers a broad set of global compute, storage, database, and other service offerings to developers and enterprises’ is difficult to pin down geographically, but it will very likely also have much of its revenue coming from the US. Sixty-six percent of Amazon’s total net sales of $136bn in 2016 came from the US. This share was up from 61% in 2014, showing the continued, even higher, importance of the US base.
Amazon’s operating income (loss), 2014-2016, year to 31 December ($ million) [3]

2014 2015 2016
North America 360 1,425 2,361
International (640) (699) (1,283)
AWS (Amazon Web Services) 458 1,507 3,108
Total 178 2,233 4,186

The growth of US (North American) operating income, and especially that of AWS, has outrun increasing losses in Amazon’s international business, as shown in the table. Higher international losses are mainly due to higher operating expenses as Amazon expands its ‘fulfilment centres’, technology infrastructure and marketing in these countries. But that still means Amazon has faced prolonged losses on its international business, financed by its North American (mainly US) operations.

So Amazon’s magic has not yet worked elsewhere, although it is continuing to invest in that prospect. Germany, Japan and the UK, in declining order of importance, are its major foreign markets at present, generating a combined 25% of its total net sales in 2016, with the rest of the non-US world making up another 8%. But Amazon has hardly been able to penetrate another major market, China, where it has less than 1% of e-commerce business there – minuscule compared to the local company, Alibaba, which has nearly 60%.
Power to pressure suppliers and targets

The first companies to feel Amazon’s competitive pressure were book publishers, which had previously operated in a cosy cartel keeping high book prices for consumers. Amazon’s volume of sales enabled it to demand price discounts from them, ones that it could pass on to purchasers given that it had relatively low costs for warehousing and delivery. This squeezed the margins of publishers and also spelled the end of many bookshops, including Borders in 2011. Pressure was also put on those publishers or booksellers offering eBooks. Amazon dominates eBooks, with around three-quarters of the US market, and close to half of other main ones, helped by its development of the Kindle, which became a favoured method of reading eBooks.

One of Jeff Bezos’s famous aphorisms is ‘your margin is my opportunity’. That certainly applied to books. It has also been applied to other products, such as CDs, DVDs and other more specialised goods. Because other offline companies found it difficult to match the scale and efficiency of Amazon’s commercial operation, they sometimes tried to use its system for their sales to consumers. But they often lost out, such as Target and Circuit City in the US, with Circuit City eventually going bust. Others have had mixed fortunes, using it, boycotting it, and then coming back again.

Amazon was also able to undermine the arrangements that some producers had with their offline retailers to maintain a ‘minimum advertised price’ that would help secure both their and their sellers’ profit margin. Amazon could use its Marketplace option as a means of delivering products at below these prices, and could also threaten producers that it would put advertisements of lower-priced rival sellers next to any of those showing the producer’s own products.

Amazon’s monopolistic power also extends beyond its purely commercial strength. The best example, one from Brad Stone’s book, The Everything Store, was where Amazon wanted to develop video sales and streaming, and was in competition with Netflix, Google and others. Netflix was strong in the US, but another company, Lovefilm, had a big operation in the UK and Germany, focused on DVD-by-mail and streaming video on demand. In 2008, Amazon did a deal with Lovefilm, exchanging its UK and German DVD rental business and investing cash to become its biggest shareholder, with a stake of around 30%.

Lovefilm later had to get more funds for expansion, but to do that it would need to do a stockmarket IPO (initial public offering). Normally, that is what the shareholders aim for, so they can make a big capital gain on their holding as the company floats on the market and they also have an opportunity to cash in some of their stake. But Amazon had different plans. It had enough influence on the company to prevent Lovefilm from doing the IPO, and this was the leverage that made them sell out to Amazon in 2011, for a low price of some £200m, since their alternative was to stagnate. The monopolist’s bet turned out well, since video streaming – rather than downloads or deliveries – has grown strongly.
Expanding Amazon

Amazon has moved very far from being just a US-based book, CD and DVD warehouse, into many other markets and other countries. Its financial resources have helped it undertake more than 70 mergers and acquisitions since 1998, principally in the US but also in the UK, Germany, Israel and China. It has also expanded into India with its own investment. The largest recent deal was to buy Twitch, a live streaming and gaming platform, for $970m in 2014. But the biggest ever Amazon deal is currently under way and subject to regulatory approval, its purchase of Whole Foods Market Inc, a US-based premium grocery chain, for $13.7bn. If finalised, this deal would add to Amazon’s other forays into groceries, such as Amazon Fresh. It goes against the company’s normal business model, being based in stores on the street, but this is seen as a useful physical footprint from which to pressure other premium retailers.

Such expansion helps Amazon sell more or less everything, presumably creating openings for new business from anyone attracted by just one of its many tentacles. But the data (see the previous table) show that the bulk of its earnings come from its web services arm, AWS, not from the more visible retail business.

AWS was built from the core commercial online business that also depended upon an effective technology infrastructure of software and computer servers. It now has a very strong position in the ‘cloud’, that euphemism for the physical, very much on the ground set of computer facilities, often located in the US, which is accessed via the Internet, and which has become an important source of services for everything from data storage to building applications and website development. AWS reportedly has a million customers, including not just General Electric, Kellogg’s, McDonalds and Netflix in the US, but also BMW, Canon, Nokia, Philips, Siemens, Sony, Tata Motors, the UK’s Guardian and the UK Ministry of Justice.

Recent surveys show Amazon has around 40% of cloud business, well ahead of Microsoft, Google/Alphabet and IBM. Amazon’s business revenue and profits from this source have also grown very rapidly in recent years. As with most other areas of new markets in the global economy, this is one in which only the largest companies, with the best access to finance, can compete. A Wall Street Journal story reported that Amazon, Microsoft and Google/Alphabet alone spent $31.5bn in capital expenditures last year on cloud-related items.
Economics of imperialism

Amazon’s business operations highlight many of the paradoxes of modern imperialism. It provides an efficient delivery of a wide range of goods and services to satisfied customers, but the workers involved in the process are stretched to the limit, and businesses competing with them are liable to come off badly, or may have to do a deal that undermines their viability. It exemplifies how economies of scale and good technology can provide low cost products to the mass of consumers, and how this also undermines previous areas of market privilege (books, music, specialist products, etc) from which sections of the population had formerly benefited. This is the ‘market disruption’ lauded by proponents of capitalism, but is one that inevitably leads to monopolistic power. For now, Amazon is valued by the stock market as a company that is able to use its huge scale and scope of business to eventually produce the required profits. Amazon does not necessarily want to destroy the competition, but to absorb other companies into the market system it has built.

[1] This is the third of my analyses of major corporations highlighting key features of capitalism today. Previous articles were on Apple and Alibaba.

[2] At end-2016, Amazon had outstanding 497m shares in common stock.

[3] Business accounting definitions can be tricky to follow, but note that Operating income is defined as Net sales minus Operating expenses minus Stock-based compensation and other items. Also, Net income is defined as Operating income minus Non-operating income/expense, Provision for income taxes and Equity-method investment activity, net of tax. So the total net income in 2016 of $2.4bn, mentioned earlier in the article, is much lower than the operating income of $4,186m shown in the table.

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