Why does Amazon have such a low profit with such a high revenue?

The largest companies recently published financial statements for the first quarter of 2016. It turned out that the company Amazon for the first time in a long time showed a substantial profit . Profit for this period was the highest for the entire 22-year history of the company and reached 513 million dollars. For comparison, losses for the same period last year amounted to $ 57 million, and in general the last five years in this regard were not the most successful for the company. Despite the fact that Amazon more often showed losses than profits, investors give it much greater freedom of action than other companies in this market segment. We wondered - why is this happening?

Let's start from the beginning. The company, now known as Amazon, was founded in 1994 by Jeff Bezos and was then called Cadabre. The name was unsuccessful, because it resembled the word " cadavre ", so a year later it was replaced with Amazon. The company received its name in honor of the world's largest river - the Amazon, as Jeff Bezos set out to make his business the largest in the world. In addition, the name seemed sonorous and memorable. Indeed, in the online business, as Jeff Bezos said at the time, the name means much more than in the real world.

There is a “city legend” that at the time of the start, the tables in the company's first office were made of doors, and the office itself was located in the founder’s garage. The tradition to put tables in the office out of doors still remains, although the need for austerity has long disappeared.

At the very beginning, Jeff Bezos planned to sell only books over the Internet, since all you need to do is to place only an annotation on the product card. In any case, it seemed to him at that time. But things quickly went uphill, and gradually the range of goods expanded. In 1996, online sales were almost a wonder, and many customers liked the new way to shop. In an interview, Bezos shared his memories:

“We started receiving letters from customers asking them to sell music, DVDs and electronics in this way.”

Thanks to bold solutions, the Amazon store quickly grew and became one of the largest online stores. His success is associated not only with a successful commercial strategy, but also with the founder’s business philosophy. At the time, Jeff Bezos left the post of vice president of a major investment firm DE Shaw in order to start his own business. In an interview with Time magazine, he told me that he wanted to have a business that he wouldn’t regret. And Amazon has become such a thing. In the 90s of the 20th century, internet business was a risky undertaking, but Jeff Bezos took this risk and won.
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The winnings, however, were not instantaneous. Only in 2003, the company received its first profit - $ 35.28 million for the year. During the whole period of the company's existence, the financial analysis showed that the profit growth was relatively small, and if you look at the illustration below, the chart constantly fluctuates around zero. Let's see why. First, in terms of transactions, Amazon plays the role of an intermediary or provides its brand for partners without setting its price. Continuously improving logistics processes are also costly, but for US customers, delivery is usually free. All this makes it difficult to obtain super profits. In addition, Amazon often acts — in different business segments — rather as a platform for other businesses, sacrificing current profits for further development.

However, fast super-profit was not the goal of Bezos. One of his main strategies is long-term work. Take a close look at Amazon's net income curve.



As can be seen on the graph, despite significant long-term growth in gross income, net income remains at a rather low level. Why it happens? First you need to say that the overall schedule does not reflect the whole picture. Amazon, as we have said, consists of many segments that operate independently of each other. Some of them are known in the market and bring good profits. Others are startups and, like all startups, require significant investments with little income. Finally, a significant portion of revenue comes from fees and commissions on goods and services provided by third-party firms, for which Amazon acts only as a platform. This means that the growth in gross income does not provide direct information on changes in consumer prices and the margin of Amazon itself. The graph reflects only the dynamics of the sum of all the factors listed above.

Perhaps the ratio of free (FCF) and operating (OCF) cash flows will help better to understand why net profit remains low.



Amazon primarily pays attention to free cash flow. But let's look at the operating cash flow graph. Operating cash flow is nothing more than a company's business income minus operating expenses. If we take away capital expenditures (CAPEX) from the resulting value, we get a free cash flow. As is evident on the graph, with a significant increase in operating cash flow, the free cash flow graph remains at the same level. This means that all additional proceeds are invested in capital expenditures or, in other words, in the growth and development of a corporation. That is, over the period from 2011 to 2013, over $ 5 billion was invested in business development.

Jeff Bezos himself spoke about this when he depicted the activities of his company in the form of a diagram posted at the beginning of our article. Please note that there is no arrow on the chart in the direction of the “income generation” item. The flow of capital in Amazon is a closed loop that supports continuous growth and development .

It was significant and continuous investment throughout the work of the company that helped Amazon to develop and implement innovations that ultimately took a strong place in various types of online businesses. Among them - the "order in 1 click", which today has become the standard of e-commerce. The system remembers the buyer's data entered at the time of the first order, and allows you not to re-enter them with each subsequent order. The option, without which it is difficult to imagine any online store, was once a bold step.

When Amazon added the ability to post product reviews on its website, it also caused mixed reactions in the market. Analysts predicted a drop in sales due to poor feedback. But that did not happen. The pace of sales continued to grow, while customer loyalty increased due to more reliable information about the quality of goods.

Amazon was among the first companies in its segment to begin developing its own products. The Kindle ebook reader first went on sale in 2007. The first batch of devices was sold in 5.5 hours. Now the seventh-generation Kindle is the best-selling device for reading among electronic books.

Kindle is by no means the only and not the most famous company initiative. Now Amazon is the largest player in the cloud business. In 2006, the Amazon Web Services (AWS) project was launched. At first, it was only a data warehouse of up to 5 terabytes. Now it includes more than 50 services, from file hosting, distributed data storage, renting virtual servers and providing computing power to business intelligence. AWS operates in 33 different zones in 12 regions of the world; Next year, 11 more accessibility zones and 5 new regions will be added. The data center Amazon in Northern Virginia is among the ten largest cloud-based data centers in the world. Customers include both startups and well-known global brands - Netflix , Adobe , Siemens , Vodafone, and others. Thanks mainly to cloud services, the company showed such a high profit last quarter.

Amazon services are not limited to the sale of consumer goods and cloud services. In 2007, Amazon launched its own MP3 music store. And in 2013, the AutoRip service appeared, which began to provide buyers with free MP3 copies of their purchased CDs. The Amazon Appstore for devices on the Android platform was opened in 2011 and is now available in more than 200 countries. In October 2008, Amazon began working with a game developer, Reflexive Entertainment, and in November 2012, it released its first mobile game, Air Patriots . Original works of art appeared on Amazon in August 2013, when the Amazon Arts service was launched. Art lovers are offered more than 4,000 items of art objects, including, for example, Claude Monet’s L'Enfant a la tasse worth 1.45 million dollars. Separately, it is worth noting that not all Amazon startups are equally successful.

For the convenience of customers, Amazon today accepts almost all types of credit and debit cards, and also cooperates with many payment systems. However, the team of the Internet giant is trying to stay ahead of the market, and now, Amazon is already preparing to introduce its own face recognition system for user verification. The new payment system will allow users to instantly pay for purchases and surpass the famous “one click” payment system. Amazon has received a patent for a biometric recognition system, where the online payment will be confirmed with a wink.



So, Amazon is constantly evolving, creating and acquiring new types of business, introducing new technologies, acting as a platform for other businesses (be it an e-commerse, logistics and warehouses, complete files or cloud services). The vast majority of the money earned is immediately invested in development. Let the comparative net profit be small, shareholders see growth in business and market share, as well as a very solid and ever-growing cash flow. Today, Amazon accounts for about 1% of the US market. Should he stop developing new projects and develop new markets and, instead, receive well-deserved profits? Perhaps he should leave some segments, leaving them for other companies? The opinion of Jeff Bezos on this issue is very clear - you need to continue to invest, because withdrawing capital from business means missing new opportunities. And so far, shareholders agree with the founder of Amazon.