What Gives?

Amazon Stock May Be Up, but the Company Still Doesn’t Make Any Money

After 20 years, the much admired company still hasn’t managed to turn a profit. Daniel Gross on whether it ever will.

Paul Sakuma/AP

Amazon.com and Jeff Bezos, its founder and chief executive officer, are having a moment. They are the subject of a new, admiring bestselling book, The Everything Store, by Brad Stone. Bezos just plunked down $250 million to buy The Washington Post. The buoyant stock, up 64 percent in the past year, got a nice jolt on Friday as investors were enthused about its third-quarter results: revenues were up 24 percent from a year ago, and Amazon issued a positive forecast for the Christmas season. The company is killing it in books and retailing goods, has a rapidly growing cloud storage and computing business, and is getting into original content and devices. It sports an impressive market capitalization of about $166 billion.

And yet.

The company, first founded in 1994, still doesn’t make any money. In the third quarter, it reported a $41 million net loss.

Historically speaking, it is rare for a company to be in hypergrowth mode when it is nearly 20 years old and has annual sales of about $65 billion. That’s why investors love Amazon. But historically speaking, it’s also very rare for a company that has been around for 20 years—large or small—not to make money, to run on margins so thin that they can easily be eaten up by interest cost, or capital expenditures, or the loss of value in an investment like Living Social. (Amazon.com had to write down its investment in the daily deal company by $169 million in the most recent quarter.)

Indeed, when you look back through history, it’s very hard to find an analog. Many years ago, about the time that Amazon launched, I wrote a collection of great business stories in American history. (It’s still in print, if you want to check it out at Amazon.com.)

One thing many of the historically great companies share is reliable, decent operating margins. By the 1920s, 20 years after Henry Ford founded the Ford Motor Company, Ford was racking up profits of about $90 million per year. Between 1893 and 1901, John D. Rockefeller’s Standard Oil threw off $250 million in dividends alone. The company was so profitable that Rockefeller didn’t know what to do with the profits and was forced to invent modern philanthropy just to get rid of it.

Some more recent examples: Intel was founded in 1968 and operated in a highly competitive, capital intensive industry. Yet in 1988, Intel earned $452.9 million on $2.87 billion in revenues—a fat 16 percent profit margin. The first Walmart opened in 1962. In 1982, 20 years into its life, Walmart had sales of $2.4 billion and profits of $55.7 million, a razor-thin 2.5 percent margin but a profit nonetheless.

Now, Walmart has grown a great deal more in the 30 years since. Sales in 2012 were $443 billion, and operating income was $15.766 billion, a margin of about 3.5 percent. And that sort of insane growth is what gives Amazon.com investors faith. Even given the extraordinary growth off the high base it is putting up, Amazon still has plenty of headroom. Walmart in the past 30 years has boosted sales by 200-fold. In the past 30 years, McDonald’s has increased sales seven-fold. It’s a big world out there, and Amazon plays in so many areas—digital media, physical goods, artwork, business services, devices, and who knows what else—that the opportunity before it is almost unfathomably giant. Its addressable market isn’t a vertical, like books. It’s the entire $72 trillion global economy.

Just read this exhausting paragraph from Amazon’s third-quarter report:

“It’s been a busy few months—we launched a new Paperwhite and new Kindle Fires to positive reviews and surprised people with the revolutionary Mayday button—average Mayday response times are just 11 seconds!” said Jeff Bezos, founder and CEO of Amazon.com. “And that’s not all. In the last 90 days, our AWS team got back to work on a big government contract, we brought 8 million square feet of fulfillment center capacity online, deployed 1,382 Kiva robots in three FCs, provided a new venue for artists to reach customers, signed up millions of new Prime members, announced Kindle MatchBook, Login & Pay, and nine new original TV pilots, joined the Code.org coalition, acquired TenMarks—a company that helps kids with math, scored a win for customers who want to use Kindles on airplanes even during takeoff and landing (also, a big hat tip to Nick Bilton on that one), began hiring and training 70,000 new U.S. FC employees to help serve customers this holiday season, and saw the Kindle Million Club grow to include 14 KDP authors.”


The problem is that market share and raw sales don’t do you much good, ultimately, unless you can make money. And yes, size matters. The key to industrial success is Scale and Scope, as the business historian Alfred Chandler put it. Once you get sufficiently large, you can reap great efficiencies and thus boost profits. Or you can gain market power. If you capture a big chunk of the market, or drive a bunch of your competitors out of business, or establish big advantages, you have the leeway to raise prices and increase your margins.

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But Amazon can’t really do any of those things, given its ambitions and global scope of operations. It is just extremely difficult to dominate large markets so thoroughly that you can ring up big margins. Walmart controls about 10 percent of retail sales in the U.S. but maintains its market position only by keeping profit margins low. What’s more, customers are fickle. Innovation happens rapidly, and inefficiencies tend to be competed away. As recently as a few years ago, cable companies had great market power and could easily push through price increases. Today consumers react by cutting the cord and switching to cheaper alternatives. BlackBerry went from the dominant hero to a zero in a matter of months. Borders may be dead, but there are still lots of ways to get books—in physical and digital form—aside from Amazon. Indeed, there are probably more ways to get books—in physical and digital form—than ever before. Were Amazon to take advantage of its market power to increase prices and margins, consumers and competitors would certainly react. After 10 years, Amazon this week finally raised the threshold free-shipping order size from $25 to $35. We’ll see how that affects consumer behavior. My hypothesis is that Amazon is really powerful but not powerful enough.

The beauty of digital businesses is that they are comparatively frictionless. You don’t have to spend proportionally more to service more customers. You don’t have to build a new store to reach another 10,000 people, as Starbucks or McDonald’s does. It costs roughly the same to distribute 1,000 apps as it does to distribute 1 million apps. Netflix can add to its subscriber rolls geometrically while expanding its expenses arithmetically.

But Amazon, which is in lots of digital businesses—digital media products, services, streaming video—has plenty of friction in its business model. It constantly spends to create new digital businesses, and it is rapidly expanding its physical businesses. As noted, the company added 8 million square feet of physical space in the most recent quarter and each year hires tens of thousands of temporary workers to help move products around. And so, as impressive as its sales increases are, the company’s costs are rising at almost exactly the same pace. Sales in the third quarter of 2013 were $17.092 billion, up from $13.806 billion in the third quarter of 2012. But operating expenses were $17.117 billion, up from $13.834 billion. Revenues rose 23.8 percent, while operating expenses rose 23.7 percent.

Because it is still growing, the company has to spend a lot of money building new infrastructure—warehouses, yes, but also other equipment. Infrastructure costs a lot of money (the company values its property and equipment at $10 billion), and then it depreciates in value and has to be replaced. Amazon also has taken on a small amount of long-term debt, about $3 billion, to fund its investments. It pays low interest rates, to be sure. But in the third quarter, interest expense was $36 million, compared with $22 million the year before. Through the first nine months of 2013, Amazon spent $102 million on interest.

Investors seem to believe that at any minute, Bezos and Amazon could simply take their foot off the gas, cut down on expenditures and investments, and ramp up prices and fees across the board. And then profits would flow like a stream. At the moment, the reasoning goes, they’re just not choosing to do so because investors aren’t demanding it and because there is so much to be gained in the long term by gaining market share and customer loyalty in the short term. Bezos is not yet 50, after all, and his time horizon as CEO could stretch for another 30 years.

That’s entirely possible. But it’s also entirely possible that such moves could backfire, or tamp down growth, or that a global economic hiccup could push demand down. And it’s entirely possible that another Jeff Bezos in Brazil or Malaysia or India is concocting a set of business models aimed at doing to Amazon what Amazon aimed to do to Barnes & Noble and Borders.

The great question about China is whether it can get rich before it grows old. Amazon.com is already rich. The great question about the company is whether it can get profitable before it grows old.