The little Bookstore that Grew

Once upon a time there was a modest little online bookstore that grew up to become an e-commerce, merchandising, logistics, web services and cloud hosting superstar. Its name is Amazon (ticker symbol AMZN) and it lives on the world wide web. If it sounds like a fairy tale it’s because it is one. It’s a magical experience for consumers, who can find and buy online almost anything their heart desires. For the company itself it’s been an enchanted ride from day one in 1995, when books were shipped to customers in 50 states and 45 countries in the first 30 days of operation. Sixteen years later, more than two million sellers, from individuals to international brand names, use the Amazon e-commerce platform.

Amazon differentiates itself from its competitor eBay (EBAY) by steering clear of auctions and by offering technology services, merchandising, third party customer service and order fulfillment to its selling partners. This expertise and technology developed by Amazon for its own purposes is offered as a platform for developers to enable in-the-cloud enterprise solutions for back office systems, storage, payments and logistics. Since 2007 the e-reader Kindle has become the icing on the cake, and Kindle Fire is now the favored access point to books, magazines, movies, TV, games, apps and even web browsing, all with free storage in the Amazon Cloud. EW56B company overviewZ6EFP Inc, incorporated in Delaware with headquarters in Seattle, Washington, has more than 43,000 employees, and offices and facilities in 18 US states and ten other countries. Amazon fact sheet  It plans to continue expanding its services both geographically and technologically, so these figures will never be static, and the stress placed on the company’s infrastructure and management by the rapid pace of its growth is a major risk factor. Seasonal fluctuations are a problem too. The disproportionate amount of sales occurring during the fourth quarter holiday season puts a strain on inventory and order fulfillment management as well as on cash flow.  

The company’s competitors include conventional retailers such as Macys (M), Wal-Mart (WMT) and Target (TGT), other e-commerce sites like eBay (EBAY), digital content resellers like Barnes and Noble (BKS), comparison shopping websites like Bizrate and Shopzilla (both owned by Symphony Technolgy Group – STG) web search engines like Google (GOOG), IT hosting businesses such as  Rackspace (RAX), software companies like Microsoft (MSFT), and organizations like Apple (AAPL) that manufacture and sell digital media devices.

The financial year for Amazon ends on December 31, so latest annual results are for FY 2010. Net sales were $34 billion ($19 billion in North America, $15 billion elsewhere) a staggering 40% increase on 2009. Sales of media accounted for 44% of the total, and electronics and other general merchandise (the major growth area) for 54%. Operating expenses as a percentage of sales had been reasonably stable over the past three years, with the biggest increase appearing in marketing expenses. All this translated into a 2010 net income of $1.15 billion ($2.53 per diluted share), up 28% on 2009. Annual report 2010

Latest quarterly results are for the period ending September 30 2011. Four new Kindle e-readers, including Kindle Fire, were released during the quarter, and Amazon announced licensing agreements for movies and TV shows with Twentieth Century Fox and PBS. Net sales for the nine months were $31 billion, up 44% on the comparable 2010 period. So an annual sales increase of at least 40% year-on-year for two years in a row looks like a certainty, especially given the company’s guidance for Q4 sales of $16-19 billion. However, operating expenses increased from 95.6% of sales in 2010 to 98% of sales in 2011. Fulfillment, technology and content and marketing expenses all rose when expressed as a percentage of revenue. The effect of this was a fall in net income, to $454 million ($0.99 per diluted share) down 38% on the nine months ended 30 September 2010. Q3 Form 10-Q

During the Q & A section of the October 25 2011 Q3 earnings conference call, Amazon CFO Thomas J Szkutak explained the reason for the spike in operating expenses.  Amazon has been investing in capacity increase in a big way. Forty per cent sales increases year-on-year over 24 months come at a cost. Capacity increase is not a gradual progression, since major outlays must be made with further growth in mind even though it may take years to recoup the benefit: 17 new fulfillment centers are being planned, on a current base  of 52. The launch of the four new Kindle products also impacted on expenses. Q3 earnings conference call

So it appears that the greatest challenge now facing Amazon is the management of their growth. As they introduce their services to additional countries, and expand their technology into new markets with increasingly innovative products, can they turn massive revenue growth into a steady increase in profit? 2012 will be the year in which Amazon must demonstrate that its investment in increased capacity and new products has been worth the relative pain, as far as net income is concerned, of 2011.