The Amazon Effect

Amazon Inc. is a truly astonishing company. Founded in 1994, the e-commerce platform has grown from a small garage in Seattle to become the second largest (publicly traded) firm in the world, valued at $ 763 billion. This was not without a few bumps along the way; Amazon came close to bankruptcy from the dot-com bubble as its share price crashed 94% in 2001. Investors who sold at its (adjusted) low of $ 5.97 now watch with horror as Amazon shares regularly flirt with the $1600 mark. Nevertheless, for investors, Amazon remains a very polarizing company. As in the early 2000s, there are many investors who point to its low margins, growing competition, and even threats from President Trump as reasons why it is heavily overvalued. But there are even more who believe Amazon is just getting started and that it can continue its relentless growth, disrupting conventional businesses and changing how we shop along the way.

Jeff Bezos, Amazon’s founder and the world’s wealthiest person, has run the company under one prevailing philosophy: always be obsessed with your customers. By going the extra mile, Amazon solidifies its image as a company that not only offers low prices but also excellent customer service. Furthermore, it has been investing ruthlessly in establishing infrastructure such as distribution centres to expand and secure new markets all over the world. This has been accompanied by a growing workforce; in 2017, Amazon became the second largest private employer in the United States with over 566,000 employees worldwide. Its revenues are equally impressive, amounting to just under $ 178 billion in 2017. The vast majority of these are from e-commerce retail, which is at the core of Amazon’s operations.

Amazon’s e-commerce business offers vendors two ways of selling their products; Fulfilment by Amazon (FBA) or Merchant Fulfilled Network (MFN). By using FBA, vendors ship their goods directly to one of Amazon’s fulfilment centres where its storage, distribution, and customer service is taken care of by Amazon itself. In return, vendors must pay a fee for how much warehouse space the item occupies, how long it is shelved, and if the item is returned by the customer. Vendors that use MFN, meanwhile, only use Amazon to place their items on its website and ship the items themselves. While it is much less expensive than FBA, vendors cannot make use of Amazon’s highly efficient distribution network and excellent customer service, nor can it sell to Prime members.

But Amazon is more than just an e-commerce company. Amazon Web Services (AWS) has become a leader in cloud computing with over one million active users, competing with the likes of Google and Microsoft. Thanks to its margins being significantly higher than retail, AWS contributed the majority of Amazon’s profits in 2017. Amazon Prime, meanwhile, is a paid subscription service giving members free two-day delivery, discounts, and access to music and video streaming (competing with Spotify and Netflix). At the end of 2017 Prime members amounted to 100 million people, serving as a relatively steady stream of income for Amazon. Additionally, Prime members can benefit from exclusive discounts at Whole Foods – a premium organic grocery store acquired by Amazon in 2017 for $ 13.7 billion.

In addition to grocers, Amazon is rumoured to begin competing against pharmacies by selling pills to customers. On the day these rumours emerged, shares of U.S. pharmacy companies CVS and UnitedHealth plunged 4% and 11.5%, respectively, reflecting investors’ fear of Amazon’s power. These concerns are not invalid; earlier this year Toys ‘R’ Us declared bankruptcy – largely from competition from Amazon. The so-called Amazon Effect has made the lives of many small business owners more difficult as customers compare their business to that of Amazon and demand an equally flawless buying experience.

Although Amazon clearly has tremendous potential to keep expanding and competing in a variety of markets, it continues to ask lots of patience from investors. Amazon only achieved its first profitable year seven years after it was founded, and its retail operating margins have remained tight ever since. Despite its global reach, Amazon makes a loss on its international operations due to its relentlessly low prices and focus on investment. While this has enabled it to capture market share at an impressive rate, investors are waiting for this strategy to bear fruit through higher earnings rather than reinvesting. Some have lost faith, claiming that the market is overly optimistic about Amazon’s ability to raise prices without losing customers. Others point to President Trump accusing Amazon of abusing its power over the U.S Postal Service, suppliers, and small businesses. Although his power to break up Amazon is widely seen as exaggerated, Amazon shares dropped by over 5% on the day the tweet was sent. Additionally, there is the threat of growing competition from Amazon’s Asian counterpart, Alibaba. Though smaller in terms of revenues ($ 40 billion in 2017), Alibaba is growing at a faster rate and is expanding into similar markets, such as video streaming through acquiring Youku Tudou in 2016.

Overall, Amazon is one of the most impressive growth stories on Wall Street today. By always obsessing over customers and investing in the future, Bezos has managed to create not just the world’s largest e-commerce platform but also one of most disruptive –and feared –companies around. While some investors dismiss Amazon as extremely overvalued, others believe it is just getting started –praising the forward-thinking nature of Bezos and the company’s relentless investments into the future. Though competition will undoubtedly increase, its investments place Amazon in a unique position where it will be able to reap the benefits from a growing e-commerce industry better than anyone else.

 

Written by Jasper Thouin