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Amazon shock: on the same planet as everyone else

The analysts have jumped all over Amazon, following the release of a set of fourth quarter and full year results that demonstrated that no company walks on water (well, not indefinitely).   In part, Amazon have brought this upon themselves; they failed to live up to their guidance, having not learnt the “under-promise, over-deliver” rule that Apple always applies to its relationships with the investment community.

Jeff Bezos has reminded us that he wants to be a high sales, low margin company, rather than vice versa.  It’s well understood that Amazon is investing in distributing barely profitable Kindle hardware in order to secure future content sales worth many multiples of the original investment.  But that spectacular P/E ratio has come under some pressure – the Publishers Weekly account of the investors’ call is worth a look.

When I’m looking at financial statements, I always start with the obvious operational numbers, and these certainly suggest a flattening in Amazon’s growth trajectory:

North America:

Sales uplift, Q4:

2011 vs 2010:  +37%

Sales uplift, full year:

2011 vs 2010:  +43%

This does feel like a reversal, in that one would expect all of the hard work from the full year to deliver extra benefits at Christmas, and that those much discussed Kindle Fires would have made a material difference to sales in Q4.

Unfortunately, operating expenses are up, so margins have tightened.

Operating expenses, Q4:

2011:  97.1% of sales

2010:  95.9%

Operating expenses, full year:

2011:  96.5% of sales

2010:  94.9%

Operating income, Q4:

2011:  2.9% of sales

2010:  4.1%

Operating income, full year:

2011:  3.5% of sales

2010:  5.1%

What is a little unusual about these numbers is that they fly counter to normal retail practice.

If I’m running a bricks and mortar shop, my occupancy costs in the fourth quarter are largely unchanged – perhaps a little more heat and light than in the summer, but rent and taxes are stable.  My staffing costs are higher, but not proportionately – retail staff are much more productive in the Q4 than through the rest of the year.  So, although my gross margins may be subject to competitive pressure, my costbase shrinks hugely as a percentage of sales.

This is why traditional retailers refer to Q4 as the “golden quarter” – it’s when they deliver the lion’s share of their annual profitability, and run with the highest efficiency.  In a bookstore, I might see my pay-to-sales ratio drop from 11% in June to 6% in December.  This is because hitting the cash registers is a small part of the total work done instore, and other activities – receiving goods, merchandising, interacting with customers – deliver much higher returns in December.

However, I guess it’s different online.  I have no doubt that Amazon runs some of the most sophisticated warehousing in the world, but I’m going to guess that higher transaction volumes lead to higher payroll cost – there are fractional gains from selling large quantities of a small number of titles, but the manual processing required won’t diminish exponentially, as it does in a physical shop.

The other possibility that these numbers suggest is that Amazon discounts even more furiously in Q4 than it does through the rest of the year, in pursuit of always providing the very best value for its customers.  Given that Amazon is so often the price leader in its category, you do wonder if some of that discounting is being sliced just a little too thinly for Amazon’s own good?

Now, these are simple, bricks vs clicks parallels – and the opacity of Amazon’s reporting inevitably leads to much speculation.  There are plenty of questions specific to the Amazon model for investors to ask – is Prime costing more than it’s delivering; when will Amazon reap the dividend of selling Kindles at around cost, etc.

All of the above applies to Amazon’s “mature” market, North America, where sales are up by “only” 37%.  The rest of the world is lumped under the heading of “International”; new territories are being opened up, and new products and categories launched.

International:

Sales uplift, Q4:

2011 vs 2010:  +31%

Sales uplift, full year:

2011 vs 2010:  +38%

Away from North America, growth is significantly lower than it is at home (and exchange rate shifts mean that like-for-like growth is overstated here).  This may reflect the very sluggish/recessionary European economies – America is starting to see a recovery that Europe is still waiting for.  Of course, Q4 growth of 31% (29% currency-corrected) still compares pretty favourably to, say, the BRC’s +2.2% UK like-for-like sales in December, or CapGemini’s +16.5% like-for-likes for online retailers in the UK over the same period.

But it all comes at a cost:

Operating expenses, Q4:

2011:  97.6% of sales

2010:  94.3%

Operating expenses, full year:

2011:  97.0% of sales

2010:  93.7%

Operating income, Q4:

2011:  2.4% of sales

2010:  5.7%

Operating income, full year:

2011:  3.0% of sales

2010:  6.3%

In mature retailers, when margins halve, alarm bells ring.  There might be one-off costs, of course – launching new products; or one-off crises – warehouse meltdown being a favourite.  However, there’s no suggestion from Amazon that they’re anything but happy with these results, and they’ve weathered worse.  Still, that economies of scale question is an interesting one to ponder…


Photo ©Les Wilson

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2 Comments on “Amazon shock: on the same planet as everyone else”

  1. Mercedes Berger says:

    Hi Philip – the drop in profit is attributable to selling the the kindles, especially the fire at what must be a loss. If not selling all at a loss, they’re selling perilously close to cost.

    I don’t think Amazon is looking for profit at this point, they’re looking to own the ereader and possibly tablet market. The profits once the consumer is “hooked” with their device are easy and assured.

    Take care in NY

  2. gous says:

    The question of Amazon’s real value – both as a stock and as a company – is becoming quite the conundrum. The positive case is well-known, for the negative case you can peruse the articles by Paulo Santos at the seekingalpha.com website.

    I suspect that the entire retail operation at Amazon is being run at break-even, with the profit being made solely through their Marketplace of third party sellers. See http://www.fonerbooks.com/selfpublishing/?p=1579 for a quick analysis.