Amazon Says Long Term And Means It
Published: December 16, 2011
In 1997, the year Amazon.com went public, its chief executive, Jeff Bezos, issued a manifesto: “It’s all about the long term,” he said. He warned shareholders “we may make decisions and weigh tradeoffs differently than some companies” and urged them to make sure that a long-term approach “is consistent with your investment policy.” Amazon’s management and employees “are working to build something important, something that matters to our customers, something that we can tell our grandchildren about,” he added.
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Over the years, Amazon shares have been periodically buffeted by short-term results that seem to have disappointed investors. “The stock has been bumpy,” a Morgan Stanley analyst, Scott Devitt, told me this week. “Investor trust seems to go in cycles.”
The notion that public companies should maximize shareholder value by managing for the long term is pretty much gospel among good-governance proponents and management experts. Jack Welch advanced the concept in a seminal 1981 speech at the Pierre Hotel in New York and elaborated on it in subsequent books and articles while running General Electric, when G.E. was widely lauded as the best-managed company in the country. It has been especially championed in Silicon Valley, where technology companies like Google have openly scorned Wall Street analysts and their obsession with quarterly estimates and results by refusing to issue earnings guidance.
Amazon, in particular, has been true to its word to manage for the long term. It remains one of the world’s leading growth companies and its stock has soared 12,200 percent since its public offering. In late October it reported quarterly revenue growth of 44 percent to almost $11 billion, which came on the heels of 80 percent growth a year ago. “We’re seeing the best growth which we’ve seen since 2000, meaning in 2010 and so far over the past 12 months ending September,” the chief financial officer, Thomas Szkutak, told investors in October. But operating earnings fell sharply to $79 million. While that was in line with most estimates, Amazon offered a forecast for the fourth quarter in which it said it might lose as much as $200 million or earn as much as $250 million, and even the high end would represent a 47 percent drop.
The reason Amazon is earning so little while selling so much is that it is spending so much on long-term growth. It’s opening 17 new fulfillment centers — airport hangar-size storage and shipping facilities — this year and aggressively cutting prices. Its profit margin for the quarter was just 2.4 percent, and it said it might be zero for the fourth quarter. (By comparison, Wal-Mart’s margins are 6 percent on revenue of $440 billion. )
Amazon seems to be taking customer focus to new levels, willing to run its ever-bigger global business while earning little or nothing in return. To the dismay of some, Mr. Bezos even takes a long-term view of price cuts. “With rare exceptions, the volume increase in the short term is never enough to pay for the price decrease,” he told shareholders in 2005. But that kind of thinking, he added, is “short term. We can estimate what a price reduction will do this week and this quarter. But we cannot numerically estimate the effect that consistently lowering prices will have on our business over five years or 10 years or more.” Selling at low prices may undercut profits, but they create “a virtuous cycle that leads over the long term to a much larger dollar amount of free cash flow, and thereby to a much more valuable Amazon.com,” Mr. Bezos said.
Amazon has done little to dampen speculation that it is selling its revamped Kindle e-reader devices and its recently introduced Fire tablet at a loss. Amazon simply doesn’t think like most other companies. When “we think about the economics of the Kindle business, we think about the totality,” Mr. Szkutak said. “We think of the lifetime value of those devices. So we’re not just thinking about the economics of the device and the accessories. We’re thinking about the content.” In other words, profits will come down the road when Kindle users buy content through Amazon.
“If everything you do needs to work on a three-year time horizon, then you’re competing against a lot of people,” Mr. Bezos told reporter Steve Levy last month in an interview in Wired. “But if you’re willing to invest on a seven-year time horizon, you’re now competing against a fraction of those people, because very few companies are willing to do that. Just by lengthening the time horizon, you can engage in endeavors that you could never otherwise pursue. At Amazon we like things to work in five to seven years. We’re willing to plant seeds, let them grow—and we’re very stubborn.”
Whatever they might say about long-term shareholder value, this is simply too much for many of today’s investors, many of whom are hedge funds, pension funds and institutions who measure their results — and earn their pay — based on quarterly benchmarks. “If you look at the average length of ownership of a stock, the period is declining,” Mr. Devitt said. “Amazon is marching to a different drumbeat, which is long term. Are they doing the right thing? Absolutely. Amazon is growing at twice the rate of e-commerce as a whole, which is growing five times faster than retail over all. Amazon is bypassing margins and profits for growth.”
For Amazon, long-term growth confers two major benefits: the kind of economies of scale enjoyed by Wal-Mart and eliminating or weakening competitors. The book retailer Borders has been forced out of business and a rival, Barnes & Noble, is struggling. Best Buy, the electronics retailer, reported this week that earnings plunged 29 percent, despite higher revenue and a surge of Black Friday sales, because the chain had to cut prices and offer free shipping to compete with Amazon. Amazon inflamed many competitors this holiday season by offering extra discounts to shoppers who took mobile devices into stores and then used them to compare prices and order from Amazon.
The revamped Kindle line and especially the new Fire tablet illustrate Amazon’s long-term strategy. “Amazon has much greater ambitions than near-term profits or margins,” Ken Sena, an Evercore analyst, said.
“Some people are griping that the Fire is sub-par,” Mr. Sena continued. “It’s not an iPad. And some investors are confused. Why would they give it away, even lose money on it? But getting it into as many hands as possible is important to them. They’ll use it to drive higher physical and digital good sales on their site. And these devices also bring Amazon deeper into the local retail opportunity, not to mention the app marketplace potential that exists. Media sales on the device are just the beginning. I think Amazon understands all these components.”
The Fire “isn’t meant to be another iPad,” Mr. Devitt noted. “It’s a device to sell Amazon content. All indications are it’s a success. It’s the most gifted item on Amazon. It’s too soon to tell, but it seems more promising than it’s getting credit for.” This week Amazon said it had sold more than a million Kindles a week for the last three weeks.
Nearly 15 years after Amazon’s public offering, it’s safe to say that Mr. Bezos and his colleagues have realized their goal of creating a company to tell their grandchildren about. But one of these days Amazon has to deliver on its promise of higher margins and profits, however long term that may turn out to be. “To many investors, long term is a year,” Mr. Devitt said. “For Bezos, he’s looking at a 10- to 20-year time line. When he says long term, he means 2020 or 2030.”