Is this an Amazon Tipping Point?

Are we witnessing a massive Amazon Tipping Point? Is Amazon changing subtly but importantly as a company? Is it restructuring its DNA and raison d’être?

Well, let’s consider recent events –

  1. The rates increase for Amazon sellers that has a lot of Amazon 3rd party sellers up in arms. The rates went up from 7% to 12% which is a 70%+ increase in 3rd party seller fees.
  2. The decision to end associate commissions to sites that have gotten ‘too good’ at promoting Kindle Free Books. Want associate income from Amazon? That means you have to stop mentioning free books which Amazon loses money on (3G costs) and have to instead mention deals.
  3. The reluctance to fight the eBook Wars on price. Where are the big price drops after the end of the Agency Model?
  4. The handicapping of lower priced books. Basically, a shift from ‘We are the Future of Publishing’ to ‘We are the New Gatekeepers of Publishing. Just like the Old Gatekeepers of Publishing’.
  5. Amazon’s shift to In-App Purchases in its Android Store and its own Amazon currency in the Kindle Fire App Store. Interesting that a company that was totally focused on using ‘Free App of the Day’ to add customers is now shifting to selling ‘gold coins’ that can be used as ‘virtual currency’ to buy ‘virtual goods’. So many levels of abstraction that Zynga is clapping.
  6. Amazon signing a contract with the CIA where, instead of providing cloud services, it will provide in-house services. Basically, Amazon is morphing into an Enterprise Software Company for the CIA.
  7. Amazon’s inordinate focus on Prime and ‘profitable’ Prime customers. Has there been any other time in Amazon’s history when it focused on ‘profitable customers’ and not just ‘more customers’?

These (and other similar signs) signal some very big shifts –

  1. Amazon, at some level, is shifting from ‘gratification in the future’ to ‘profits now’.
  2. Amazon, at a very deep level, feels it has reached ‘untouchable’ status in lots of markets. Amazon’s algorithm and data analyzing PhDs are telling it – You’re home safe. There’s no other viable option. We’re past the ‘Amazon is King’ Inflection point. Now it’s time for new Inflection Points – Amazon as Profitable Company, Amazon as Benevolent Dictator.
  3. Amazon is realizing that it has to start making good on all the promises of HUGE Profits at some distant point of time in the future. That it can’t keep delaying gratification FOREVER.
  4. Amazon is perhaps realizing that the economy might go into a prolonged state of nothingness. That it has to shore up its defences so that it can survive. That for survival it needs more than $676 million a year in operating income.
  5. Amazon is, even though it doth protest much to the contrary, bowing down to Wall Street and its demands. Because Wall Street can really hurt Amazon if it decides Amazon isn’t playing along.

Let’s look at a few things.

  • Why is Amazon restructuring its DNA (or trying to) and shifting to a Profits Focus?
  • What happens if Amazon succeeds?
  • What happens if Amazon doesn’t succeed?
  • Can Amazon change customers focused on free and cheap to profitable customers?
  • What are the factors outside Amazon’s control?

First, the restructuring.

Why is Amazon restructuring its DNA and shifting to a Profits Focus?

Amazon was founded in July 1994 and it went online as in 1995. Today is April 23rd, 2013.

In 2012 Amazon had a whopping $61.09 billion in revenue and a surprisingly low $676 million in operating income. It even had a net loss of $39 million.

To put that in context, out of the Big 4 Tech companies (Apple, Microsoft, Google, Amazon), Amazon is the only company that isn’t raking in billions of dollars in profits every month. Apple, Microsoft, and Google are making roughly $3 billion a month, $2 billion a month, and $1 billion a month in profits.

Amazon is making nothing in profits. All it has are businesses that have HUGE potential and MIGHT be HUGELY profitable at some distant point of time in the future.

This is a problem for two reasons –

  1. Firstly, if there is another big crash or a prolonged depression, then Amazon will be in a lot of trouble. $676 million operating income on $61.09 billion revenue is a stunning 1.1% profit margin. That leaves absolutely zero room for error (or, for that matter, for sales tax impact).
  2. Secondly, it means Amazon keeps getting left further and further behind as Microsoft and Apple (especially these two) and Google keep adding to their Total Assets and their Profit Streams.

It’s one thing to invest in a big bet for the future. It’s something completely different to ONLY make big bets that will ONLY pay off in the far future. What happens if something goes wrong? What happens if your competitors and compatriots find businesses that are profitable NOW and also profitable in the FUTURE?

Fundamentally, someone at Amazon has realized that Profits aren’t a bad thing. It might seem trivial. It might be common sense. However, Amazon is so far-thinking that it tends to forget the present and near future. It’s nice that someone woke up and said – Hey, perhaps we can make billions NOW and also make Hundreds of Billions in 2059.

The other possibility is that Jeff Bezos woke up one morning and thought – My dreams of making a company that lasts for 10,000 years might get disrupted if we have another big crash and we don’t have enough margins or assets to survive. What if there’s a 5 year stretch of desolation? Wouldn’t it be nice to have $100 billion in the bank like Apple and Microsoft do? Wouldn’t it be nice to have profit streams of billions of dollars a month like Microsoft, Google and Apple do?

Whether you think of Amazon as a business that wants to make profits for shareholders (I promise I won’t laugh), or as a business that wants to live forever (a rather fruitless endeavour), shifting to a profits focus suddenly seems like a really, really good idea.

Remember: Profits = A Hedge against bad times.

What happens if Amazon succeeds?

Amazon has several businesses that can be shifted with some amount of effort to being very profitable –

  1. Kindle and Books.
  2. Kindle Fire and Apps and Movies.
  3. Electronics. I suspect this might already be quite profitable.
  4. Physical Media.
  5. Kitchen Sinks. You would not believe how much those custom fitted Italian Faucets cost.

Amazon also has several businesses that are probably already profitable and will keep becoming more profitable as Amazon scales them –

  1. AWS is the big one. This might end up becoming Amazon’s Star Cash Cow, unless other Cloud Companies (looking at you Azure) spoil the party.
  2. Luxury items like designer shoes and designer jeans and designer handbags.
  3. Amazon Wireless. While it is possible that Amazon is avoiding profits here, it’s hard to do. Even Amazon might be unable to avoid wireless data plan profits.

Finally, Amazon has new businesses it might be launching soon. These would provide additional opportunities to profit –

  1. Kindle Phone. This is going to be a big profit center if Amazon doesn’t get greedy about number of sales.
  2. Amazon Russia.
  3. Amazon expansion to other companies.
  4. Amazon Logistics Services and Intelligence to other companies.
  5. Amazon Ad Exchange and Advertising.
  6. Amazon NanoAnt Farming. Just checking if you’re paying attention.

So we see lots of businesses that Amazon has up its sleeve that will provide the ‘Profits Magic’ it seems to now be looking for. Add that to the ones that are already profitable and the ones that can be made profitable and we have quite a large portfolio of businesses.

If Amazon succeeds in making some of its existing businesses profitable and also adds some new profitable businesses, we’ll see something very interesting – A company that has never embraced profits ending up with 5 to 10 very profitable lines of business and perhaps even 2 to 4 BIG Cash Cows.

At that point Amazon will probably look for 5 to 10 additional big bets. It might even double down on some interesting bets like its own TVs, and its own TV Series, and its own movies, and its own cars and its Publishing imprints.

Perhaps most importantly, Amazon would suddenly be in a stronger position than any other technology company. Why? Because it would have all three of –

  1. Hundreds of Millions of Customers that are paying it money and are available for it to try lots of different experiments.
  2. 2 to 4 Big Cash Cows that are generating solid profits.
  3. 5 to 10 additional profitable lines of business that might one day become additional cash cows.

It could then collaborate with all the secret projects Amazon has a stake in (Space Travel, Reforesting the Amazon, Energy, etc.) and become a Samsung type chaebol/conglomerate. Except it would span the world and it would not run ads starring hipster baristas.

What happens if Amazon doesn’t succeed?

The first negative possibility is that Amazon just gets stuck in the ‘low profit, high revenue’ business state forever. Hard to beat because it’s willing to forfeit profits. Hard to like because it’s more of a charity than a business.

Note: Just because Amazon wants to change its DNA doesn’t mean it can. If all you have is a ‘We can take losses’ Hammer, then everything seems like a Zero Profit Nail.

The second negative possibility is that Amazon loses the ‘low profit, high revenue’ attitude but doesn’t quite get the grasp of the ‘high profit, high revenue’ model. Then it’d be stuck and might end up dead.

To be quite frank, neither of these is very likely. At least one and perhaps two or more of Amazon’s big bets are likely to pan out. That would mean it would have at least one highly profitable business and it’d be in a Google type position. One huge unassailable cash cow (well, seemingly unassailable) and trying to find more.

The most interesting thing with that scenario is that it might actually be worse for Amazon than its current state. In a strange sort of way, Amazon has the least worries of any of the Big 4 Technology companies. If Apple does something wrong and messes up iPhone, or if Microsoft does something wrong and messes up Windows, then those companies will suffer greatly.

If Amazon were to blow up Kindle. Well, that’d be $237 million a year in losses Amazon might never find again. I have this strange feeling Amazon would get over it, eventually.

Same for most of Amazon’s businesses. Amazon is FREE OF WORRIES because it doesn’t really have any cash cows to defend. If it were to go from this carefree state to a state like Google where 97% of its earnings and 100% of its profits were based on one Cash Cow (Search+Advertising), then Amazon might find itself fixated on protecting that one cash cow. Building moats instead of finding new billion dollar in profits a year businesses.

The most intriguing aspect of Amazon’s attempt to restructure its DNA and become a profit-attracting company is its customers.

Can Amazon change customers focused on free and cheap? Can it change them into profitable customers?

No, it can’t. However, there’s a very interesting solution as to what it can do with unprofitable customers.

It’s one thing to restructure your own DNA.

It is, however, almost impossible to change ‘cheap and free’ focused customers into ‘profitable’ customers. There will always be someone else willing to play the game of ‘We’ll make it up on Volume’. Cheap focused customers will choose that company instead.

Amazon is basically stuck with a large number of not-very-profitable customers and a somewhat small number of profitable customers.

The trick it can pull off, and it is very much trying to pull it off, is to turn these not-very-profitable customers into ‘products’ it can sell to advertisers.

So we get a mix of things –

  1. Attract new Profitable customers. This would be Prime and selling $499 LTE Kindle Fires.
  2. Filter out the existing Profitable customers. Sell more things to them.
  3. Turn the unprofitable customers into ‘end product’ for advertisers. Keep selling them things to keep them coming back.

So we get –

  1. Apple type customers and Microsoft type customers that Amazon sells things and services to. These are both existing and newly acquired. These are the profit streams.
  2. Google type customers and Facebook type customers that Amazon sells to advertisers, while also selling them some unprofitable or not-very-profitable things.

It’s a very difficult shift to pull off. However, you can see how Amazon is trying to do exactly this.

My guess is that, at some point of time in the next 3-4 years, one group of customers will win out and Amazon will focus mostly on those.

A lot of the shifts we are seeing i.e. focusing on recurring payments for apps (which is what IAP is, in a sense), taking a larger cut from 3rd party sellers, focusing on Prime customers – are all about filtering out unprofitable customers and attempting to influence customer behavior to make customers more profitable.

It’s a very drastic step. It’s very, very different from everything Amazon has done in the past.

What are the factors outside Amazon’s control?

Quite a few, actually.

  1. Changing a company’s DNA (or a person’s habits) is incredibly difficult.
  2. Changing unprofitable customers into profitable customers is almost impossible.
  3. Changing unprofitable customers into ‘products for Advertisers’ is also difficult.
  4. Amazon’s competitors specialize in Profits. Google specializes in profits from customers as product. Amazon doesn’t have any of this expertise.
  5. Amazon customers are habituated to ‘cheap’ and ‘deal’ and ‘great value for money’. How does Amazon shift to a profits focus without losing them?
  6. The Economy. All of Amazon’s efforts might be for nothing if the economy tanks. In fact, even if the economy stays as it is, Amazon’s grand plans are in danger.
  7. New companies that are quite happy with Amazon’s 1.1% profit margins. This is, in many ways, Amazon’s biggest weakness. As Amazon evolves into a profits focused company, it becomes very vulnerable to an attack by a new Amazon.
  8. WalMart.
  9. Microsoft and Google and Apple.
  10. The Internet.

Amazon is attempting the type of change we rarely ever see.

From a ‘volume is important, profit isn’t’ and ‘tomorrow is important, today isn’t’ type of company, to a ‘profits focused’ and ‘today focused’ company.

If you look at Apple and Microsoft and even Google – These are companies that have always stayed on the course they set out a long time ago, usually at their inception. Their values and DNA have been very, very similar to what they started out with. They might have entered new markets and they might have had ups and downs. However, the DNA was the same.

Amazon is transforming before us. It’s a $61 billion in revenues and $676 million in operating income company that cares more about 2059 than 2013. It’s transforming into something thrillingly different.

Whether or not it succeeds, and regardless of whether it ends up a $61 billion profits company or a disaster, it’s going to be a very interesting transformation. We are at the single biggest inflection point that Amazon has gone through. We might also be seeing the single biggest transformation this decade in a company’s DNA and raison d’être.


Get every new post delivered to your Inbox.

Join 9,487 other followers