I have studied Amazon as an extraordinary business case in innovation for some time now. One of the reasons for it is the fact that the share price of Amazon has continuously reached new heights.
The picture below shows the sheer scale of this phenomenon.
That’s right, If you had bought shares in Amazon just four years ago, today your investment would have increased its price six-fold.
This happens despite the fact that Amazon has barely delivered bottom line in over twenty years, compared to its revenues. Indeed, and even so troublesome, the amount of free cash flow delivered is almost negligible or even negative.
In fact, as Michael Wiggins De Oliveira in a recent article in Seekingalpha states:
For instance, Amazon’s capital lease obligations in H1 2018 reached $3.3 billion, compared with Amazon’s net income for H1 2018 which stood at $4.2 billion. Other uses of cash which Amazon’s earnings do not account for include, Amazon’s capital expenditures, leasehold improvements and website running costs, which totaled up to roughly $6.3 billion in the past 6-months.
These numbers would bring the real free cash flow deep into red territory. BTW, acquisitions are still not even included in these calculations. If the reader wonders why Amazon seems so obsessed in making everyone a PRIME customer, well, that’s probably the reason. The company probably needs those moneys in advance just to keep the machinery (and liquidity) working. Indeed, the beast has to continuously grow or die.
So, how is it possible that investors close their eyes to this reality and still make the shares of Amazon climb ever higher prices?
The magic of Amazon is having transformed its indoctrinated shareholders in its most valuable, resource. This is the real competitive advantage of Amazon.
De Oliveira states it bold and simple:
Amazon’s shareholder base has been heavily indoctrinated into long-term thinking. Thus, Amazon is able to operate largely at cost while other companies need to post profits and growing earnings, or they will fall out of favor with investors. Thus, Amazon’s ability to operate with close to zero profit margins is a phenomenal and impregnable competitive advantage, which is unlikely to disintegrate any time soon.
This is what indeed makes Amazon so powerful and dangerous: Jeff Bezos has indoctrinated the shareholders of Amazon into thinking that neither profits nor free cash flow matter. Amazon shall be measured only on growth.
This implies a couple of vital strategic implications for CEOs, competitors and investors.
For competitors, the awareness of this advantage means that price is hardly a viable tactic to compete on any more. Amazon can beat any price because its shareholders don’t even care about making money. Low margins have already spread in retail as a disease. An alternative for competitors is to become partners with Amazon sworn enemies, like Wall-Mart has done with Microsoft.
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For investors, there are some red flags too. Amazon cannot stop growing or the entire company may collapse. Any serious miss in growth targets or guidance can provoke a sell off. The need for growth can also push Amazon into entering ever less profitable industries just for the sake of selling the growth story.
Finally, for CEOs, Jeff Bezos has made it clear that hiding behind the assumed wishes of its shareholders is not an excuse to underperform or to leave real innovation behind. A CEO with a clear communicated strategy that sets the company apart from competitors and delivers on it can transform the shareholder base into a powerful ally.
Are you as a top manager winning your shareholders over to your side? Are you letting them take their own guess because they don’t know what your company is supposed to differentiate itself on?
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