01636819816 hello@minsterfb.com

Amazon skeptics have long repeated a narrative about the e-commerce behemoth now worth $891 billion: that it doesn’t make money, that its razor-thin margins meant to crush competitors are unsustainable, and that its business model will surely, eventually, fail.

And pretty much every financial quarter, I make the same chart for Amazon’s quarterly earnings that seems to reflect this narrative. It compares Amazon’s revenue (gray line) — seasonal peaks and valleys that go up and to the right to the tune of more than $63 billion last quarter — to profit (pink line), a much more modest line that reflects a small percentage (4 percent last quarter but historically much less) of those sales. It shows relatively low profits on gargantuan sales.

But the idea that Amazon’s relatively low profits mean it’s failing at business is not strictly true — at least not anymore.

In fact, as my colleague Jason Del Rey reports in the latest episode of Land of the Giants, his podcast about the rise of Amazon, these small profit margins are one of the secrets to the company’s success.

Amazon intentionally posts low profits because it takes the vast majority of the money it earns and invests it right back into the company so that it will profit all the more in the future. Its business model, once reviled on Wall Street, has spurred numerous other companies like Uber and WeWork to emulate Amazon and forgo profits for the sake of growth — though many of these companies haven’t really proved that they could ever be profitable.

A short explanation

When I make the same chart every quarter that shows seemingly lackluster profits, I generally get the same responses every quarter from readers.

Amazon is failing.

Amazon is winning.

You forgot free cash flow; that’s much more important than revenue and profit.

Here’s what that all means:

Think of revenue as Amazon’s cut of third-party sales or the total of your Amazon shopping cart, if you’re purchasing Amazon products. This includes sales of products and services, including when Amazon ships goods for third parties. Amazon collects that money but doesn’t keep most of it.

Profit is how much of those total sales in a given quarter Amazon actually gets to keep, after it accounts for the cost of selling those items: the items themselves, shipping, package thefts, marketing, keeping the lights on. Profit is calculated assuming that everything is purchased and paid for in that one quarter.

Free cash flow (yellow line) is a bit like profit, except it doesn’t assume that Amazon has to pay for everything in the same time frame it sells it. And thanks to how Amazon’s payment cycle works, it usually gets money for selling an item long before it has to pay for that item. Last quarter, for example, it took Walmart on average two days to receive payment for goods after it paid its suppliers, while Amazon on average received payment 20 days before it paid its suppliers, according to cash conversion cycle data from the financial research platform Sentieo.

Amazon’s sales are also growing, meaning it’s not in danger of reversing the free cash flow trend, which has been growing thanks to margins that have risen faster than capital expenditures. It has even more money coming in before the money for last quarter’s bills is due. Therefore, its money on hand, or “free cash flow,” is always higher than its profits.

It’s important to note that Amazon’s profit margins aren’t actually that low, depending on what kind of company you consider Amazon. Among most retailers, single-digit margins are perfectly normal. And thanks to Amazon’s other, higher-margin businesses — advertising and its Amazon Web Services cloud computing services — those margins are ticking higher.“You could take Snap, Twitter, and Pinterest and combine their revenue and that would be less than the free cash flow Amazon is generating”

Amazon’s free cash flow is also incredibly high.

“Its free cash flow is higher than most of the revenue you’re seeing in many tech companies,” managing director at RBC Capital Markets Mark Mahaney told Recode. “You could take Snap, Twitter, and Pinterest and combine their revenue and that would be less than the free cash flow Amazon is generating.”

Free cash flow is an important metric for Amazon — the company’s CEO, Jeff Bezos, has called it Amazon’s “ultimate financial measure” — for a couple of reasons.

For one, people commonly determine a stock’s value based on its future cash flow, so it directly relates to how much a stock should cost. Many investors also think it’s a better gauge than profit of a company’s health.

Perhaps most importantly: money talks. Amazon’s access to cash enables it to do everything from paying its employees, suppliers, and shareholders to investing in its future.

And while investing in its future lowers its profits, it also lowers its taxes by creating less taxable income.

Investing

Amazon keeps profit and free cash flows artificially low by investing money right back into its business in the form of capital expenses, like building data centers, upgrading distribution networks, and creating wind and solar farms. It can do so without having to borrow money, which means it won’t incur interest costs. (Note that in addition to its strict tech investments like data centers and hardware plants, Amazon has to build out physical warehouses where it stores, sorts, packages, and ships goods from hundreds of thousands of sellers.)

All these investments have led to lines of businesses like AWS cloud computing and advertising that are relatively much more profitable than its e-commerce segment.

“They’re going to barely be profitable, but they’re going to reinvest their profits rapidly into new innovative products — and then you see them go from books to music to jewelry to toys to private label to AWS to Alexa to advertising on the platform to acquiring Zappos to acquiring Twitch to acquiring Ring,” venture capitalist and trend forecaster Mary Meeker told Del Rey on the latest episode of Land of the Giants.

“You go, ‘Okay, so I see the growth. I see the lifetime value of the customers rising,’” she said, explaining how investors began to justify Amazon’s costly investments.

Amazon had a record $24 billion in capital spending last year, nearly as much as Google parent company Alphabet, which last year brought in $30 billion in profits on $136 billion in revenue, a profit margin of 22 percent.

Investing in itself has been a core tenet of Amazon’s business, and it doesn’t show signs of flagging. The company has held fast to its “It’s always Day One” mantra, a mindset Del Rey has reported on in depth.

“The day Amazon makes an announcement that its margins are rising because it can’t find new areas to invest in and it’s going to return it to shareholders, growth investors are not going to be interested anymore,” Mahaney said.

“People like [Amazon] because [it has] invested in or created or established new industries. People keep expecting [Amazon] to do so because it has a track record of doing it.”

Taxes

Amazon’s internal investments also keep its tax bill down, saving the company money.

While we don’t know exactly what Amazon pays in taxes, various estimates suggest its rate is low thanks in part to its huge investments in its business. What we do know is that its taxes have provided plenty of fodder for presidential candidates like Joe Biden, who’s mentioned it on his campaign and on Twitter, and Elizabeth Warren, who included the company as an example in her new corporate tax proposal. President Donald Trump has also harangued the company for not paying enough in taxes.

Amazon has responded that it’s simply paying what the government says it owes.

When Amazon upgrades its warehouses or builds new data centers or solar farms, it can immediately deduct that amount, which reduces its taxable income — and, by extension, its tax bill.

As Amazon told the Wall Street Journal last year, “Because we are in a low-margin industry and invest in innovation and infrastructure, we don’t make as much pretax profit as other tech companies, so our taxes are lower.”

While low profits haven’t always been something Wall Street has tolerated, they actually form a key element of Amazon’s success. In a way, its low profits are making it more profitable.

They have enabled Bezos to become the richest man in the world at the helm of one of the world’s most valuable companies. And as Amazon has kept its profits low and its investments expansive, it has changed not only the way we purchase books and clothing, but also how we communicate with our devices and how the internet operates — and its growth is far from over.Recommended.

To read the full article on vox.com please click here:
https://www.vox.com/recode/2019/8/21/20826405/amazons-profits-revenue-free-cash-flow-explained-charts