Is Amazon Set to Hit Its Prime?

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Wharton's Daniel Raff and Syracuse's Amanda Nicholson discuss Amazon

E-commerce giant Amazon surprised Wall Street last week by posting much higher earnings than expected for the fourth quarter of 2014: $0.45 per share versus analysts’ estimates of $0.17. In October, the company had posted a third-quarter loss of $437 million — its biggest loss in 14 years. In its latest report, Amazon cited growth in its Prime membership program as a main reason for the increase in profits. Following the announcement, the firm’s stock rose 13%.

Is Amazon on the upswing? According to Wharton management professor Daniel Raff, the company has a lot going for it. He is impressed that Amazon has “very deep pockets,” a CEO in Jeff Bezos “who is brilliant … and usually very clear about what he wants to try,” and a shareholder base that has thus far trusted the company and its senior management. “They look for new and interesting things to do,” he said.

Amanda Nicholson, professor of retail practice at Syracuse University’s Martin J. Whitman School of Management, noted that Amazon has grown from an e-commerce company into one that straddles diverse businesses such as publishing, making movies, producing TV serials and leasing remote computing services. “It’s like talking about a Goliath,” she said.

Raff and Nicholson spoke about Amazon’s earnings announcement and the challenges it faces going forward on the Knowledge@Wharton show on Wharton Business Radio on SiriusXM channel 111. (Listen to the podcast at the top of this page.)

“The big question is — how long will investors keep sticking with [Amazon]?”–Amanda Nicholson

During the Sirius interview, Raff praised Bezos. “He understood from a retailing and general competitive perspective the opportunity the web represented as early as anybody, and he moved very aggressively,” he said. “He heard the music very early on.” Raff noted that Amazon went public at the height of the dotcom bubble in 1997 to raise $54 million “at an enormous valuation” (of $438 million then, which is now at $168 billion). “He had investible funds very early on and he has used them very aggressively.”

Nicholson agreed that Bezos was “clearly a genius who started very early.” She added that traditional big box retailers are “only now revving up to figure out” the opportunities the Internet offers.

Questions on Expenses, Margins

However, both Raff and Nicholson tempered their optimism for Amazon by highlighting weaknesses and threats the company faces as it grows. For one, Nicholson saw cause for concern with the company’s finances. Even though Amazon grew sales by 20% to $89 billion in 2014, it incurred a loss of $241 million, compared with a profit of $239 million in 2013. She noted its gross margin increase in the latest quarter — thanks, perhaps, to selling third party merchandise — but found its expenses “extremely high” and continuing to rise. “You can’t still keep piling up those expenses unless you have operating margins going up,” she said.

Raff noted that investors would be concerned about the prospects for Amazon Web Services, the business that leases server capacity. It may be Amazon’s most rapidly growing business unit, but it faces stiff competition from other large and deep-pocketed technology companies (like Google), he added. “It’s not at all clear what sorts of margins they are going to be able to command in the future for web services.”

“It’s not at all clear what sorts of margins they are going to be able to command in the future for web services.”–Daniel Raff

Amazon has had successful products like the Kindle, but also some “boo-boos [such as] the disastrous [launch of its] Fire phone last year,” Nicholson added. “But [Bezos] also understands how you can bring communities of sellers in a different way. He’s opening up the market places to everybody. So he has an unlimited market … because he is saying, ‘I don’t have to own you; you can come through my system.'”

Raff agreed that Amazon’s forays on various fronts suggest that Bezos has “no fear” in trying out all kinds of business ideas. He noted that Amazon’s model may well be to “conduct lots of experiments,” and commit financial or human resources only when the firm has a sense of how successful a venture could be. “It’s exploration, basically,” he said. Nicholson agreed but warned that mistakes could cost the company and its shareholders dearly. “The big question is — how long will investors keep sticking with them?” Twitter 

Not a Prime Outlook?

Raff and Nicholson raised questions also about the outlook for Amazon’s Prime service, which offers members free two-day shipping with unlimited deliveries for an annual fee of $99 ($49 for students). Amazon proudly announced last week that its worldwide Prime membership base “in the tens of millions” grew 53% last year over that of 2013. Nicholson said it was encouraging that Amazon’s Prime members spend up to three times that of non-Prime members. However, she noted that while Amazon sells more and more third party goods, many traditional retailers have also begun offering free shipping. In that scenario, Prime members may “start to [wonder] if this membership is now worth it,” she added.

Amazon’s long-range plan of drones delivering shipments at doorsteps also has a blurred outlook, especially with potential regulatory obstacles, according to Nicholson. Raff agreed, and said the crash landing last week of a small drone on the White House lawn will be certain to raise regulatory barriers.

“You can’t still keep piling up those expenses unless you have operating margins going up.”–Amanda Nicholson

Raff and Nicholson did not see a clear-cut positive in Amazon’s latest bid to buy some stores of RadioShack, the Fort Worth, Texas-based electronics retail chain that is expected to declare bankruptcy soon. Raff said Amazon could use the stores to sell hardware like its Kindle e-readers — as “something comparable to the Apple stores.” Nicholson pointed out that many RadioShack stores are old and “not in the most advantageous locations.”

Amazon’s plans to grow as a content provider also came in for scrutiny. The company recently made headlines when it signed up Woody Allen to produce a TV series. “They are trying very hard on … as many fronts they can think of to be a content provider, and it’s all a matter of exploiting economies of scale,” said Raff. Nicholson found that strategy risky. “Investors get tired of spending on film and television stuff — there is a ton of competition out there,” she said. “But it makes perfect sense. If you hit it right, it’s golden.”

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