What Jeff Bezos Gets That Amazon's Critics Don't
Amazon.com has generated a cumulative $315 billion in sales since 1997. Its cumulative profits during this period are less than $2 billion. Its lifetime profitability, then, is about a half of 1%. Pitiful.
This might be normal for a start-up, but if Amazon were a person, it would be old enough to vote and buy cigarettes. Companies its age usually aim for steady and reliable profits. Amazon doesn't. It reported a small loss last quarter. All the company seems to care about is revenue, revenue, revenue. Predictably, more critics are stomping their feet and wondering when -- or if -- CEO Jeff Bezos will shift tactics and attempt to turn a real profit.
They should stop, and recognize that Bezos knows exactly what he's doing. He is not running a shareholder-owned charity. It's quite the opposite. His indifference to profits today reflects his deep understanding of how retailers maximize income in the long run.
Here's what Bezos knows: High margins are hard to maintain for any company. For a retailer, they are nearly impossible. Competition drives them into the ground, and the low-cost provider always wins. That's how capitalism works. Look at the most profitable retailers in the world -- they all have razor-slim margins. Wal-Mart's net income margin was 3.6% last year and Costco's was less than 2%. Compare this to the S&P 500 average of nearly 9%. Retail just isn't a high-margin business.
In any commodity-type business that is destined for low margins, there is only one way to increase the total dollar amount of net income: Grow revenue. Forget increasing margins beyond anything but a trivial amount. It's not going to happen. Size should basically become the sole focus. Here's how Bezos once put it:
Percentage margins are not one of the things we are seeking to optimize. It's the absolute dollar free cash flow per share that you want to maximize. If you can do that by lowering margins, we would do that. Free cash flow, that's something investors can spend.
If Amazon is destined for low margins, the goal should be to become as big as possible as fast as possible. That's how you maximize the dollar amount of net income for long-term shareholders. By investing like crazy and forgoing short-term profits, it's exactly what Amazon is doing.
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The article What Jeff Bezos Gets That Amazon's Critics Don't originally appeared on Fool.com.Fool contributor Morgan Housel has no position in any stocks mentioned. The Motley Fool recommends Amazon.com and Costco Wholesale. The Motley Fool owns shares of Amazon.com and Costco Wholesale. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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