Does Mr. Bezos leave Amazon in its Prime?
Updated: Feb 9, 2021
Back in the summer of 1994, Jeff Bezos was an entrepreneur packing paperbacks in boxes. By the time the company went public in 1997, it carried over 2.5M titles and generated annual sales of $148M. Its inventory turned over 42 times that year, compared to only 2.1 times for Barnes & Noble. By 1998, Mr. Bezos hinted at his outsized ambitions, changing the company’s tagline from the “Earth’s Biggest Bookstore” to “Earth’s Biggest Selection” and had expanded its offering to include things like CDs, DVDs, clothing, toys, and office products. Fast forward to 2021, he is one of the most prominent business leaders with a net worth of $196B and Amazon is a digital conglomerate worth $1.6T that the consumers are inseparable from, the politicians hate, and investors have learned not to bet against.
Over the last few months, the pandemic has certainly played a role in making Amazon more relevant to the ordinary, primarily because of its crucial role in eCommerce, logistics, and cloud computing. In response to the pandemic, Mr. Bezos has focused on the growth of Amazon and kept his side projects on hold. It has been a great time for Amazon, but as Mr. Bezos exits as the CEO, Amazon faces problems–a fraying social contract, financial bloating, re-energized competitors & antitrust investigations.
During the start of the pandemic, the digital surge began with consumers' original bulk ordering necessities. This led to Amazon's first-quarter sales rising by 26% YoY. When the stimulus cheque arrived in April, Americans let rip a broader range of goods beyond necessities. eBay & Costco saw online activity speeding up in May. Walmart.com was making excellent progress parallelly with Walmart+ being launched in September 2020. Amazon was in for some trouble trying to keep up with the growing demand. This led to Amazon hiring 175,000 staff, equipping its people with 34M gloves, and leasing 12 new cargo aircraft, bringing its fleet to 82. AWS supported the eCommerce growth and saw a 33% rise in first-quarter sales of 2020.
A question that often comes up is whether the digital surge will subside. Shops have opened with restrictions globally, but we are still seeing the early signs that eCommerce is here to stay. Of course, you have the set of customers who were always digital-first, but the pandemic led to the rise of a new cohort of people who have only recently moved online. This cohort now has a Prime membership, digital payment options, and is only realizing the convenience that online shopping offers. Another sign to answer the question is the many physical retailers who have suffered fatal damage. Many have defaulted or are on the brink, including Century 21, J Crew, and Neiman Marcus to name a few. In the past year, the shares of warehousing firms, which thrive on eCommerce, have outperformed those of shopping-mall landlords by 48%.
All this may sound perfect for Amazon and Mr. Bezos, who has written to Amazon shareholders over the years about the rise of eCommerce. From books, it leaped to eCommerce, then opened its cloud and logistics arms to third-party retailers, making Amazon enter vast new businesses. Amazon keeps customers loyal by perks, such as Prime, a subscription service, and Alexa. By this account, the new digital surge confirms Amazon’s relentless rise. That is the view on Wall Street too, where Amazon’s shares reached an all-time high on June 17th, 2020.
But here is where the multiple problems start. The first is the fraying social contract. Some common criticisms of Amazon such as its market definition are simply misdefined. Market definition plays a key role in understanding if a company has a monopoly or not. Last year, Amazon had a 40% share of US eCommerce which is part of the US retail, which is 16% in 2019 and spiked to over 20% in 2020. So, does Amazon have ~40% of eCommerce or ~10% of retail? Amazon’s lawyers would argue, entirely reasonably, that Amazon competes with Walmart, Costco, Macy’s, and Safeway - that it competes with other large retailers, not just ‘online’ retailers. Indeed, many people who argue most strongly for antitrust intervention against Amazon do so because Amazon directly competes with physical retail and they worry about what Amazon will do, not just to the local Costco but to their neighborhood stores. On that basis, Amazon’s market is ‘retail’ and its market share in the USA is between 5% and 10%. On the other hand, if you’re a book publisher, you can argue about how Amazon runs its books business, it unquestionably has market dominance. But by this definition, you have to pull out a segment, not the entire company. Of course, this works both ways - if you’re pulling out segments, then Amazon has 1% of US grocery sales, and you can’t complain about it buying Whole Foods. To add to the argument, studies of the “Amazon effect” suggest that new warehouse and delivery jobs help offset the decline in shop assistants, and the minimum hourly wage of $15 in the USA is above the retail trade median. But Amazon’s strategy implies huge disruption in the jobs market even as the economy reels. In addition, viral outbreaks at its warehouses have reignited fears about working conditions. Amazon’s role as a digital jack-of-all creates conflicts of interest. For example, does its platform treat third-party sellers on equal terms with its own products? How comfortable should other firms be about giving their sensitive data to AWS, given that it is part of a larger conglomerate which competes with them is another question bought up?
Amazon’s second problem is bloating. Back in 2006, Amazon began offering AWS as a cloud computing service. It had built the technology to run its own website and figured it could make a buck renting it to others. The service quickly attracted customers, including Facebook, LinkedIn, NASA, and Netflix. It has served as a cash cow for the company and closed out 2020 with more than $13.5B in annual operating profits, responsible for over 63% of the entire company's operating profits for the year, on annual AWS revenue of $45.3B. As Mr. Bezos has expanded into the industry after industry, his firm has gone from being asset-light to having a heavy balance-sheet. Today, it has $104B of plant, including leased assets, not far off the $119B of its rival, Walmart. As a result, returns, excluding AWS, are puny and the pandemic is squeezing margins in eCommerce further. Mr. Bezos says the firm can become more than the sum of its parts by selling ads and subscriptions like Prime. So far, investors have taken this on his word, but the weak eCommerce margins make it harder for Amazon to spin off AWS. The spin-off would get regulators off its back but would deprive Amazon of the money-machine that funds everything else.
Amazon’s third worry is competition. Mr. Bezos has long said that he watches customers, not competitors, but he must have noticed how his rivals have been energized by the pandemic. Digital sales at Walmart, Target, and Costco have accelerated in 2020. Independent digital firms are thriving. Not to forget, Direct-to-Consumer brands are on the rise with the support of companies like Shopify. From a technological advantage standpoint, Amazon’s investment in autonomous drone delivery and ships without tills shows it is alert to the threat. In much of the world, regional competitors rule, not Amazon; among them are MercadoLibre in Latin America, Noon in the Middle East, Jio in India, Shopee in South-East Asia, and Ali Baba in China.
Amazon’s biggest problem is antitrust investigations. The company is possibly the next target for regulators, state attorney general, and lawmakers who are increasing their antitrust scrutiny on Big Tech. Facebook and Google are already sued in the US last year for alleged antitrust violations. Amazon could be up next year as investigations throughout the US and EU continue. In November, European regulators charged Amazon with misusing data from its third-party merchants and opened an investigation into potential anti-competitive practices. The antitrust will focus on the relationship with third-party sellers who make up a large percentage of the overall sales on Amazon, but many have complained and struggled with the constraints Amazon puts on them and the platform. As chief of AWS, the company’s lucrative cloud division, Andy Jassy played a role in Amazon’s decision last month to boot Parler from the Internet after last month’s Capitol riots. AWS is also embroiled in a court battle over a multibillion-dollar contract the Pentagon awarded to Microsoft, amid heavy scrutiny from former President Donald Trump.
Mr. Bezos, who I truly admire, is leaving Amazon to solve several puzzles, even though he has solved multiple since Amazon’s Inception. If Amazon were to raise wages to placate politicians, it would lose its low-cost edge. If it were to spin off AWS to please regulators, it would be financially fragile. And if it were to raise prices to satisfy shareholders, its new competitors would win market share. Twenty-five years on, Mr. Bezos’s vision of a world that does everything online has come true but has gotten a lot of increased scrutiny. He does leave Amazon at its prime, but the job of running Amazon for Andy Jassy will not be easy.