Amazon spends a lot to secure dominance—don’t expect that to change

February 22, 2017 02:05 PM

(Bloomberg Gadfly)—Which is the real Inc.? Is it the company whose 2016 operating profit was five times the level of three years earlier? Or is it the Amazon that has mostly delivered minuscule profits and instead redirected nearly every dollar in sales toward its mission of world domination?

Believe in history. It's the latter.

It is true that Amazon generated $4.2 billion in operating profit in 2016—nearly equal to the company's operating profit in the previous five years combined. Pat on the back, Amazon, for "only" spending 97 cents of every dollar coming in the door last year.

The step-up in profit is a big reason Wall Street started to expect Amazon's profit to soar in coming years, although some doubts have creeped in recently. It may be time to rethink those expectations.

Amazon, No. 1 in the Internet Retailer 2016 Top 500 Guide, has made it clear that it is splurging to build up its package-shipping warehouses and entertainment programs for its Prime video service to fuel future revenue growth. The number of full- and part-time Amazon employees rose 48% in 2016 to 341,400. Amazon continues its pattern in which its core operating expenses, excluding purchases of merchandise and other direct costs for its business, are growing faster than its revenue.

The trouble is it's hard to predict the full tab for Amazon's blueprint to crush every industry in which it competes. Amazon CEO Jeff Bezos has expressed great affection for Amazon’s voice-activated technology, including its Echo line of home speakers and the companion Alexa software that competes with Apple's Siri. Nearly every day Amazon announces another city in which it is expanding its short-term package delivery service Prime Now, or its associated restaurant delivery service. (Tuesday's expansion was Las Vegas.) None of that will be cheap.

Neither is Amazon's foray into physical bookstores, convenience shops and grocery stores. The scope of Amazon's store game plan isn't clear, but a recent Morgan Stanley analysis estimated Amazon could incur roughly $400 million in capital costs for each 50 grocery stores it opens. There was also a flurry of news reports in recent days about Amazon's growth plans in Europe, both for additional shipping distribution centers and for technical workers. SunTrust stock analysts estimated Amazon will add roughly 15,000 new employees in the U.K., Germany and France.

Those Amazon war plans suggest Wall Street expectations for Amazon's future profits are still too high, even though they already went back to the drawing board late last year. In October, Wall Street expected Amazon to post more than $8 billion of operating profit in 2017 and $13.6 billion next year, according to the average of stock analyst estimates compiled by Bloomberg. Now those expectations have downshifted to $5.8 billion for 2017 and less than $10 billion for 2018. 

Amazon is like an adorable puppy that eats your shoes and urinates on the rug. You really can't get too angry at her. No one should expect puppies to act out of character. You believe some day the annoyances will pay off and she will grow up to be a loyal companion rather than an incontinent brat.

Amazon, of course, has been in the profits puppy phase for a long time. Maybe it always will be. Nevertheless, investors should realize that is the species they are taking home when they buy into Amazon. It's important to understand what Amazon truly is and not be deluded into thinking it is something that it's not.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.




Top Solution Providers