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July 10, 2005
by Nicholas G. Carr
Amazon.com turns ten this week, a good occasion for some partying – and a little soul-searching, too.
Amazon’s rapid growth testifies to the vision and daring of its founder and chief executive, Jeff Bezos. Bezos’s refusal to play by the rules is the reason he now runs the world’s largest Internet store. Back in 1994, when retailing’s big guns were oblivious to the Web, he was staking his claim to the vast new territory. He saw what the rest of the pack was blind to.
But now that Bezos heads a $7 billion public company, he’s finding that making up your own rules doesn’t work quite so well, particularly when it comes to financial reporting. Plagued by losses or weak profits ever since it opened its virtual doors, Amazon wants to exempt itself from the traditional measures investors use to evaluate stocks. It wants shareholders to ignore its earnings numbers and judge its performance by its free cash flow instead.
Bezos feels so strongly about the issue that he devoted his last shareholders’ letter to a defense of the cash-flow standard. It read like something out of an introductory accounting textbook, complete with a hypothetical case study. “Why not focus first and foremost, as many do, on earnings, earnings per share or earnings growth?” he wrote. “The simple answer is that earnings don’t directly translate into cash flows, and shares are worth only the present value of their future cash flows, not the present value of their future earnings.”
Bezos makes a valid point. The only problem is, he’s a CEO, not a tweed-wrapped academic. Wall Street found the letter at best quixotic and at worst bizarre. As analyst Frank Husic drily commented, "It's a terrific argument, but people pay for earnings growth in the stock market."
The real problem with Amazon is not a matter of measures. It’s the fact that Bezos’s operation now houses two very different businesses. On one side is the familiar on-line retailer, pitching everything from books to toasters to plasma TVs. On the other is an information technology company that provides other merchants with a software platform for Internet sales. Amazon, in other words, is playing both ends of the supply chain—it’s a retailer, and it’s an infrastructure supplier to other retailers.
Although the infrastructure business grew out of the retailing operation, the two Amazons have little in common. Their economics, for instance, are fundamentally different. The retailing business has microthin profit margins. Despite Amazon’s strong brand, it remains pinned under relentless pricing pressure from pure-play Internet competitors like eBay and Overstock.com as well as multi-channel retailers like Best Buy and Wal-Mart. To draw customers, it’s been forced to offer cheap or free shipping on most purchases, further squeezing its margins. Renting out a software platform, by contrast, is a profit-rich business requiring no inventory and a relatively small labor force. To see how lucrative it can be, just look at eBay’s mile-wide margins.
For investors, it’s becoming difficult to figure out exactly what kind of company Amazon is.
Even worse, the two business models have inherent conflicts. As a retailer, Amazon competes directly with the customers of its infrastructure business. The many merchants that piggyback on Amazon’s site, including giants like Target and Office Depot, have to be concerned about directing their customers to the storefront of a price-slashing competitor intent on expanding into ever more product categories. That may well be one of the reasons Circuit City dumped Amazon as a partner earlier this year.
The conflict is even beginning to muck up the Amazon.com site itself. It’s becoming harder for customers to figure exactly who’s selling what—and under what terms for shipping and returns. Such confusion threatens to erode the customer loyalty that Amazon’s retail operation has so painstakingly built up.
As Amazon enters its second decade, maybe it’s time for Bezos to once again do something really dramatic: to split Amazon into two companies by spinning off the infrastructure business. Such a division may be the only way to give the company’s investors a clear view of its economics—and to give its managers a clear playing field to pursue their two very different strategies. With eBay having just announced it will begin providing merchants with storefronts on its own e-commerce platform, Amazon can’t afford to hamstring its infrastructure business much longer. The potential is too great.
A version of this article originally appeared at BusinessWeek Online.