Amazon’s Loss Leader Strategy Results in No Gains

For the first time in several years Amazon posted a loss in two of the previous four quarters. The second quarter loss occurred despite a revenue increase of 22 percent over the same period — April through June — last year. The reduction was modest, $7 million on revenues of $15.7 billion, and Wall Street didn’t bat an eye as Amazon’s stock dropped less than two per cent. Regardless of the financial losses, Amazon stock has gained 27 percent year-to-date, outperforming the general market.

When Amazon announces results for the quarter ending September 30, it’s expected to report a loss of 9 cents per share. Analysts were expecting it to bounce back to some gain.

Amazon stock report offered by Yahoo.

Behind the Numbers — It Is a Strategy

Why is Amazon unprofitable despite strong sales growth? It’s the result of a purposeful strategy, not bad execution. The business is investing heavily in research and development. Spending has increased over 300 percent during the last three decades. The majority of the expenses are for the Kindle, which Amazon has revamped from an e-reader to a fully functioning tablet.

Amazon is also spending a whole lot of money purchasing rights to streaming video content that’s distributed through its Prime support. The business’s outlays for licenses to construct a movie library for Kindle customers reach into the hundreds of millions. Amazon can sell Kindle tablets at a reduction since it makes money on electronic downloads of novels and movies. Pundits are predicting that Amazon will go into the hardware market with a set-top apparatus that will compete with Roku and Apple TV. If Amazon does introduce a set-top box, then it would be the first significant company to offer an integrated video streaming and hardware bundle. The Wall Street Journal predicts the device will be available for the upcoming holiday shopping season.

Amazon has also made some high-profile acquisitions through the years, including powerful online shoe purveyor Zappos, online movie database IMDb, and most recently, Goodreads, a book recommendation website. Goodreads has been added to the most recent Kindle devices.

Amazon is also spending more on its own workforce. It currently has close to 100,000 workers; a year ago it had 69,000. These new workers are in warehouses and development and research labs.

Amazon isn’t neglecting its ecommerce roots. The business is building more warehouses throughout the country. 1 reason is that it has negotiated agreements with countries that wanted Amazon to collect sales tax on purchases in their boundaries. Amazon has managed to postpone the collection by various years by building warehouses and creating projects. However, the principal reason behind the warehouse growth is Amazon’s approach to offer same day delivery in major cities and achieve a competitive edge.

Amazon Enters the Grocery Business

The same day delivery is very imperative to the achievement of AmazonFresh, the business’s grocery delivery service. It’s been operating the grocery delivery service in the Seattle area for several years, offering meat, dairy, and fresh produce in its own trucks, delivered the exact same day as ordered. This past June, Amazon started offering same day delivery service in the Los Angeles region, eight months after launching a new warehouse . It’s expected to expand into the San Francisco Bay region soon. While Amazon doesn’t break out its AmazonFresh financials separately, analysts feel that the Seattle service hasn’t attained a profit.

AmazonFresh trucks. Photo credit: Reuters.

It’s apparent that Amazon’s focus is diversification and growth, not profits. The undiminished support from shareholders will let it follow this route for the near future as long as earnings continue to grow. However, this strategy isn’t sustainable forever. The Kindle product line is sold at cost and generates no profits. The AmazonFresh grocery delivery service also hasn’t turned a profit and its growth will add more costs for warehouses and trucks in some rather expensive geographies. Groceries are a notoriously low margin business, where merchants depend on regular inventory turns to incur a gain. In the first days of ecommerce, Webvan tried delivering markets the exact same day. Though well known, Webvan went out of business due to increasing costs and logistical issues.

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Few companies can always sell services and products at a reduction, even if they’re subsidized by other more profitable services. Amazon Web Services is allegedly the provider’s cash cow but fresh cloud competitors are springing up each day and there are increasing concerns about cloud security and information privacy. Amazon’s core ecommerce company is also healthy and no additional online market can match its success. Amazon will likely have a stellar fourth quarter in terms of revenue but not turning a profit in this vital quarter will likely diminish support from shareholders. It’ll be interesting to see what happens in 2014 as Amazon continues its loss pioneer approach to business.

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