VideoFor all its diversification, however, Amazon still derives three-quarters of its revenue from products that it inventories, sells, ships, and fulfills via its own supply chain, which includes six warehouses in the United States and four overseas. Those who have followed the brief history of E-commerce know it wasn't supposed to be that way: Amazon's original vision posited the company as a much more virtual entity, an electronic middleman light on capital assets. Instead, centralized distribution driven by technology—everything from inventory systems to real-time logistics analysis—has proved a potent combination.
To leverage those capabilities, a CFO needs to think in terms of inventory velocity. "Say both Amazon and a physical store are selling a digital camera for $300," Szkutak says. "The physical store's inventory turns are 7.5 times a year and ours are 20 times a year. The hypothetical value of the camera one year later, due to obsolescence, is, say, $210, an obsolescence loss per week of $1.70. However, since the camera is in inventory an average of 7 weeks at the physical store and only 2.6 weeks at Amazon, the obsolescence cost per unit works out to $12 for the store and $4.50 for Amazon. As a percent of sales, that's 4 percent for the physical store and 1.5 percent for Amazon. In short, our inventory velocity translates to margin benefit."
Got that? Amazon's annual gross margins of 25 percent (for its North American segment) and nearly 20 inventory turns, important twin metrics in the retailing sphere, compare very well against traditional retailers like Wal-Mart Stores (22 percent gross margins and 7 inventory turns) and Costco (13 percent and 11 turns), according to the Securities and Exchange Commission filings of these companies. But Amazon's extensive array of products surpasses even that of the superstores, a factor even more important to the company's financial viability than low-priced merchandise, according to an MIT study. "Amazon carries [several million] book titles, whereas conventional bookstores carry on average about 40,000 titles," Brynjolfsson says. "Previous research indicated that consumers on average saved 8 percent by buying books online. However, our newest study found that greater product selection and convenience were far greater contributors to total consumer value. The extra choice creates value because consumers can find products that are a better fit for their particular interests and needs," he explains. "The value can be calculated in dollar terms. Consumers at Amazon gained more than $1 billion of additional consumer value due to the extra product variety for the year 2000. This was about seven times more than the extra value consumers received from the 8 percent lower prices. Clearly, product selection and convenience, not lower prices, are the biggest areas of consumer benefit."
Live Free or Die?
Having reported its first billion-dollar quarter (Q3) and posted its first yearly profit, Amazon seems to have benefited from its decision to expand its product offerings; cut prices on books and other items; and offer free shipping on orders over $25. Free cash flow in Q4 was $346 million, up from $135 million in the same period a year earlier, an achievement that has analysts smiling. "Profits as defined by GAAP are not as relevant as return on free cash flow," says Anthony Noto, a managing director for Goldman Sachs. "Economic value is created more by free cash flow than by GAAP earnings. At the end of the day, it is free cash flow that companies are rated on."
That free cash isn't just in the form of dead Presidents. As Amazon continues to sprout tributaries around the world, from Japan to Europe, it expects its current international sales, which already account for 40 percent of the total, to play an ever-larger role in its success. "We are examining other country sites, which I'm not able to discuss," Szkutak says. "I can say that our international revenue is up some 71 percent from third-quarter 2002 to third-quarter 2003, from $973 million to $1.6 billion."
The good news has not escaped Wall Street; indeed, investors seemed to anticipate it. Amazon's stock value tripled in 2003, but took a dive just as the company was announcing its positive annual results, a correction that most saw as sensible. On February 10, Standard & Poor's put Amazon on "credit watch positive," but didn't actually raise its rating. Szkutak downplays any and all tribulations, saying, "We're still the same high-tech company...focused on fulfilling Jeff's dream of building a place where people can find anything online."
No Time to Rest
Jeff, of course, is Jeff Bezos, Amazon's founder, chairman, and CEO, and Time magazine's "Person of the Year" in 1999. Lauded by the magazine as the "King of the Internet," Bezos had a legendary epiphany in May 1994, when he spied an Internet site that measured Net usage; it was growing at an astonishing 2,300 percent a year. He quickly grasped an, if not the, essential value proposition of the Net: the ability to sell nearly anything to anyone with maximum convenience and minimum overhead. Books were a perfect start, since a catalog of all books available for sale would be the size of a New York City phone book—that is, too big, unwieldy, and expensive to mail out. Amazon.com was founded that year, and its Website was launched in July 1995, billed as the "Earth's Biggest Bookstore." And it was also its most innovative, with a host of customer-friendly enhancements rolled out almost monthly. "The only reason left for a customer to go to an actual physical store," Szkutak says, "is because he or she needs something right now, this minute."
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