A few years ago, I just didn’t get it. I couldn’t for the life of me understand how a company like Amazon could operate, let alone flourish. I spent the majority of my time following Apple, a company which in many ways was the antithesis of Amazon. Apple was all about huge margins, big profit. Amazon seemed to avoid profit like the plague. The more razor-thin the margin, the better. They were Bizarro Apple.
And clearly, I’m not the only one confused by Amazon. When The Washington Post broke the news today of The Washington Post being acquired by Amazon founder and CEO Jeff Bezos, the flow of snark was fast and furious. “Bezos acquisition of WaPo shows just how much this man loves low-margin businesses.” “So, now Jeff Bezos owns two lifestyle businesses.” Etc. Etc.
I piled on as well, but only to ensnare some folks in a conversation about what I’ve been thinking about for the past year or so: Jeff Bezos is no fool, he’s a genius. And if you can’t spot that, you’re the fool. Certainly, I used to be.
While the game Amazon is playing is not as straightforward as Apple’s, that doesn’t mean it’s a bad game to play. In fact, you could argue that it’s a better game to be playing right now in the respective life cycles of the two companies.
I understand, of course, that Amazon isn’t buying The Washington Post, Bezos personally is. And in an age where Newsweek (incidentally, once owned by The Washington Post) is getting sold for perhaps fifty cents on the literal dollar, and The Boston Globe is being sold for effectively negative $40 million, this move may seem to make less sense than Bezos’ Amazon operations. But I would not bet against Bezos here either.
Here’s the thing that most people, and certainly many in the tech press, don’t seem to understand about Amazon, and by extension, Bezos: when it comes to business, there’s a game being played almost flawlessly.
The goal is actually to not make a huge profit too early, and Bezos manages it perfectly. You want to avoid showing your cards too early as you continue to lay the groundwork for an ever-larger business. Occasionally, you’ll have to show those cards and win a hand to prove that you can. But the rest of the time you call and fold, as you await the monster to take the entire pot.
I know that sounds crazy. Cash is king, right? Not always. Just look at Apple. They are the kings of cash. $13 billion in profit one quarter, $9 billion the next, and so on. The vault is so full of gold coins that even Scrooge McDuck would need a lifeguard to swim in it. And yet, Apple’s story the past year has largely been one of a company in flux. Will they ever right the ship? Is it over?
These silly doomsday projections are mainly a result of Wall Street swinging from ultra-bullish to extremely bearish on the company in that same timeframe. The “problem”? Apple was too successful, too quickly. Because the iPhone was such a good business — a bigger business than all of Microsoft, in fact! — Apple posted profits that were only surpassed by a few of the best quarters from the largest oil companies. As a result, the company shot from a has-been to the most valuable public company in the world.
But growth and more importantly, growth potential is what matters most to Wall Street. And when you happen to stumble into one of the best businesses in the world (the high end of the carrier-subsidized smartphone market), the only way to keep that growth going is to find an equal or greater business (or several smaller ones that add up to a larger one). It’s not clear if Apple will ever find this business, even with the fabled television and watch products. The iPhone business was just that good.
But Amazon has no such problems on Wall Street. Again, they’re Bizarro Apple. They’re not showing their cards. While their businesses keep growing from a revenue perspective, profit has gone from negligible to non-existent to an actual loss this past quarter. And Wall Street loves them for it!
Why? Two reasons.
First, they know that Bezos is devouring Amazon’s profits by pouring them into infrastructure build-outs. Data centers, shipping centers, etc. These are one-time costs that should pay off in the long run.
Second, they believe that at some point in the future, Amazon will flip a switch and, voila, profit. In fact, Amazon has the ability to do it at almost anytime, as Bezos has made clear in the past, but people seem to forget. As Adam Lashinsky reminded us in a profile of Bezos last year:
Bezos even takes a practical approach to his love-hate relationship with Wall Street. Having worked at a hedge fund in his twenties, he understands the investor mentality probably better than most CEOs. Perhaps as a result, for the first many years of Amazon’s existence, Bezos frustrated investors by refusing to realize Amazon’s profit potential. Then, around 2007, Amazon’s investments began to bear fruit, and investors were delighted. The stock is up 10-fold in the past six years. “We believe in the long term, but the long term also has to come,” says Bezos, explaining that periodically Amazon wants to “check in” with its ability to make money. Thus, in 2007, Amazon more than doubled its profit, to $476 million, on a 38% increase in sales to almost $15 billion.
Here’s what else you may not realize: while Amazon may be earning little-to-no profit each quarter, they continue to bring in money that they can actually use. How? As former Amazon employee Eugene Wei explained last year:
Almost all customers paid by credit card, so Amazon would receive payment in a day. But they didn’t pay the average distributor or publisher for 90 days for books they purchased. This gave Amazon a magical financial quality called a negative operating cycle. With every book sale, Amazon got cash it could hang on to for up weeks on end (in practice it wasn’t actually 89 days of float since Amazon did purchase some high velocity selling books ahead of time). The more Amazon grew, the more cash it banked. Amazon was turning its inventory 30, 40 times a year, whereas companies like Barnes and Noble were sweating to turn their inventory twice a year. Most people just look at a company’s margins and judge the quality of the business model based on that, but the cash flow characteristics of the business can make one company a far more valuable company than another with the exact same operating margin. Amazon could have had a margin of zero and still made money.
And so I repeat, Bezos is a genius. He’s flying under-the-radar until he can buy the radar. And probably the company that makes all the radars as well. With Amazon, it’s not “now or never”, it’s “next”.
It’s certainly possible that Amazon slips up and they are never able to live up to the ambitions that Bezos has been building towards for the past two decades. But even pure mishaps like the LivingSocial and Pets.com investments didn’t do much to deter the trajectory.
So while The Washington Post purchase may sound insane, it’s probably a much more calculated maneuver by Bezos. He’s likely once again playing chess while we’re all trying to parse the way he’s playing checkers. And if it fails, what’s $250 million for an ever-more-wealthy billionaire anyway? Have you seen Amazon’s stock price recently?
[image: 20th Century Fox]