Amazon "loses" money, Apple makes tons if it. And yet, Wall Street prefers Jeff Bezos's losses to Tim Cook's. A look at the two very different cash machines will help dispel the false paradox.
The words above were spoken by an old friend and Amazon veteran, as three French émigrés talked shop at a Palo Alto watering hole. The riposte would fit as the epigraph for The Amazon Money Pump For Dummies, an explanation of Amazon's ever-ascending stock price while the company keeps "losing money".
(I don't like the term Business Model, and Bizmodel even less so. I prefer Money Pump with its lively evocations: attach the hose, adjust the valves, prime the mechanism, and then watch the flow of money from the customer's pocket to the investor's purse).
Last quarter, Amazon's revenue grew by 24% year-on-year, and lost about 1% of its net sales of $17B. This strong but profitless revenue growth follows an established pattern:
Despite the company's flat-lined profits, Wall Street loves Amazon and keeps sending its shares to new heights. Since its 1997 IP0, AMZN has gone from $23 to $369/share:
[Professional accountants: Avert your eyes; the following simplification could hurt.
Profit isn't cash, it's merely an increase in the value of your assets. Such increase can be illiquid. Profit is an accountant's opinion. Cash is a fact.]
Amazon uses its e-commerce genius to prime the money pump. The company seduces customers through low prices, prompt delivery, an ever-expanding array of services and products, and exemplary customer attention. What keeps the pump going is the lag between the moment they ding my credit card and the time that they pay Samsung for the Galaxy Note tablet I ordered. Last quarter, Amazon's daily revenue was about $200M ($17B divided by 90 days). If it waits just 24 hours to pay its suppliers, the company has $200M to play with. If it delays payment for a month, that's $6B it can use to invest in developing the business. Delay an entire quarter...the numbers become dizzying.
But, you'll say, there's nothing profoundly original there. All businesses play this game, retail chains depend on it. Definitely — but what sets Amazon apart is what it does with that flow of free cash. The company is relentless in building the best services and logistics machine on Earth. Just this week, we read that Amazon has hired the US Post Office to deliver Amazon packages (only) on Sundays.
Amazon uses cash to build a better Amazon that keeps bringing in more cash.
Why do suppliers "loan" Amazon such enormous amounts of cash? Why do they let the company grow on their backs? Because, just like Wall Street, they trust that the company will keep growing and give them ever more business. Amazon might be a hard taskmaster, but it can be trusted to pay its bills (eventually) — the same cannot be said of some other retail organizations.
Amazon doesn't care that it doesn't make a "profit" on the sale of a box of Uni-Ball pens that it ships for free. Rather, it focuses on pumping enormous amounts of cash into the virtuous spiral of an ever-expanding business. Wall Street rewards the company with an equally expanding market cap.
How long can Amazon's expansion last? Will the tree grow to the sky? If we consider a single line of business — books, for example — saturation will inevitably set in. But one of the many facets of Bezos' genius is that he's always been able to find new territories. Amazon Web Services is one area where the company is now larger than all of its competitors combined, and shows no sign of slowing down or of approaching saturation.
In the end, we mustn't be fooled by the simplicity of Amazon's money pump. Bezos' genius is in the implementation, in the details. Like a chef who's not afraid to disclose his recipes, Bezos writes to his shareholders every year — his missives are all here — And he always appends his first 1997 letter, thus reminding everyone that he's not about to lose the plot.
The other friend in this conversation, an old Apple hand, happily nodded along as our ex-Amazon compatriot told stories from his years in the Seattle trenches. When asked about the Apple money pump and why Wall Street didn't seem to respect Apple's huge profits, he started with an epigraph of his own:
'The simplest encapsulation of Apple's business model is the iPod.'
To paraphrase: The iPod is the movie star, it brings the audience flocking to the theatre; iTunes is the supporting cast.
iTunes was initially perceived as a money-losing operation, but without it the iPod would have been a good-looking but not terribly useful piece of hardware. iTunes propelled iPod volumes and margin by providing an ecosystem that comprised two innovations: "music by the slice" (vs. albums,) and a truly new micro-payment system (99 cents charged to a credit card).
That model is what powers the Apple money pump today. The company's personal computers — smartphones, tablets, and laptops/desktops — are the movie stars. Everything else exists to make these lead products more useful and pleasant. Operating systems, applications, stores, Apple TV, the putative iWatch...they're all part of the supporting cast.
Our Apple friend offered another thought: The iPod marked the beginning of the Post-PC era. By 2006 — a year before the introduction of the iPhone — iPod sales had exceeded Mac revenue.
Speaking of cash, Apple doesn't need to play Amazon's timing games. Product margins range from 20-25% for desktops and laptops (compared to HP's 3-5%), to 65% or more for iPhones. With cash reserves reaching $147B at the end of September 2013, Apple has had to buy shares back and pay dividends to bleed off the excess.
Far from needing a "loan" from its suppliers, Apple heads in exactly the opposite direction. On page 37 of the company's 2013 10-K (annual) filing, you'll find a note referring to "third-party manufacturing commitments and component purchase commitments of $18.6 billion". This is a serious cash outlay, an advance to suppliers to secure components and manufacturing capacity that works out to $50 for every person in the US...
Wall Street's cautious regard for Apple seems ill-advised given Apple's ability to generate cash in embarrassing amounts. As the graph below shows, after following a trajectory superficially similar to Amazon's, Apple apparently "fell from grace" in 2012:
I can think of two explanations, the first one local, the other global.
During Fiscal 2012, ending in September of that year, Apple's Gross Margins reached an unprecedented high of 43.9%. By all standards, this was extremely unusual for a hardware company and, as it turned out, it was unsustainable. In 2013, Apple Gross Margin dropped by more than 6 percentage points (630 basis points in McKinsey-speak), an enormous amount. Wall Street felt the feast was over.
Also, Fiscal 2013 was seen as a drought year. There were no substantial new products beyond the iPhone 5 and the iPad mini announced in September and October 2012, and there was trouble getting the new iMacs into customers' hands during the Holiday season.
More globally important is the feeling that Apple has become a "hits" business. iPhones now represent 53% of Apple's revenue, and much more (70%?) of its profits. They sell well, everything looks rosy...until the next season, or the next round of competitive announcements.
This is what makes Wall Street nervous: To some, Apple now looks like a movie studio that's too dependent on the popularity of its small stable of stars.
We hear that history will repeat itself, that the iPhone/iPad will lose the battle to Android, just as the Mac "lost" to Windows in the last century.
Our ex-Apple friend prefers an automotive analogy. Audi, Tim Cook's preferred brand, owns a small portion of the luxury car market (about 7.5%), but it constantly posts increasing profits — and shows no sign of slacking off. Similarly, today's $21B Mac business holds a mere 10% of the PC market, but Apple "uses" that small share to command 45% of market profits. The formula is no secret but, as with Amazon's logistics and service, the payoff is in the implementation, how the chef combines the ingredients. It's the "mere matter of implementation" that eluded Steve Ballmer's comprehension when he called the MacBook an Intel laptop with an Apple logo slapped on it. Why wouldn't the Mac recipe also work for smartphones and tablets?