“There is a terrific misconception about retail margins, it all depends on velocity.”
Hey Denny, no misconceptions here, just looking at the actual numbers. I think our terminology might be getting confused. When I say margin, I mean total profit margin from each dollar of sales. The holding costs/working capital that you are talking about is definitely a part of it, but as you have said, a lot of retailers (and certainly the behemoths like Walmart, go into a Walmart near you and look at how many empty shelves they have because they’re trying to squeeze a few cents out of the negative working capital philosophy) nowadays have negative working capital, which means Amazon does not have an advantage over these companies. Additionally, to your second point, Amazon is actually at a huge disadvantage when it comes to volume discounts, at least compared to Walmart, since it’s selling 1/4 of the volume WMT is doing
Let’s walk through an apples to apples comparison, just so you can see what I’m talking about.
Amazon’s 10-Q is here: https://www.sec.gov/Archives/edgar/data/1018724/000101872416…
Walmart’s 10-Q is here:
https://www.sec.gov/Archives/edgar/data/104169/0000104169160…
Net Sales for Walmart for the quarter was 119 billion, while retail sales for Amazon (on page 16, under segment reporting) was 19b in North America and 11b internationally, for about 30b total. Net profit for Walmart before income tax was 5.6b, while operating income for the retail segments at Amazon BEFORE stock comp AND income tax was 362 million (694-332). Margin for Walmart is then 4.7%, while for Amazon is 1.2%. Remember, we are not including stock comp for Amazon, while we are for Walmart, for simplicity purposes (I can go get the stock comp expense for Walmart from the equity footnotes, but didn’t want this to be more complicated than it already is). 3.5% is huge in retail. For Amazon, this would be over $1 billion, which is enough to pay for all of its G&A corporate (at 639m this quarter), or enough to pay for 60% of its marketing budget
Now just talking through things from an overview perspective - Amazon’s cost advantage isn’t directly in their inventory practices, but in the amount of overhead they might employ for their inventory. They might have a slight advantage because they rely on warehousing/fulfillment centers to deliver their products, whereas Walmart would need the giant warehouses along with actual stores to display the inventory. But where they pick up savings there, they lose out majorly, at least currently, after shipping costs are taken into consideration. The “last mile” problem is going to be a huge drain until Bezos innovates a way to reduce the need for costly/margin killing partnerships with Fedex/UPS etc. That said, as Walmart starts to get into the fight with Jet, they will start eating into their own profit margin as well.
Amazon’s greatest advantage is actually its shareholders. There’s no profit directive like with Walmart or other retailers, instead, the company generates just enough cash to continue to continue to build out its fulfillment centers/warehouses and pay for its R&D (for AWS, Blue Origin, etc. - heavy industrial zones in space is Bezo’s next dream, as an aside, I’m not a fan of Amazon stuffing its warehouse lease payments in the “financing” activity portion of the cash flow statement, it feels underhanded/manipulative to me, but at the end of the day, free cash flow is free cash flow). In other words, Amazon sells things cheaper now because it doesn’t have a need to make much of, if any, profit. I can only speculate, but I believe the rich valuation is due to the belief that the company will continue to take market share, and, eventually, turn its focus to increasing its margin. But in capitalism, there is no free pass to execute, there are plenty of companies that already has in place the giant distribution systems that Amazon has been building up, and there’s nothing stopping them from fighting back by lowering their own margins
To sum, Amazon is an amazing company for customers, and that’s part of the reason why its fundamentals continue to grow like gangbusters, but it’s hard to say that if the margins for retail don’t eventually expand (and I’ve already outlined why there would be no reason for Bezos to do so), that there would be much value assigned to the retail segment. The AWS segment is fantastic though, if price ever falls to a workable level (doubt it, but as I have admitted, I don’t understand the valuation the market is assigning to the retail segment), I’d be very interested