Originally published by BetaShares
“I really underestimated the brilliance of the execution” – Warren Buffet on Amazon at 2017 Berkshire Hathaway (NYSE:BRKa) AGM
Amazon.com Inc (NASDAQ:AMZN) went public 20 years ago at just $18 a share. In that time the company has transformed from a $400 million dollar online bookstore into a $450 billion dollar e-commerce behemoth. Name a consumer good and chances are Amazon now has it available at the click of a button, often with free same day shipping for its US customers.
In 2016, Amazon accounted for 43% of all US online retail sales. However, more impressive than that, it has been responsible for a fundamental transformation of consumer behaviour and left a trail of struggling traditional retailing powerhouses in its wake. In the United States, bricks and mortar retailers have announced more than 3,200 store closures so far in 2017. Retail bellwethers JC Penney and Macy’s have each announced over 100 store closures for 2017, around 15% of their respective store bases. Amazon, which as little as a decade ago was smaller than each of Target, Best Buy, Sears, JC Penney, Staples and Macy’s is now worth over 6 times as much as all of them combined.
During Berkshire Hathaway’s annual general meeting earlier this month, Warren Buffet recognised that “the department store is now online”
“We see this retail weakness, which is occurring despite a relatively healthy economy, as part of a permanent evolution in how and where Americans spend their money.”
The company has clearly hit an inflection point in recent years and the question now is where to from here? The answer, in my view, can be found in how they got here in the first place.
From the outset, Amazon had its eyes set on market leadership in a potentially huge market. Founder and CEO, Jeff Bezos decided to utilize the internet to sell products, he settled on books as the best option. They were easily shipped, non-perishable, generally not expensive and the decision making process for the customer was not overly complex.
The book industry though is a relatively small market, and Bezos has always been upfront with his ambition and long-term mentality. In his now infamous first letter to shareholders, aptly entitled “It’s All About the Long Term,” Bezos laid out the company’s fundamental management and decision making approach. He emphasised the company’s focus only on long-term shareholder value, rather than short-term Wall Street reactions, which could only be created by extending and solidifying their market leadership position:
“The stronger our market leadership, the more powerful our economic model.”
Until very recently, Amazon was famously unprofitable. The company has never paid a dividend nor has it ever issued guidance for quarterly earnings. Rather, Amazon is focused solely on long-term growth and free cash flow. “Free cash flow trumps margins,” and it’s this focus on maximising free cash flow and then redeploying that cash into expansion and new initiatives that have allowed Amazon to continuously focus on rapid growth and staying ahead of its competition.
“If we needed to see meaningful financial results in two to three years, some of the most meaningful things we’ve done we would never have even started. Things like Kindle, things like Amazon Web Services, Amazon Prime. The list of such things is long at Amazon.”
What’s unique about Amazon’s cash flow engine is the time gap between the receipt of customer payments and the time it takes for them to pay suppliers. Amazon’s cash flow conversion cycle is negative, meaning it is generating revenue from customers before it has to pay its suppliers for inventory and thus providing the company with an interest-free means of financing operations and initiatives by essentially borrowing from suppliers. Most highly efficient retailers, Walmart (NYSE:WMT) for example, have a cash flow conversion cycle in single figures. Though falling, in-line with growth in Prime and Amazon Web Services, it has been estimated that Amazon’s cash flow conversion cycle still sits around -15 days (Harvard Business Review). For Amazon, all the extra cash allows the company to finance its growth initiatives and makes it possible for them to undertake the experiments like Alexa.
Bezos is also widely known for his relentless focus on the customer and customer service. The company collects large amounts of data on customer satisfaction, valuing it as highly as any financial metric, and invests significantly in customer facing initiatives such as same day delivery and website load times. What this has always come down to is customer trust.
“In the long run, if you take care of customers, that is taking care of shareholders. We do price elasticity studies. And every time the math tells us to raise prices. But doing so would erode trust. And that erosion of trust would cost us much more in the long term.”
It’s difficult not to attribute Amazon’s dominance and success to Bezos’ long-term vision of driving growth by constantly reinvesting in new initiatives and continually improving the customer experience and building trust. He outlined this vision in his first letter to shareholders and over the past two decades built the engine necessary to finance it.
Amazon is now a global leader in cloud computing through Amazon Web Services. Its dominance in the digital streaming market is growing. And it is pioneering voice computing through its Alexa platform. The key to Amazon’s future, as they continue their global retail expansion and into areas, we likely haven’t even envisioned, certainly lies in the leadership capabilities of Jeff Bezos and his now famously unique long-term approach to management.