Can Amazon Survive?
August 30, 2000 • 10 min read
Amazon.com is arguably the biggest name in online shopping, the gold standard against which all dotcoms are judged. Is it really possible, then, that someday we will be forced to live in a virtual world without this mammoth bookseller? Certainly, it's too soon to write a eulogy. But on the savage frontier of Internet commerce, even the biggest and toughest – though they may have been the first to stake the choicest claim – are not assured survival. Knowledge at Wharton discussed the company's future with Wharton faculty members and industry experts.
Eric Bradlow
Peter Fader
Amazon.com is arguably the biggest name in online shopping, the gold standard against which all dotcoms are judged. Is it really possible, then, that someday we will be forced to live in a virtual world without this mammoth bookseller?
Certainly, it's too soon to write a eulogy. But on the savage frontier of Internet commerce, even the biggest and toughest – though they may have been the first to stake the choicest claim – are not assured survival.
"I don't know if the company is smart or stupid," jokes Peter S. Fader, professor of marketing at Wharton. Fader says the Internet-retailing industry is so young, so full of money-losing behemoths like Amazon, that there is no way to tell which business models will succeed.
The six-year-old seller of books and CDs sits atop millions of computer users' Favorites lists. But many investors, Wall Streeters and academics who have studied the company cannot ignore some frightening facts: The company has lost well in excess of $1 billion, and its losses have grown even though sales have skyrocketed. Most seriously, it is saddled with enormous debts.
Amazon is struggling to attract more customers by offering an ever-wider range of products, including toys and even cars. But the attempt to be more than a book and record store, to offer everything to everyone, smacks of desperation.
"Now the company is broad but shallow," Fader says. Costs could soar even higher and the new offerings could create a management nightmare. And, most important, Amazon risks "diluting what the brand means," Fader says.
For Amazon, it's a reversal of fortune. The company went public in May 1997 at a share price, adjusted for subsequent splits, of $1.50. By any measure the stock was an enormous success in the first two years, peaking at $113 last Dec. 9. But it has been sinking ever since, hitting a low of just under $28 on July 31. Recently, it has traded around $39.
While falling share prices have afflicted many Internet companies this year, Amazon.com clearly has real problems. Despite attracting 23 million shoppers, it lost nearly $720 million in 1999, compared with losses of $125 million in 1998, $31 million in 1997 and $6 million in 1996. Losses soared despite the enormous gains in sales — $1.64 billion in 1999 versus $610 million the year before, for instance.
Investors were particularly concerned when the company reported late in July that sales growth had nearly come to a standstill. For the second quarter of 2000, sales were only 1% higher than in the first quarter.
Rather than focus on that number, the company emphasized the comparison with the same quarter a year earlier, showing an 84% jump in sales. Amazon CEO Jeffrey P. Bezos has bristled at suggestions that the company is in serious trouble, arguing it will pay off in the long run to stomach losses in order to broaden the customer base and expand product offerings. Trying to reach profitability too soon would force the company to spend less on expansion, stunting its long-term growth, he argues. In announcing the recent quarter's results, Bezos says new automated systems at the company's warehouses and marketing efforts to get past customers to buy more should help the company become profitable. But he has repeatedly declined to say when he expects the company to move into the black.
Still, the company clearly recognizes it has problems. Last month Amazon was forced to give new stock options to employees because the falling share price had made earlier options grants worthless. Like many online companies, Amazon's low pay is counterbalanced by what are intended to be generous options grants. If options look like they won't pay off, vital employees and executives may jump ship.
One high profile departure has already caught media attention. Amazon president and chief operating officer Joseph Galli quit in July to become president and chief executive of VerticalNet, a Horsham, Pa. business-to-business website. Galli walked away from Amazon options that, according to one estimate, could have been worth more than $1 billion if Amazon shares rose by even a relatively modest 10% a year. He said he wanted to run a company and be closer to his family.
Wall Street analysts have been losing their ardor for Amazon, with about a third of them recently shifting their ratings from "buy" to "hold," a kind of purgatory that's not much better than the outright damnation of a "sell" rating.
"Despite our personal fondness for the site, we are cautious on the shares near-term," Faye Landes, an analyst for Sanford C. Bernstein & Co., said in an early August note to investors. Landes was concerned that her firm's research had shown that few Amazon customers knew it sold products other than books and CDs. The cost of getting the message out on cookware, patio furniture and other newer offerings could drive Amazon shares down as low as $12, she said. Landes made that estimate before Amazon announced ambitious, promotion-dependent partnerships for selling toys and cars. It has also just announced that it will sell electronic books in partnership with Microsoft.
Landes is one among many Amazon watchers to have focused on the company's immense costs. Amazon claims to sell 18 million items, requiring a network of expensive warehouses and legions of employees to find and ship items that customers order. Like many Internet retailers, Amazon also spends enormously on marketing and promotion.
In contrast, one of the most successful online enterprises – and one of the few profitable ones – is eBay, the auction site. The key to eBay's profitability is its lean costs, says Gerald Lee Lohse, research director of the Wharton Forum on Electronic Commerce, who studies Internet companies. When eBay's sales double, costs rise only 4%, he says. That's because eBay doesn't take possession of the items sold on the site. It merely brings buyer and seller together.
Priceline.com, where customers bid for airline tickets, groceries and other products, also doesn't need to build its own inventory, leading some observers to suggest its approach may ultimately prove better than Amazon's. Priceline also has yet to turn a profit.
Clearly, staggering costs could swamp Amazon. Ravi Suria, a Lehman Brothers analyst, wrote in a July report that the company might already be out of business had it not been able to borrow $681 million through a convertible bond sale last February. Amazon's "negative cash flow, poor working capital management and high debt load" make the future questionable, he wrote.
Amazon's vast product offerings recalls a 19th-Century gold rush, with miners racing to stake claims at any cost before competitors could tie up promising territory. But there's a big difference: A gold prospector might really secure exclusive rights to a claim, but no one gets exclusive rights to Internet territory, where competitors can pop up overnight.
"What's going to stop me from starting a website and selling books?" asks Wharton accounting professor Peter H. Knutson. All it would take, he adds, is some deals with book publishers and a few accounts with credit card companies.
And although Amazon.com would appear to have a tremendous asset in its widely recognized name, there is every sign that Internet shoppers' loyalties are shallow, making brand names less important, Knutson points out. If another bookseller offers a lower price, easier ordering system or friendlier customer service, the customer may well desert – especially as trying another online store takes only a few keystrokes, not a drive across town. And now customers don't even need to know what other online stores are out there, as there are search engines, like www.dealtime.com, which will scour many sites at once for the best prices, Knutson says. "Customers have no loyalty at all," he adds.
Eric Bradlow, professor of marketing and statistics at Wharton, notes that selling products is not Amazon's only game. The company can also sell advertising space on its site. To make this pay, Amazon must be able to provide advertisers with large numbers of potential customers. At the same time the company must minimize its own cost of obtaining these so-called eyeballs. But the key to this is, again, creating customer loyalty – getting people to come back again and again on their own. So far, Bradlow says, it's not clear that any website can achieve such customer "stickiness" without continually spending enormous sums on marketing and promotion.
"If people were not price-sensitive, if people were loyal, if stickiness actually held on the Internet, that would be a good model," Bradlow notes. "The question is whether that is true….Customer acquisition is very costly, and many companies spend way too much on customer acquisition and not enough on customer retention."
Despite all the costs, obstacles and unknowns in the new frontier of Internet retailing, Amazon does have an edge on many competitors. "You have to look on Amazon as the bell-weather for all dotcoms," says Lohse. Research has shown that customers are impressed with Amazon's site, a key to building customer loyalty, he adds.
"People find Amazon easier to use than Barnes & Noble's site, for example." But the data also show that many people who click on Internet retail sites are just curious, he says.
On average, only 2% of the people who visit a site make purchases, according to Fader. Given that, Amazon's figure of 10% is impressive. But it's far from clear that even this is enough to make an e-retailer profitable. Certainly, the manager of any traditional bricks-and-mortar business would be in despair if only one in 10 visitors made a purchase.
Moreover, many visitors who do make online purchases quickly lose interest when the novelty wears off or they are disappointed for one reason or another, or if they conclude that prices aren't low enough to justify the wait for delivery. About 15% of first-time purchasers "drop out," meaning they make no additional Internet purchase for at least a year, Lohse says. Others make a few purchases — then drop out.
Another dark cloud: Lohse sees signs that the growth in Internet purchases over the past few years is leveling off. The industry may thus be approaching a saturation point at which the current base of customers is buying as much as it ever will.
Typically, the current Internet customer comes from a household with an annual income of $56,000, nearly double the national average of about $30,000. As computer ownership gets cheaper and machines are acquired by less affluent households, there may be a second wave of potential customers, he says. But that group doesn't have as much to spend.
Fortunately for Amazon, some research has shown that customers return to the site even though they can get books cheaper elsewhere, indicating Amazon is in fact building loyalty. The main reason, Lohse says, is Amazon's added features, such as reviews, shopping suggestions, and one-click purchasing. Amazon has done a good job keeping shopping pleasant and easy for customers, and that should encourage customers to try Amazon's new product offerings.
"For Amazon to grow, it has the right strategy," he points out. Still, he adds, it's not a given that many pure Internet retailers will be able to survive against competitors, such as Barnes & Noble, which use their online business merely to complement their bricks-and-mortar stores. These more traditional competitors can come to the table with a big stake — strong revenues, loyal customers and lots of know-how.
Internet retailing looks like it will be a war of attrition, with victory going to those with the best staying power. At best, Amazon's ability to endure is in doubt. A company can only gush red ink for so long.
How to Use Neuroscience to Build Team Chemistry
A Simple Intervention That Can Reduce Turnover
Why Hybrid Work Will Reign in 2023