To buoy third-quarter sales, Amazon discounted product prices significantly and continued to offer free shipping for orders exceeding $25, a program begun in August 2002. But free shipping comes at a high price for Amazon: In the third quarter, the company paid out $27 million on delivery, more than 2 percent of sales, compared to $10 million in delivery fee charges it took in from customers, about 1 percent of sales, in the same period a year earlier, when it offered free shipping for orders of $49 or more for two months of the quarter. The more generous free shipping program could become a millstone if revenue growth slows, as now appears to be the case. Worldwide sales of books, videos and CDs rose only 28 percent in the third quarter, compared to 34 percent in the quarter a year earlier. And while sales outside the U.S., which accounts for about one-third of Amazons revenues, grew 61 percent, thats a far cry from the 91 percent increase the year beforean indication that big gains from Amazons expansion into the U.K., Germany, Japan and France may have crested. In recognition of this, Amazon has cut sales growth estimates for 2004 to just 16 percent.
"Were cautiously optimistic about the future," said Tom Szkutak, Amazons senior vice president and chief financial officer.
This mixed performance and conservative tone surprised some of Amazons most bullish analysts, who had helped the e-tailers stock run up 200 percent during the first nine months of 2003, to a market valuation of more than $20 billion, or ten times that of Barnes & Noble Inc., Amazons much more successful bricks-and-mortar rival. A day after the third-quarter earnings announcement, The Goldman Sachs Group Inc.s Anthony Notowho maintained his buy rating on Amazon throughout a 70 percent fall in the companys stock in 2000advised his clients to sell and take profits. Noto warned that from 2005 on, Amazon could expect annual earnings growth of 20 percent, a slimmed-down estimate that suggests a much lower stock price.
Sounds like a replay of words heard around the time the dot-com bubble popped. Currently, Amazon has no meaningful price-to-earnings ratio; but its current price, about $56 a share as we went to press, gives it a multiple of price-to-forward 12-months estimated earnings of 65. WalMarts is only 25. "Amazon is No. 1 in brand recognition and No. 1 in customer service," says Safa Rashtchy, senior research analyst at U.S. Bancorp Piper Jaffray Inc. "People like them. If a company is doing well, people ignore valuation."
But, as history has taught us, that only lasts so long. And thats why Amazon is remaking itself. The key to the makeover is this past Junes launch of Amazon Services Inc., a subsidiary whose ambitious goal is to sign up other retailers willing to outsource their Web operations to Amazon and sell their products at Amazon.com. (Although Amazon will also manage Web sites for companies not doing business on Amazon, that is a much less potentially profitable aspect of its new strategy.) For a fee estimated by analysts of 10 percent or more of retail revenue, Amazon Services will set up the e-tail site and handle fulfillment and customer service. Initial Amazon Services clients include Toys "R" Us Inc. and Target Corp., both of which were selling products online exclusively at Amazon even before the debut of Amazon Services. Other Amazon Services e-tailing partnersthe Gap, Office Depot Inc., Nordstrom Inc., Circuit City Stores Inc., Eddie Bauer Inc. and Lands End Inc. among themsell products at Amazon.com as well as at their own Web sites.
"Being a retailer would not have put [Amazon] over the top, so it is evolving into a tech company," says Lauren Freedman, president of the e-tailing group inc., a Chicago-based research and strategy firm.
Theres already been some payoff. In the third quarter, sales from third-party companies grew to 22 percent of Amazons worldwide units, compared with 17 percent the year before. Forresters Johnson estimates that by 2008, Amazons revenue from services could reach 50 percent of sales, but only if Amazon undertakes improvements to its Web site that make it more desirable to e-tailing partners. If this forecast pans out, third-party revenue could more than make up for the slowdown in sales in Amazons traditional businesses. Whats more, the commissions on Amazon third-party sales are mostly profit, because expenses for Amazons fulfillment and customer service systems are already included as costs in Amazons overall retail operations. As a result, Amazon Services could provide a steady and lucrative earnings stream when no other aspect of Amazons operations has yet shown to be so potentially rewarding and consistent.
"Were driving a lot of demand for third-party sellers," says Bezos. "We need to continue expanding into new product categories and increasing the depth of selection of those that we are already in."
Amazon Faces Intense Competition For Growth. To view chart click hereNext Page: Will Amazon.coms new strategy work? Some say product overload.