The Internet retailer is employing the same hardball tactics that rival Wal-Mart relies on to negotiate prices on pickles. But will that fly online?
Amazon’s fight with the publisher Hachette, which has the online store making it harder for its customers to get their hands on some book titles, has prompted some people to boycott the store. Others express wonderment that the famously customer-friendly company would do anything to slow its 1-click-happy buyers. So what is CEO Jeff Bezos thinking?
We can’t read his mind. But we can look at the economic incentives the company faces.
1. Amazon’s share price is way down this year.
2. Despite that, the stock is still very expensive relative to the company’s earnings.
Investors have generally been willing to to pay a huge premium for for Amazon shares. The typical stock on the S&P 500 trades for about 18 times its past twelve months of earnings, or profits, per share. That measure is called the price/earnings, or PE ratio. Amazon’s PE? 490. Investors have loved this company so much that they’ve even been willing to tolerate periods of negatives earnings. (During that time, Amazon literally had no PE. Or an infinite one.) But the price drop suggests Wall Street’s patience with no earnings is wearing at least a little bit thin.
3. It’s all about the sales growth.
A high PE means that investors think a company’s current earnings are just a glimmer of its future potential. The case for Amazon has long been that low earnings just reflect the fact that Amazon is still plowing money into growing its business. It’s bought a company that makes warehouse robots. It has pushed its Kindle readers out the door at cost—and many analysts suspect at below cost—in hopes of building a future market for content. So how do investors put a price on the future Amazon hopes to build? One way is to look at revenues, the money the company brings in from sales before any costs are deducted. If that’s growing briskly, then Amazon is making progress on its promise to some day pay off investors with real profits. But revenue growth of late has been disappointing for Wall Street.
And now about those pickles
Look, 22% revenue growth is nothing to sneeze at. It’s about 10 times the typical blue chip stock. But investors who want to make a high risk bet on companies with huge growth potential have other options. Recent IPO JD.com JD.COM INC JD -2.19% , often called the Amazon of China, boasts revenue growth above 60%. That company is picking low hanging fruit, selling to brand new markets. This used to be Amazon’s position, too—it’s not too much to say that it invented its market. But Amazon is now a part of the everyday way Americans shop, and that makes explosive growth from here harder.
You can see that when Amazon talks about fanciful-sounding ideas for new growth like flying delivery drones. Amazon’s other avenue for growing sales is to take a page from Wal-Mart and bring the battle to its suppliers. As Matthew Yglesias at Vox.com notes, Wal-Mart long ago set the model of forcing painful concessions from suppliers to keep prices tantalizingly low. Yglesias cites Charles Fishman, author of the book The Wal-Mart Effect and this terrific 2003 piece in Fast Company, who memorably captured how Wal-Mart plays hardball with suppliers. Check out this story about how the stores ended up carrying gallon jars of Vlasic pickles for less than $3:
[Former Vlasic executive Steve] Young remembers begging Wal-Mart for relief. “They said, ‘No way,’ ” says Young. “We said we’ll increase the price”–even $3.49 would have helped tremendously–“and they said, ‘If you do that, all the other products of yours we buy, we’ll stop buying.’ It was a clear threat.” Hunn recalls things a little differently, if just as ominously: “They said, ‘We want the $2.97 gallon of pickles. If you don’t do it, we’ll see if someone else might.’
Amazon is giving book publishers the pickle treatment. No one ever boycotted Wal-Mart for dropping their favorite brand of gherkins or kosher dills. But Amazon is different. It’s taking on a business that sells ideas and delivers differentiated products. If you want Malcolm Gladwell’s Outliers, published by Hachette, you don’t leave Amazon satisfied by ordering the latest Bill Bryson book instead. The economic pressures driving Amazon are the same as those driving the Bentonville behemoth, but because Amazon is also partly a media business, its battles with suppliers are going to more public. And perhaps—perhaps—harder to win.