How Amazon’s Strategy Allowed Them to Beat the Odds

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How Amazon beat the odds

The global stock market has had a very good year in 2017, but few individual companies can claim to have had a year quite as spectacular as Amazon. As of mid-December, the company’s shares had increased in value by more than 50 percent year-to-date. The company posted quarter after quarter of solid financial growth, even in the midst of headline-grabbing deals like its surprise all-cash purchase of Whole Foods, and its proposal to build a second headquarters.

With a market cap of around $500 billion, Amazon is currently the fourth most valuable business in the world, and one of only four companies valued at more than half a trillion dollars (the others being Apple, Google and Microsoft). But once again, the internet retail giant stands in a category of its own even in this incredible metric: Amazon went public in 1997 at a modest valuation of less than $500 million, while most of the world’s other largest corporations have been around for decades. In just the last 15 years, Amazon’s stock price has increased roughly 5,000 percent, while the rest of the market rose at a fraction of that rate.

The superlatives keep piling up for Amazon, making it a favorite among analysts, academics and financial enthusiasts. Amazon and its founder, Jeff Bezos, are among the greatest success stories of the last two decades. That begs two questions: How did they do it, and can it last?

Most of us are familiar with Amazon’s origin story as something of a pet project for Bezos, who initially ran the company’s servers out of his garage and packed individual orders by hand. Somewhat ironically, Bezos found it difficult to court investors and keep them interested — in Amazon’s early years, he estimated it would take four or five years before the company could turn a profit.

Once the so-called dot-com bubble burst around 2000, things looked especially bad for Amazon and other early internet firms like it. According to Bezos biographer Brad Stone, the company was alarmingly close to joining the ranks of countless others that failed around this time, but Amazon persevered through an act of financial wizardry: then-CFO Warren Jenson sold convertible bonds worth $672 million to overseas investors at a generous interest rate of 6.9 percent. It was an incredible risky move, but it may have saved the young company from bankruptcy, and allowed it to survive the dot-com crash.

Keys to Amazon wins

This would not be the last time Amazon defied the odds and relied on outside-the-box thinking to soar ahead of their competition. It was also one of many smart moves the company made in the early 2000s that would sow the seeds for its eventual dominance:

  • Early on, Amazon realized it could grow from a consumer sales model into a more profitable business services model. It introduced its “Marketplace” feature in 2000, allowing other businesses to sell their own products through Amazon for a fee. This paved the way for business segments like Amazon Web Services that have become extremely profitable for the company.
  • At the same time, Amazon wanted to convince the average consumer that they could buy anything online just as easily, and affordably, as in a store. It was among the first online retailers to prioritize fast, free shipping on a huge variety of products. It also was an early adopter of features we now take for granted in e-commerce like one-click purchases or subscription models that offer greater convenience for customers and more sustainable revenue for the business.
  • From its inception, Amazon has promoted a lean management structure. It continues to adhere to a rule of organizing employees into what Bezos coined “two-pizza teams,” or departments that were small enough to be fed with two large pizzas. The idea was to enable flexibility and innovation to a degree that other large, bloated companies couldn’t sustain.

Many of these foundational decisions added up to Amazon’s defining trend among financial experts: a preference for long-term growth instead of short-term profit-chasing. Even as the company’s stock price continued to climb through the 2000s, Amazon was and continues to be known for spending big on what some investors considered bad bets, like branching into web hosting or designing its own consumer electronics. These decisions caused Amazon to return only meager earnings to shareholders for several years running. However, those who stuck around long enough were rewarded eventually, if only slightly. Amazon has now posted a profit every quarter in a row for two years running, most recently around 52 cents per share.

Future growth concerns

Amazon ranks among the most entrenched companies in so many industries, from consumer retail to business services. It’s a universally-recognized brand with a huge influence on much of the world’s economy. And it has attained this status in less than 25 years, showing no signs of slowing. So what could go wrong? While optimism abounds on Amazon’s future, investors have reason to be skeptical regarding future financial performance:

  • Competition: Despite its diverse business operations, Amazon is still primarily a retailer, and retail is an extremely competitive industry with razor-thin margins. Retailers can endear themselves to consumers in several ways, but the most effective yet difficult strategy is through low prices. Amazon will need to continue locking in shoppers with subscription services and convenience if they want to rely less on price competition and therefore continue making money in retail.
  • Slowing growth: Amazon’s stock price has gone up like a rocket in a few short years, leaving analysts guessing when the inevitable stall will occur. The paradox of rapid growth is that it is often followed by rapid contraction, as inflated investor confidence falls back to reality. This is particularly true regarding revenue, since it is much more difficult to increase sales if you are already selling at your peak.
  • Speculation and market risk: Perhaps the biggest consequence of the incredible hype and enthusiasm Amazon has generated is the possibility that its shares are overvalued. No one can really know the true value of any company, but there is a case to be made that many analysts are overly optimistic on Amazon’s future growth. In addition, Amazon is considered a “high beta” investment because its share prices are more volatile than the market average. This means Amazon shareholders are more likely than others to realize disproportionate losses in the event of a broad market downturn.

Growth challenges notwithstanding, Amazon will continue to be one of the most interesting companies to watch in 2018 and beyond.

Enroll in the online Master of Science in Finance degree program at the D’Amore-McKim School of Business from Northeastern University to learn more about Amazon’s growth model, among many more topics.

 

Recommended Readings:

The Key to Business Valuation Infographic

The Pros and Cons of Index Funds

Sources:

Northeastern University’s Online MSF Program