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Until a week ago, Amazon.com had avoided much of the bloodbath that other dot-coms had suffered since March at the hands of wary investors. But Lehman Brothers' release of a scathing report questioning its credit risk, plus cautious comments by two prominent Wall Street analysts, sent its stock crashing to its lowest point in a year on June 23. Amazon founder and Chief Executive Jeffrey P. Bezos, however, remains adamant that Amazon's prospects remain bright (see BW 7/10/00 Cover Story, "Can Amazon Make It?"). He spoke with Business Week Senior Correspondent Robert D. Hof on June 28. Here are edited excerpts of their conversation:
Q: There's renewed concern that Amazon.com's business model, and by extension e-tailing in general, is flawed because it has to keep borrowing money and still can't make a profit. What do you say to them?
A: Can I give you a one-word answer? Baloney.
Q: A little more detail?
A: This is the same old argument that has been made forever -- that we're buying products for a dollar and selling them for 90 cents -- and it's just not true. Our U.S. books business is profitable. In U.S. books, music, and video, as a segment, we did $400 million in sales in the first quarter and had an operating loss of $2 million. These are very young businesses, and they're already at near-breakeven.
Q: Shouldn't they be profitable by now?
A: Why? What arbitary method are you using to decide how long it should take these businesses to be profitable? It would have been easy to make the business profitable at much lower revenue levels. But we wouldn't have had the opportunity to build an important and lasting company that we have today.
Q: Some people think you've been spending too far ahead of the curve.
A: It's absolutely true that we have a lot of operating leverage as a result of our fixed investment in these distribution centers that we are not fully utilizing.
Q: Is that a problem?
A: No. It's an advantage to have built out this space ahead of time so that we can focus this year on making efficiency improvements. We don't have to build distribution centers in the U.S. this year.
Q: How much is that going to save you?
A: Quite a bit. We invested approximately $300 million in our distribution center buildout.
Q: I believe Amazon is still planning higher capital expenditures this year. Where is that going now?
A: Some of it is outside the U.S. Some of it is on computer systems and other things. Over time, we are going to invest in more geographies.
"A lot of the learning has already been done. We just know a lot more now"
Q: The other big question for Amazon is how well you're executing on your business model. You had an inventory writedown on newer products such as toys and electronics that didn't sell over the holidays. Won't you have the same problems as you expand into other new lines?
A: In toys and electronics, we were paying a lot of tuition. With toys, for example, we had a lot of learning. And when you enter a new category, you don't have much ability to negotiate with the manufacturers. So to get certain manufacturers to say, "Yeah, we'll sell you products, but you're also going to have to buy some of this 1997 merchandise that we weren't able to sell." That's tuition. I wish we didn't have to pay tuition, but I don't know how you're going to avoid it.
Q: Aren't you going to encounter the same problems over and over?
A: No, hopefully we'll have different problems. Hard goods, like toys and electronics, kitchen appliances, and tools, are very different from things like books, music, and video. But toys and electronics are very similar to [other hard goods]. So a lot of the learning has already been done. We just know a lot more now.
Q: Ultimately, will Amazon be able to generate higher returns or higher profit margins than conventional retailers?
A: Returns on invested capital is the most important metric to shareholders. Return on capital is the thing that turns out to be most correlated with stock price.
Q: A lot of investors focus more on higher profits or profit margins.
A: Higher profit margins can lead to higher return on invested capital.
Q: Do you think Amazon will eventually have higher profit margins than [traditional] retailers?
A: I would expect over time that we would.
"What you're really trying to do is maximize dollar margins, not percentage margins"
Q: It sounds like you're not so sure. Shouldn't there be some certainty given the valuation Amazon commands?
A: Not necessarily, if you're talking about percentage margins. This is a common oversimplification that people make. What you're really trying to do is maximize dollar margins, not percentage margins. Let's say I offered you two companies. In hypothetical company A, you have 5% net margins, and in hypothetical company B, you have 10% net margins. But in company A, you have 10 times the sales of company B. If I were going to give you either of those companies, which one would you want? This is not a hard I.Q. test.
Q: Are you considering raising prices, cutting costs, or even getting out of some businesses to get profitable more quickly?
A: No, I know a lot of dot-com companies are raising prices. We're actually lowering prices.
Q: That's got to scare some people, given that you haven't shown the profits yet.
A: I don't know, but I know that our prices are completely sustainable and always have been. We've never done what many dot-com companies did in 1999, which was to have unsustainable promotional pricing. That makes no sense and is a very bad business strategy because you attract the wrong set of customers. For example, just a couple weeks ago, we went through our top 1,000 items in our electronics store, and we reduced prices on those items.
"The reason we're not profitable is not because we sell dollar bills for 90 cents"
Q: Why?
A: We could. And we wanted to make sure we were absolutely competitive. The reason is we have the scale advantage. We are a buying cooperative for 20 million customers. With that scale, we can offer the lowest prices and have it be sustainable.
Q: A lot of people would look at your losses and conclude your pricing is not sustainable.
A: We sell dollar bills for a $1.20, which is completely sustainable. The reason we're not profitable is not because we sell dollar bills for 90 cents. It's because we're investing in lots of new areas.
Q: Do you think investors will continue to allow Amazon to keep expanding enough to become the place where people can shop for anything?
A: Clearly, I do. Some of our businesses are getting so big now that over time they are going to be able to fund this continued investment. Just because you continue to grow and expand and do new things doesn't mean that you can't do it out of cash flow. Our strategy remains the same. We are focusing over the last 15 months more on driving toward profitability and having a balanced approach -- profitability and growth.
That had to do with the fact that our annualized run-rate approached a billion dollars a year. And when you're doing a billion dollars a year in sales, a one-percentage-point improvement in operating efficiency is $10 million to the bottom line. When you're a $1 million or $10 million a year in sales, if you're focused on one-percentage- point operating efficiencies, you're crazy.
Q: What seems different now is that investors are saying they want to see profits in the whole business.
A: What they're saying makes perfect sense. At annualized revenues of more than $2 billion a year, this company needs to be spending a lot of time and energy and attention on operating efficiency. Good news: We are!
Q: If you keep expanding, won't those costs of expanding continually outgrow the profits of existing businesses?
A: No, because the ratio of mature businesses to new startup businesses keeps changing. When we started our books business, the ratio of new businesses to mature businesses was infinity -- one new business and zero mature businesses. Then we opened music and video -- we had three new businesses and no mature businesses. Now finally, we're getting to the point where our books business, 4 1/2 years old, is mature. Finally, we have a denominator. That is a big change.
"We take the top 10 customer service requests and we continuously eliminate them"
Q: So investments in these new businesses going forward should be relatively less?
A: That's right. By the way, 4 1/2 years is not very much time to build a business. So even our book business is just on the edge of maturity.
Q: Where are you trying to improve efficiencies? Any examples yet?
A: One is customer service. We take the top 10 customer service requests and we continuously eliminate them, starting at the top. The No. 1 reason was "I typed in my Zip code wrong." So we built a tool where people can change their shipping address by themselves, so they don't have to call customer service. You go about systematically eliminating these top reasons for calling customer service. I'm pleased to report that at this point, our No. 4 reason why customers call customer service is to say "Thank you." That's an example of the way you go about improving operating efficiency, by removing the root causes for why customers call or e-mail.
Q: You're also promising big improvements in efficiency in the distribution centers.
A: If you go back about four years, our fulfillment cost as a percentage of sales was about 10%. In the fourth quarter and the first quarter, it was about 16%. So we're moving backwards. So how did fulfillment costs increase at a time when they were actually more primitive? The answer, of course, is this distribution center build-out. Ultimately, they will be more efficient. We expect our fulfillment expense as a percentage of sales to be in the low teens by the four quarter of this year.
Q: What's going to get it there?
A: It's greater utilization. These are highly mechanized facilities. It takes time to get all the stuff to work right. It's always worked right for the customer experience, and now we're getting it to work right for the union of customer experience and operating efficiency. So it's learning how to better operate our automatic sortation equipment, all these things.
Q: Do these new concerns about Amazon surprise you?
A: No, they do not surprise me. And I don't think that it's new. It's easy to forget, but we are the company that's been called "Amazon.con," "Amazon.toast," "Amazon.bomb," "Amazon.org -- a not-for-profit company." We've seen this movie before.
Q: But on Friday, Amazon lost more than $3 billion worth of market value.
A: How about a little bit of historical perspective? Over three years, how much is our stock up? It's up by a factor of 20. We have always taken great pains to urge investors who have a short-term investment horizon not to invest in our stock. It's not appropriate for short-term investors, period, because of the volatility.
EDITED BY BETH BELTON
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