Amazon.com's Split Personality


By Nicholas G. Carr Amazon.com (AMZN) founder and chief executive Jeff Bezos doesn't like to play by the rules. That's why he now runs the world's largest Internet store. Back in 1994, when retailing's big guns were oblivious to the Web, Bezos was staking his claim to the vast new territory. He saw what the rest of the pack missed.

Now that Bezos heads a $7 billion public company, he's finding that making up your own rules doesn't work quite so well, particularly when it comes to financial reporting. Plagued by losses or weak profits ever since it opened its virtual doors, Amazon wants to exempt itself from the traditional measures investors use to evaluate stocks. It wants shareholders to ignore its earnings numbers and judge its performance by its free cash flow instead.

STRANGE IDEA. Bezos feels so strongly about the issue that he devoted his last shareholders' letter to a pedantic defense of the cash-flow standard. It read like something out of an introductory accounting textbook, complete with a hypothetical case study. "Why not focus first and foremost, as many do, on earnings, earnings per share, or earnings growth?" he wrote. "The simple answer is that earnings don't directly translate into cash flows, and shares are worth only the present value of their future cash flows, not the present value of their future earnings."

Bezos makes a valid point. The only problem: He's a CEO, not a tweed-wrapped academic. Wall Street found the letter at best quixotic and at worst bizarre. As Frank Husic, managing partner at Husic Capital Management, drily put it to thestreet.com, "It's a terrific argument, but people pay for earnings growth in the stock market."

The real problem with Amazon is not a matter of measures but the fact that Bezos' operation now houses two very different businesses. On one side stands the familiar on-line retailer, pitching a plethora of goods such as books, toasters, and plasma TVs. The other consists of an information-technology company that provides merchants with a software platform for Internet sales. Amazon, in other words, is playing both ends of the supply chain -- it's a retailer, and it's a supplier of software to other retailers.

FAMILY CONFLICT. The two Amazons have little in common. Their economics, for instance, differ fundamentally. The retailing business relies on micro-thin profit margins. Despite Amazon's strong brand, it remains pinned under relentless pricing pressure. To draw customers, it's even been forced to offer cheap or free shipping on most purchases, further squeezing its margins.

Renting out a software platform, by contrast, means big profits -- just take a look at eBay's mile-wide margins. For investors, it's becoming difficult to figure out exactly what kind of company Amazon is.

Even worse, the two business models suffer from inherent conflicts. As a retailer, Amazon competes directly with the customers of its software business. The many merchants that piggyback on Amazon's site, including giants like Target (TGT) and Office Depot (ODP), have to worry about directing their customers to the storefront of a price-slashing competitor intent on expanding into ever more product categories. That may well account at least in part for why Circuit City (CC) dumped Amazon as a partner earlier this year.

DISTINCT GOALS. The conflict is even beginning to muck up the Amazon.com site itself. It's becoming harder for customers to figure exactly who's selling what -- and under what terms for shipping and returns. Such confusion threatens to erode the customer loyalty that Amazon's retail operation has so painstakingly built.

Maybe it's time for Bezos to once again do something really dramatic: Split Amazon into two companies by spinning off the software business. Such a division may be the only way to give the company's investors a clear view of its economics -- and to offer its managers a clear playing field on which to pursue their two very different strategies. Carr is the author of Does IT Matter? and the publisher of the blog Rough Type


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