Amazon's dilemma: Monstrous sales, roaring stock, but no profit

It just bought an online education company and introduced a payment mechanism for Internet retailers that competes with PayPal. It started selling wine for the first time in New York, updated its line of tablets, gave the go-ahead to three new comedy pilots and began a design competition for its fashion division. It is setting up mini-warehouses inside suppliers like Procter & Gamble to ship goods faster.

But one thing it will not be announcing this month: a significant profit.

Who cares? Amazon lost money in 2012, and analysts are anticipating another loss when the company releases its third-quarter results Thursday. Yet the stock is at a record high.

Amazon shares are up around 150 percent since mid-2010, which perhaps not coincidentally was the last time the company had sizable profits. In other words, investors only really decided they loved the company when net income began to slide.

"This isn't supposed to happen," said William H. Janeway, an economist and venture capitalist. "It violates mainstream finance theory. Very few companies have been valued this way outside a systemic bubble."

No one is asserting that Amazon is a flat-out bubble, but there is an increasingly noisy debate about when it will - or even whether it can - deliver the sort of bottom-line profits investors normally demand from a company expected to post $75 billion in revenue this year.

The company declined to comment.

Some analysts point out that those sales are negligible when set against the market being targeted by Jeff Bezos, Amazon's founder and chief executive. "The market is effectively limitless: all of global consumer commerce and maybe business-to-business commerce as well," said Janeway, author of "Doing Capitalism in the Innovation Economy."

With that prize as the goal, making money today would be a positive hindrance. As Benedict Evans, an analyst based in London, put it: "Bezos has chosen to run Amazon to be the biggest, most powerful and successful retailer on Earth 20 years from now. Any fool could run it profitably today."

Others argue that once a discounter, always a discounter. Amazon is branching out into many forms of commerce and technology, but at its core it sells commodity goods cheaply. A book from Amazon is the same book that it would be from any other retailer, and so is a package of diapers. Amazon also ships cheaply and has renowned customer service.

To make a significant profit, though, some or all of those variables will have to change, which might alienate customers and slow down that roaring revenue growth. That, in turn, would cause investors to demand profits even sooner.

Best not to venture down that road, said Colin Gillis, senior tech analyst at BGC Partners. "It is easier," he said, "to sell things and not make money than it is to sell things and make money."

In this view, Amazon's whirlwind of activity - a set-top box, thrusting it into more direct competition with Netflix, is expected to be announced any day, while the rumors of an Amazon smartphone will not cease - is merely a useful distraction from its retailing reality.

The premise that Amazon can change its business model from selling other people's products at a razor-thin margin to selling other people's products at a large margin "is not credible," wrote Horace Dediu, an analyst with Asymco.

Companies simply do not shift their business model so simply, he added, noting that Microsoft, for all its money and smarts, still could not reorient its PC-based strategy to take advantage of the trend to mobile computing.

The discussion about Amazon is reminiscent of the arguments about the company during the last systemic bubble, in 1999. Then, too, the corporate goal was to get big fast, to seize new markets before anyone else.

But when the crash came, all the talk of unlimited potential disappeared. It was replaced by a fierce concentration on profits, which were described as being right around the corner.

Bezos said in 2001 that the retailer would "ferociously manage the products we carry so that we sell only products that are profitable. The 30-pound box of nails isn't long for our world." Investors were mollified and the company survived.

That was then. You can once again buy a box of 4,000 nails on Amazon (shipping weight: 38 pounds) and have them delivered to your door free. But the retailer has gone far beyond such modest offers. The Thunderbird Cookie Dropping Machine costs $32,329 and weighs 1,260 pounds, but Amazon will also ship it free. (It is out of stock.)

Commercial Food Services Equipment, a third-party vendor in Chicago, lists a Thunderbird for sale on Amazon, but charges almost $2,600 for shipping.

"Amazon will sell many more cookie dropping machines than I will, but even if you buy from me instead of Amazon it will earn a commission on the sale and the shipping," said Hyo Lee, the owner of Commercial Food. "Now you know why Amazon's sales have gone from $34 billion in 2010 to $61 billion in 2012."

Still, she noted that Amazon was building dozens of warehouses across the country and hiring tens of thousands of employees for them. "It has all these fixed costs now," she said. "I think they'll have to start charging more for shipping."

Others agree that nothing grows to the sky forever.

"At some point, the piper must be paid," said George Colony, the chief executive of Forrester Research.

How? "By raising prices. I don't see any other way."

At the edges, Amazon has started doing that, reining in a bit of its largess to the annoyance of some of its customers. For example, customers who paid $79 a year to join its Prime two-day shipping service used to be able to get really urgent things delivered the next day for an additional $3.99 an item.

An Amazon customer named Perry Denton took full advantage of this when he bought a lawn mower. "My Prime overnight [fee] was $3.99," Denton wrote in an Amazon forum. "I kind of felt guilty, but I really needed a mower."

Last summer, devoted Prime users discovered that the company had started charging variable amounts according to size and weight, with a minimum of $2.99. A self-propelled Lawn Boy, for instance, is now $25 overnight.

That is still a good deal, perhaps, but not as good as $3.99. The forum was full of complaints about how Prime customers were, as one of them put it, "receiving less service for the same money." They also wondered why there was no announcement that the company was changing its shipping policies. An Amazon spokesman confirmed the change, but said the company keeps adding entertainment extras to Prime without raising the membership fee, including 41,000 movies and TV shows. Those three pilots it approved early this month, for instance, will be shown free to Prime customers. Amazon is reportedly losing up to $1 billion a year on its streaming video service.

Josh McFarland, chief executive of TellApart, a startup that helps retailers manage their data, bought a $20 pair of flip-flops from Amazon. Then he found a pair he liked even more elsewhere, and prepared to return the Amazon set. The company told him not to bother. It would give him a refund anyway.

Few retailers feel they can afford to be so generous, but other Amazon shoppers have recently reported the same experience. It is a game for the long term; will customers remember next year what you did for them today?

"What Amazon is trying to do is raise my expectations so that I'll eventually buy everything from it," McFarland said. "At some point it won't have any more competition, and I won't know if prices are being raised because I'll have nothing to compare it to."

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