Amazon.com: An Inventor, a Facilitator of Invention, and a Transformational Technology Company

Amazon.com  (Amazon) is a key holding in Insight’s model portfolio, and in various of its client portfolios. How strong is Amazon’s competitive position? Is Facebook a competitive threat to Amazon?  I read an article recently which discussed e commerce companies operating on Facebook who are selling fashion products, sports gear, etc. and the big financial backers of various of these companies.  The article also pointed out that Facebook has about 6-7X more users than Amazon. Facebook offers the ability to see what friends are buying so that is a point in Facebook’s favor; yet Amazon does offer user reviews which at least to some extent blunts that Facebook edge.  As I think about this I consider the power of the Amazon brand.  For example, would I feel comfortable giving credit card information to a Facebook retailer?  Perhaps.  If that retailer can piggyback on the Facebook brand, it’s possible.  So I don’t think the Amazon brand is invulnerable from competition in the long term.  

What I think is a more powerful competitive advantage for Amazon is its fulfillment and shipping operation, leading to immense overall pricing power.  Amazon is spending vast amounts of money in this area and recently bought a robotics company to bolster their warehouse and inventory operation.  While niche retailers on Facebook such as a fashion company with a hot product could compete,  I don’t see how as a whole e-commerce competitors on Facebook could stand up to Amazon’s price advantage given its huge power over suppliers (resulting in negative working capital and additional free cash flow), and scale advantages.  I look at Costco in this regard.   Its low cost advantage over competitors has stood the test of time.  So in the end while I think the power of the Amazon name by itself and its first mover advantage by itself is not a sufficient competitive barrier, it’s scale and fulfillment operations combine to give it a pricing power durable competitive advantage.  Again my view is niche retailers on Facebook could be competitive, but Facebook is way behind in terms of an infrastructure which could compete with Amazon on price and fulfillment, and it would be extremely difficult for Facebook to build such an infrastructure from scratch.  Note also that if Facebook did try to build a fulfillment infrastructure it could be viewed as putting itself in competition with businesses that advertise on Facebook, and advertising revenue is a key part of Facebook’s business model.

Insight is  fortunate to have a network of exceptionally talented professionals whose work spans corporate finance, bond investing, real estate analysis, investment banking, private equity, hedge funds, and equity research.  I often discuss investment analysis with these professionals, and their comments are invaluable.  One of these professionals pointed out that Amazon could  form a joint venture with Facebook in which it provides a cost saving private label outsourced fulfillment infrastructure for Facebook and its retailers which would also provide additional business for Amazon.   In fact as discussed in Jeff Bezos’, Amazon’s CEO, 2011 letter to shareholders Amazon through the development of its cloud infrastructure is providing operational help to other businesses.  Amazon , as is pointed out in this letter, is a facilitator of invention by others, through cloud infrastructure but also through its own warehouse infrastructure to its family of retailers, and as well to writers through which through the e-reader kindle device Amazon invented enables writers to in essence be their own publishers.  Amazon because of its powerful competitive position is able to both cooperate with and compete with other businesses.

 

Amazon is also busy extending its own powerful brand. I passed a bus stop the other day in Manhattan and saw a picture of a woman in beautiful pants with the title “Amazon Fashion”.  So now it looks like Amazon is setting up its own fashion brand, extending the power of its brand.  They are doing the right things to building long-term value, ignoring Wall Street’s obsession with the short term.  Amazon is also competing with Groupon, by e-mailing its vast database of customers with discounted offers of interest, such as discounted restaurant offers and even discounted dental services. 

In line with what  Bezos has pointed out, Amazon is  fundamentally a technology company, and it has used technology to transform retailing.  The analogy of an octopus extending its diverse tentacles through countless nooks and crannies fits the Amazon business model well.  Amazon started as an internet bookseller, a platform it has used to disintermediate the inferior bricks and mortar business models of sundry booksellers.    Amazon in the present uses technology to expand its own powerful online retailing business as it moves into a vast array of retailing categories.

But Amazon goes further still and is both an inventor itself and a facilitator of invention.  Amazon  has the rare ability to fundamentally transform businesses and even industries.  From a valuation point of view, how is the present value of such a company impacted by this rare ability?  It is significantly augmented, I would argue.  The company is using the e-reader kindle it invented, an invention I think which is as great as the invention of the printing press, to transform the publishing business, and support and profit from the self-publishing movement.   Now Amazon is going beyond this as it becomes the operational backbone of a wide array of internet businesses, thus reinforcing and broadening its dominant competitive position further still.   Amazon has shown the ability to transform both itself and the business world, as it  has used technology, invention, and the facilitation in others of invention to reinforce its powerful strategic position.

One brief note.  Insight wishes to thank its clients for the confidence shown by referring friends and acquaintances to Insight.  Insight prefers to build its business by referral and word of mouth, and views referrals as the best form of flattery.  Insight is currently accepting new clients.

 

Philip I. Frank, Ph.D.
President and Portfolio Manager
Insight Asset Management LLC
e-mail:  insight-asset@earthlink.net

Note:  Insight Asset Management LLC is currently long Amazon.com (AMZN) in its model portfolio, and in various client portfolios