It was a merry Christmas for electronic commerce, with online purchases from consumers in the fourth quarter tripling to more than $US3.5 billion from a year ago.
And Amazon.com suddenly has become the proxy for the success in selling to consumers, with its stock price quadrupling in the past three months. But it will almost have to monopolize its chosen fields of commerce in order to justify those expectations.
With its shares zooming from $US30 to more than $US130 since the start of October 1998, Amazon.com, which has yet to make its first dollar of profit, is worth more than Sears Roebuck, the century-old retailer that still generates $US1.2 billion of net income per year.
With a market capitalization of $US19.7 billion, Amazon.com has long since surpassed the combined value of its two biggest competitors in the physical world, Barnes & Noble and Borders Group, even though Barnes & Noble made $US53 million in its most recent fiscal year, while Amazon.com is expected to lose $US80 million this year.
The problem now: Amazon.com will almost have to completely dominate the online fields it enters, if it is to justify the expectations placed on it.
"If they encounter a hiccup, the stock is going to be crushed," said Paul Cook, manager of Munder Capital Management's Net Net Fund.
The problem: ever receding expectations for profitability, in a form of retailing that is still just getting started. For instance, when Amazon.com went public, part of Wall Street hoped it would break even once revenue reached $US400 million. Now, Amazon.com is selling about $US600 million per year worth of books, music and videos - and profitability is still not at hand.
Amazon.com executives, including Chief Executive Jeff Bezos, said chasing the expanding market for selling to consumers over the Net precludes profitability at this point. To gain ground, Amazon.com is spending $US121.8 million just to market and sell its services. Take that out, and its loss this year would turn to a profit.
But standing still is a prescription for falling back and eventually failing. "It will be important to continue to invest aggressively . . . and build awareness quickly," Bezos said in a conference call with analysts.
The alternative is to push the foot to the floor and become the pre-eminent electronic merchant in more and more types of goods. But even that is risky.
Take the size of the electronic commerce market, when it comes to consumers. Jupiter Communications is forecasting that in 1999, total online sales by consumers will reach $US8 billion. By comparison, Sears and Wal-Mart have a $US2.3 trillion market of in-store shopping to chase after.
The field for books and music is even more limited. Jupiter figures books and music sold online will total $US1.4 billion in 1999, rising to $US3.4 billion in 2001.
If, as one high-profile analyst said, Amazon.com can break even at $US2.1 billion in revenue, it would have to account for 62 cents out of every dollar of online sales in those products to do it.
Making money is even trickier. Jonathan Cohen, a Merrill Lynch analyst and notable Amazon.com bear, said he thinks the company will need to ring up $US3 billion or $US4 billion annually before it achieves operating margins of even 5 cents on the dollar. At that rate, Amazon.com might have a fighting chance to achieve limited profitability by 2002 - if it were to capture 75 percent of its current target markets.
Branching out
That is why many analysts and customers expect Amazon.com by necessity will have to move beyond books, music and videos. It will have to become what the name Amazon itself implies: a company that, like the river, will be big and deep and drain a continent. In effect, Amazon.com should be expected to move into other product categories to become the Wal-Mart of the Web.
But that will not be easy. While Amazon.com was able to build its early business on a wide open playing field, formidable competition now is lining up in almost every form of electronic selling. And Amazon.com will hardly be the only online Wal-Mart out there. Shopping agents are getting swallowed by portals looking to become e-commerce centers. New e-commerce companies such as eBay are selling goods on an agency basis rather than taking ownership of inventory. And a number of traditional retailers, such as Recreational Equipment, have managed to combine their brick-and-mortar stores with profitable Web sites.
Look at Dayton Hudson, which owns the discount chain Target. Dayton Hudson recently purchased Rivertown Trading, a small catalog retailer.
"They wanted the fulfillment capabilities [of a catalog retailer] in case they decided to put a push on for Internet shopping," said John Ronning, retail analyst at Brown Brothers Harriman. Target, Ronning said, is "in a position financially that they can afford to do something like this, and they are forward-thinking."
There are other hurdles as well: Books and music are low-margin businesses, and moving into other product categories may be more easily said than done.
Take toys, often mentioned as an opportunity for Amazon.com. "It'd be difficult for Amazon to move into toys," said Mark Peabody, a senior analyst at the Aberdeen Group. "A lot of distributor relationships would have to be made unless they went and made a relationship with a major toy retailer."
Nonetheless, Amazon.com has done everything it can so far to justify the faith that Wall Street and investors have shown. It's the first mover in a sector where being first has come to define leadership.
"They've scared the daylights out of Barnes & Noble and Borders," said Erica Rugullies, a senior electronic commerce analyst at Giga Information Group. "That indicates the type of threat they are in the industry."
Amazon.com also has consistently beaten analysts' estimates for revenue. The first quarter it offered music sales, Amazon.com brought in $US14.4 million from the effort, trouncing CDnow, the established leader in the category.
No one doubts the capabilities of Amazon.com's management team. And the company has roughly 5.5 million customers in its database. Analysts said the company's next challenge is to figure out how to sell more stuff to each of them.
But one misstep, and its love affair with investors and sources of capital could be over.
Outside forces
Critically, the stumble doesn't have to come from Amazon.com itself, which is widely regarded as having one of the best management teams of any Internet company. The number of people buying personal computers could slow down and interest in the Net could wane, meaning the growth of electronic commerce also would slow, for instance. Or, the novelty of shopping from home could wear off.
If that happens, financial markets could turn as bearish as they have been bullish. "Access to capital is going to go bye-bye," said Nick Moore, a technology analyst at money manager Jurika & Voyles. "People think that when the lights go off, they'll go off for a couple of months. They'll go off for a couple of years."
Amazon.com management wouldn't comment on its stratospheric stock price. "We within the company don't focus on stock price at all," said Kay Dangaard, an Amazon.com spokeswoman. "It's really just for the analysts."
But Merrill Lynch's Cohen thinks otherwise. In a September 1988 research report, he wrote: "We suspect that its share price may be a source of some significant concern for Amazon.com's management . . . share price fluctuations have the ability to profoundly influence a company's operating business, both positively and negatively."
It's possible that investors may even find a better proxy for the success of online shopping than Amazon.com. Almost at the same time Amazon.com announced that it sold $US250 million of goods in the fourth quarter of 1998, America Online said its members spent $US1.2 billion on merchandise, just from Thanksgiving through Christmas.
The announcement showed the tightwire act that Amazon.com must execute. Even though the amount was $US100 million more than the previous quarter's sales, investors initially were miffed. The chat rooms were expecting Amazon.com to double revenue, to $US300 million. Shares of Amazon.com fell, before rebounding that day. Indeed, Amazon.com last week crossed $US400 per share, not counting a 3-for-1 split. That price was laughed at in December 1998, when one Wall Street analyst gave it as a long-range target.
Amazon.com continues to get good reviews from bullish analysts, such as Morgan Stanley Dean Witter's well-regarded Internet specialist, Mary Meeker. But there are lone rangers like Cohen. "Amazon.com is probably the single most expensive piece of publicly traded equity, not only across the Internet space, but probably in the history of the modern equity markets," Cohen said on a recent conference call.
Cohen, citing thin operating margins for Amazon.com's wares, said there's a possibility Amazon.com will never make money. "In the next 12 to 18 months, we expect the stock to trade for something less than $50," he said.
Amazon.com won't be proving Cohen wrong anytime soon. The company said its strong fourth-quarter sales won't yield any improvement in the bottom line because of aggressive pricing, increased sales of lower-margin video and music products and fulfillment costs. Profitability looks to be years off, as Amazon.com tries to broaden its brand. And revenue may even decline in the first quarter, as Amazon.com starts to experience the seasonality of selling to consumers.
In order for it just to break even, Amazon.com will have to lop off more than 15 percent of all forms of online selling to consumers - while Wal-Mart has managed to chew off only 5.4 percent of the conventional retailing market.
"Investors are not exactly acting rationally with regard to Internet stocks, so it is very difficult to call specific near-term moves," said Lise Buyer, an analyst at CS First Boston. "Guessing the [stock's] behavior on any particular day is a fool's errand."
As Amazon.com's Bezos said: "Unless we execute extremely well, we can quickly become a footnote in the history of e-commerce instead of a chapter or a book."
