Amazon To Face Major Challenges Over Its Business Complexity And Rising Costs

| About:, Inc. (AMZN)

Over the last 15 years, the share price of Amazon (NASDAQ:AMZN) has gone up from $1 to $275. Jeff Bezos founded Amazon when he learned about the rapid growth in Internet use and the new U.S. Supreme Court ruling at that time that online retailers do not have to collect sales taxes where they lack a physical presence. Today, there are sales or consumption taxes collected by Amazon in some jurisdictions. Internet usage is increasingly popular and important. More people start to shop online for convenience and to save time. This is good news for Amazon as the major online retailer company in the U.S. However, the competition is also intense as many competitors in different industries including retail, e-commerce services, digital content and digital media devices, and web services.

Amazon is financially stable and healthy; it has enough cash reserve for its expansion. In 2012, the cash generated from operating activities was $4.2 billion. Amazon announced fourth-quarter sales up 22% to $21.27 billion and operating income up 56% to $405 million.

After five years, eBook has grown fast and is up about 70% from last year compared with a 5% increase in books. Today, eBook has become a multi-billion dollar category for Amazon, and is expected to grow even more. More people are using eBooks because they are easy to carry, lightweight, inexpensive, and offer high storage capacity. Students are better off carrying a Kindle or iPad with a capacity to store hundreds of eBooks compared with carrying 10 books to the school. Students can easily buy the book they want to read without going to the bookstore. This is a transition we see around the world that is good for Amazon: increasing online retail, Internet and digital device usage.

The company sells Kindle Fire HD, the most popular item and No. 1 best selling since its launch. Amazon expanded its business by acquiring new licensing agreements with Turner Broadcasting, allowing people to view more than 36,000 movies and television episodes through their devices. In addition, Amazon launched Kindle Stores for Brazil, Canada, China, and Japan. The global expansion resulted in increasing complexity for Amazon's business, causing strain on the business operation. The success of international market expansion is highly critical for Amazon's growth. The growth in Amazon business is highly influenced by the ability to retain, increase, attract, and satisfy customers through a competitive website and pricing, favorable terms for products, and minimizing the cost of conducting business.

The cost of operation will increase due to increases in the price of fuel and gasoline, paper, and packing supplies. A slowing of the economy will impact the online retail sales. The fulfillment center is the heart of Amazon's business operation where orders are fulfilled primarily from a single location with limited ability to reroute orders to third parties for drop-shipping. The fulfillment costs represent cost of buying, receiving, inspecting, and warehousing inventories. This cost has major impact to Amazon's profitability, given an evolving business model and products offered. High operational cost will definitely hurt Amazon unless an integrated coordination with a cost-effective solution can be implemented.

Despite these concerns, Amazon has a solid business model for sustainable growth. Yet, it has a volatile stock price due to its rapidly evolving business model and variety of exposure to payments-related risk, foreign exchange risk, interest rate risk, system interruption risk, commodity risk and fulfillment risk. Amazon engages in a variety revenue generating segments from selling Kindle devices, and commission on selling books and content.

As of the March 8, 2013 closing, Amazon stock priced at $274.19 with a market capitalization of $124.63B. The asset book value for the year 2012 is $32B. I think the Amazon stock price can go down to the $200-230 range in the next three months due to increasing cost of sales and increasing business complexity. Institutional investors represent 68% of the stock ownership, and some are expected to liquidate their position due to the rising costs and risks involved. If the stock can touch the $220 level, it has a good chance to go down to the $180-$200 range in the year. In the long term, Amazon has a good bullish trend.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

About this article:

Author payment: $35 + $0.01/page view. Authors of PRO articles receive a minimum guaranteed payment of $150-500. Become a contributor »
Problem with this article? Please tell us. Disagree with this article? .