Why Are Google And Amazon.com Imitating Each Other?

Jun.18.14 | About: Alphabet Inc. (GOOG)

Summary

Amazon.com and Google are more than just competitors, they're imitators.

To survive and thrive, Google and Amazon.com need to build moats and float.

There might be serious limits to the ability of online companies to generate cash, and Google and Amazon could be approaching them.

Something very interesting has been happening in recent months: Amazon.com Inc. (NASDAQ:AMZN) and Google Inc. (GOOG, GOOGL) are becoming more and more alike.

Amazon has started marketing a smartphone, and Google has entered the delivery business with its Shopping Express. The companies are trying to imitate each other's business models. Both companies also are offering payment solutions in competition with eBay Inc.'s (NASDAQ:EBAY) PayPal. Google and Amazon.com are also both big players in the Internet infrastructure and data center businesses.

Why Are They Imitating Each Other?

What's going on here? Why are these Internet giants constantly expanding into new areas far from core businesses, which seem to be very profitable and enjoy high stock prices? Google reported a quarterly gross profit margin of 61.34% on March 31, 2014, and Amazon.com reported a quarterly gross profit margin of 28.80% on the same date.

Judging by that figure, it might make sense for Amazon.com to imitate Google, but why would Google imitate Amazon? The reason is simple: revenue. Amazon.com reported a TTM revenue of $78.12 billion on March 31, 2014, and Google reported revenue of $61.28 billion on the same date.

Chart watchers know that both companies' revenues have been rising dramatically for the last few years. Google's revenue rose from $52.48 billion in March 2013 to $61.28 billion in March 2014. Amazon's revenue went from $63.98 billion in March 2013 to $78.12 billion in March 2014.

The revenue at each of the companies is growing by leaps and bounds, yet both organizations are now taking dramatic risks by boldly entering new areas. Revenue indicates that each company has a lot of momentum in its core area. Yet, each is desperately trying to expand outside that area.

My guess is that Larry Page and Jeff Bezos are worried about the limits of online commerce. The two are afraid that there are limits to e-commerce, and that the popular view that there are an unlimited number of ways for an online company to generate cash flow might not be true.

Something to remember is that Google and Amazon.com are both numbers companies. Their business model is largely based upon crunching numbers and creating new enterprises or solutions based upon those numbers. Those numbers might have projected some limits to online business, which is why both giants are working hard to create new online and offline businesses.

There also seems to be an interesting plan here; the two companies are trying, on some level, to imitate Warren Buffett's Berkshire Hathaway business model. Buffett's business model employs two broad principles to make money and protect itself: moat and float.

A moat is a wide barrier that competitors will have a hard time breaching. As my fellow contributor Bram de Haas points out, Bezos' Amazon.com model seems designed to create a moat. Amazon.com's moat is largely based upon customer service and convenience - it delivers a high level of customer service that competitors cannot match.

Google's moat is its ability with mathematics and its sheer unpredictability. Since nobody knows what business Google will move into, how can you compete with it? Google also enjoys the luxury of moving at its own pace and ignoring the market (much like Buffett does).

Neither of these barriers is stable, and both are very vulnerable to deep-pocketed competitors. Amazon.com has to worry about Wal-Mart (NYSE:WMT), eBay and now Alibaba, as well as Google. Google has to contend with Microsoft, eBay and Amazon.com, among others.

My guess is that Bezos and Page are trying to build up gigantic ecosystems that could serve as moats, or rather mine fields, to keep enemies out. Part of the way moats work is by making the cost of competing too high. A classic example of a company that has done this is Wal-Mart, which has a similar business model to Google and Amazon.com by dabbling in a lot of different fields in a continuous search for more revenue.

This brings us to the other part of the Buffett equation: float. Float, as I've noted elsewhere, is a continuous stream or stash of cash that a company can tap or borrow against when it needs it. Buffett has famously invested in industries with a lot of float, including insurance, newspapers (historically), reinsurance and banking, to name but a few.

Google and Amazon.com both seem to generate a lot of float, but it is not necessarily stable. As de Haas notes, online businesses are inherently volatile. As I've noted in my previous article, "Why Amazon.com Has Entered the Payments Business: Cash Flow," Amazon.com's cash flow goes up and down like a yo-yo.

Google's free cash flow (FCF) is pretty steady. Google reported free cash flow figures of $2.43 billion in March 2013 and $2.046 in March 2014. Google's free cash flow has actually fallen in recent years - it was $3.087 billion.

These figures indicate that Google might be in even more need of float than Amazon.com is. That could be why Google is interested in delivery and retail. Amazon.com has demonstrated that a company can generate a lot of cash in those areas at certain times of the year. Amazon.com reported a free cash flow figure of $4.69 billion in December 2013.

Amazon.com and Google are going to keep moving into each other's turf in the years ahead. They may need to simply survive or avoid suffering Yahoo's (NASDAQ:YHOO) fate as an "also-ran."

Disclosure: The author is long EBAY, BRK.B. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I conduct retail sales through both Amazon.com and eBay. I also use Google AdWords to promote my blog.