Signs Of Amazon.com Mismanagement

| About: Amazon.com, Inc. (AMZN)

Usually, this kind of article is written after a stock has fallen substantially. I will break the mold and write it before, using arguments which will be repeated often after it finally breaks.

First of all, it's important to remind people that the market always enshrines the management of companies whose shares are soaring. It's no different with Amazon.com (NASDAQ:AMZN). Jeff Bezos is called a genius, quite possibly the next Steve Jobs, not because people see signs of genius, but because the shares have been behaving well in the past. Such will change dramatically once Amazon.com gets cut in half or worse.

More important is the realization that there are already signs of mismanagement today. Although the share price will blind most people to these signs, the fact that this article can be written is a testament to the problem.

Jack of all trades, master of none

Amazon.com did not start out as a jack of all trades. Quite the contrary, Amazon.com started out as a focused online seller of books. And it could have evolved over the years into a focused seller of several different goods. But no, instead Amazon.com evolved not into a focused seller of anything, but a provider of all things, digital and physical, in an unfocused, un-optimized, manner.

The latest move into social gaming shows this aspect. There's little to be gained for Amazon in entering the social gaming arena. It has mostly no synergies, it is a market with network effects which Amazon.com doesn't have and it demands more expensive, specific, costs. Yet Amazon.com entered anyway, corroding away just a little bit more profitability.

The same thing is happening with video, with music, where it doesn't stand any chance of facing Apple's (NASDAQ:AAPL) iTunes. Or with its plunge into car parts and tens of other different segments.

Warehouse efficiency

As SKU's increase, warehouse complexity increases and overall efficiency drops. More importantly, as SKUs increase efficiency drops both for the old SKUs, and for the new ones. The "we sell everything" mantra forgets this.

Other companies limit the assortment of products they sell not out of an inability to sell different stuff, but because it's not economical to do so. Amazon has not chosen a smarter business model here; it has in fact chosen an uneconomical business model.

A bit of a positive here, though. There's the chance that deploying automated warehouses - of which Kiva is an example - might help Amazon.com regain part of the efficiency it has been losing over the years. However, I must also say that to buy automated warehouses, Amazon.com did not need to buy a maker of them, which is probably another sign of mismanagement.

Going against entrenched leaders

The move against Google (NASDAQ:GOOG), by launching a forked Android tablet, the Kindle fire, was perhaps one of the most ill-advised moves Amazon.com has ever made. Google was forced to respond with the Nexus 7 tablet, a tablet superior to the Kindle fire in every regard, while also selling it at cost. There's no way for Amazon.com to outspend Google, and there's no way for Amazon.com to develop a forked OS to Android 4.1's specification, either. Amazon.com simply doesn't have the huge installed base to amortize the cost of doing so over many units. So Amazon.com basically picked a fight it can't win.

This doesn't even require Apple launching a 7" iPad, which it is widely rumored to be about to do. Google alone was enough to frustrate Amazon.com's plans. Yet, this move probably cost a bit more profitability all by itself.

Amazon.com is trying to face companies that are better capitalized, better positioned and more able to field the technologies in question. Amazon.com is trying to win where companies which were much better placed to win, such as Nokia (NYSE:NOK), have had trouble doing so.

Competing on price while not leading on cost

Although Amazon.com is widely believed to present some of the lowest prices in what it sells because of having a lot less overhead than bricks & mortar stores, such is not the view one gets from looking at the P&L of Amazon.com versus those on retailers such as Wal-Mart (NYSE:WMT) or Costco (NASDAQ:COST). By and large, these retailers show a lower operating cost/revenues ratio than Amazon.com does. Amazon.com's (operating costs ex-cost of sales)/revenues are 25.2% of sales (Q2 2012), whereas Wal-Mart's are 19.2% (2012 FY), and Costco's are 9.5% (Q1 2012).

Part of this might be related to the fact that customers do not consider the cost of them going from home to the retailer and picking up stuff from the shelves, whereas if Amazon.com tries to charge for delivery and handling, those costs are noticed. This means Amazon.com has to eat such costs, whereas the physical retailers don't.

Amazon can't compete on service

It's fashionable to say that as Amazon.com is forced to collect sales taxes and thus loses some pricing advantage, it will then compete on service. For sure, Amazon at times is famous for the service it provides on the products it sells. However, Amazon.com can't compete on service. The reason is simple. 40% of the units Amazon.com sells are 3P, and the overwhelming majority of these are not fulfilled by Amazon.com, but by third parties. Amazon.com can't control the service provided by third parties, and as such it can't provide a consistent service experience.

It's no coincidence that the majority of complaints regarding Amazon.com are now emerging from these sales. The complaints are from sellers being scammed, buyers being scammed by sellers, supplier companies seeing Amazon.com selling counterfeit goods, buyers complaining of bad selling service/delivery, etc. This is made worse by the fact that when Amazon.com is faced with a complaint because of a third party, it doesn't make much to alleviate the problem, other than block the third party seller's account or refunding the buyer even if it's a scam.

The free video blunder

Some might disagree, but giving existing Prime members free video content might have been a very large blunder with significant impact on Amazon.com's earnings. Prime membership numbers in the millions and while the video is free for the members, it is far from free for Amazon.com. So with this move, Amazon.com created an instant increase in costs with no offsetting revenue - since the existing Prime members were already paying the $79 yearly charge anyway. This move was all cost. At most, it decreased churn in Prime membership.

Investing heavily in unprofitable areas

It has become fashionable to indicate that Amazon.com's great promise is in the higher-margin 3P segment. Yet, nobody seems to question why, if this is so, does management keep sinking billions in investment into structures (warehouses, datacenters for AWS) which aren't actually even needed by the 3P segment that's supposed to produce the margin!

Indeed, even worse, if 3P really has the juicy margins so many are led to believe exist, and since Amazon.com's overall profitability is trending towards zero, the obvious conclusion is that Amazon.com ex-3P is actually unprofitable. So Amazon.com is sinking the vast majority of its investment into unprofitable segments while promoting 3P as the margin generator. It makes no sense.

Conclusion

Today Amazon.com is the Teflon stock, which can do no wrong. After it eventually drops, though, articles stating the same as this one does today will be a dime a dozen. This ought to make you consider that Amazon.com might not be as well managed as article after article makes it seem.

Amazon.com is a clear sell, on account of mismanagement, an unbelievable earnings multiple, earnings and estimates on a continuous path downward and structural threats to its business model, both internal (in the form of mismanagement) and external (sales taxes collection, digital goods selling paradigm changing towards OS-integrated stores).

Finally, this article is by no means extensive - there are many other signs of mismanagement. These are what I can recall right now.

Disclosure: I am short AMZN.