Amazon's Brick-And-Mortar Strategy A Mistake

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

Summary

The Wall Street Journal reported that Amazon will be opening its first retail store in New York City in time for the holidays.

The idea is not only ironic, but it simply doesn't fit what has made Amazon so successful.

Amazon can't manage a meaningful net profit with its current model. What makes management think it can with this new one?

The Manhattan store may become an NYC novelty, but expansion beyond that would be foolish.

Amazon (NASDAQ: AMZN) is planning to open its first retail store in Manhattan just in time for the holiday season. According to The Wall Street Journal:

The Manhattan location is meant primarily to be a place for customers to pick up orders they've made online, but also will serve as a distribution center for couriers and likely one day will feature Amazon devices like Kindle e-readers, Fire smartphones and Fire TV set-top boxes, according to people familiar with the company's thinking.

Whether this decision is an attempt to innovate in a crowded e-commerce industry in order to ward off competitors, or this is simply just one more thing Jeff Bezos is keen on trying out, branching outside of the online retailing realm isn't a good idea for Amazon.

Isn't it Ironic?

For years, Amazon has been pretty darn efficient at edging brick-and-mortar bookstores out of the market. Since the introduction of the Kindle, traditional bookstores have been hard-pressed to keep up. So isn't it ironic that Amazon is forsaking that advantage to try out what all those bookstores that closed down were doing?

Additionally, with Amazon's recent spat with publisher Hachette, New York's publishing houses are definitely not amused. Of course, at this point, there is no word whether it's in the plans to sell books alongside its signature gadgets, but it definitely shouldn't surprise anyone if Bezos plans to go that route.

Nobody wants an Amazon store

The one thing that has made Amazon uniquely successful over the past 20 years is that it's an online, hassle- and bustle-free environment. Customers don't need to leave their houses, let alone put on pants, to have the full Amazon experience. Add to that the fact that New York City already has same-day delivery without the store, and it simply doesn't make sense.

Some have argued brick-and-mortar retail is still relevant and "it worked for Apple," but Amazon is no Apple (NASDAQ: AAPL). Amazon has millions and millions of products, while Apple only has an elite handful. Even if physical retail stores are still relevant, that's not what has endeared Amazon to its customers.

Margins are already suffering

Gross margins in the brick-and-mortar retailing industry aren't terrible comparatively, but net margins are generally pretty paltry. For example, net margins for Target (NYSE: TGT) for FY2013 were 2.7%, while Best Buy (NYSE: BBY) was only able to muster 1.6%. Amazon's gross profit margin has steadily increased over the last few years, reaching 30.72% in its July quarterly report. But over that same time, net margins have decreased. The most recent quarter ended up a disappointing -0.65%.

If Amazon is struggling to stay out of the red on net margins without all the extra costs that come with a physical retail store, what makes Jeff Bezos think it can turn this new plan into a profitable one?

The Internet business model has given Amazon countless cost advantages in the past. It has been able to avoid sales tax in many states, and it hasn't had to pay store employees or the costs of keeping the lights on. These have all been key to helping Amazon develop its current cost structure, but there's simply not enough margin left to add all of those.

Conclusion

According to The Wall Street Journal article, Wells Fargo analyst Matt Nemer said that opening the physical location is "about marketing the Amazon brand. Same-day delivery, ordering online and picking up in store are ideas that are really catching on. Amazon needs to be the center of that."

But the thing is that Amazon can't afford to be in the center of all of that. A brick-and-mortar store may end up a cute novelty as it sits in the shadow of the Empire State Building, much like the M&M store and the Disney store. With New York City attracting millions of visitors every year, I don't doubt that the Manhattan location would be profitable. But any sort expansion beyond that would be at a high cost, and would ultimately be foolish.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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