A lot of investors have looked at Amazon (NASDAQ:AMZN) with consternation, as the company has not only not followed the normal pattern or retailers in general, but it also hasn't followed the pattern most tech companies have followed in the recent past. This has resulted in the company outperforming in many quarters, followed by projections it'll get crushed under the weight of weak margins and earnings.
Granted, a lot of that happened before the emergence of its powerful AWS cloud service. Yet, even with that as a significant part of the company's overall growth, the retail segment still is the largest part of AMZN and continues to defy the odds. This isn't because its model is misunderstood, but I believe because the transition to e-commerce by consumers is stretching out a lot longer than other tech businesses have experienced when scaling and disrupting existing markets.
The other issue in my view is while Amazon has disrupted the retail business on the delivery and convenience of doing business on the Internet, it hasn't changed the demand side of retail, which remains in place. In other words, the disruption was different than say, the disruption that came from the introduction of mobile phones in the beginning, which has bypassed most of those using landlines and the phone technology used under those conditions.
People of course will also communicate, but the mobile phone, which has morphed into the smartphone, has disrupted an entire business. It's similar to how people were going to still travel at the time horse-and-buggy were replaced by automobiles.
Consumers are increasingly moving toward the convenience of online shopping and all the perks associated with it. Amazon is by far the best at doing this, and e-commerce is far from being a saturated market not only in the U.S., but also globally.
With that in mind, the announcement by Amazon it's going to add another 100,000 jobs in the U.S. supports the thesis that it sees a lot more room to grow before it considers the U.S. market saturated. As for the rest of the world, there is even more growth potential there.
How to view Amazon's announced job growth in the U.S.
There are several things to consider with the additional jobs Amazon says it's going to add over the next 18 months in the U.S. The most obvious is it isn't going to come cheaply. Most of the jobs are earmarked for its fulfillment centers, but some are higher-paying jobs targeting its other businesses.
Obviously the costs of doing business are going to rise, but it should be accompanied by significant growth to, for the most part, offset it. That said, there will be lag time as the new hires eat up capital, and that will provide for some low-performing quarters in the next year and a half. I expect the share price to be volatile during that time.
On the other hand, the increase in workers will help the company further separate itself from its closest competitors, which are far behind them on the e-commerce side of retail, which means taking more share of the general and online retail business. That will definitely generate more revenue, but not necessarily more earnings.
Some of that will be made up for by its high-margin cloud business, but I only want to focus on e-commerce in this article.
The online U.S. retail trend has a lot of impetus left in it, and when measured by overall retail sales, remains less than 10 percent of all U.S. sales. That is only going to increase, and if Amazon maintains its superior service, it's going to get by far the largest portion of those sales.
Its competitors would have to spend billions to only maintain their position against Amazon, let alone gain in it.
Amazon's scaling potential
One of the things I haven't heard talked about much or at all is the specific retail environment Amazon is operating in, and how it's different than say the phone market when Apple (NASDAQ:AAPL) took it by storm years ago.
In the case of Apple, in the U.S. market, it is close to the saturation point, with some upside left in it, but not a lot it can do any longer to differentiate from competitors. It's the same in China, where it struggles to separate from the competitive pack. This isn't true for Amazon, which has a lot of scale left in all the markets it competes in, including the U.S.
As the graph below shows, in the U.S. alone the percent of e-commerce sale versus overall retail sales hasn't even reached the 9 percent level, and this is after many years of e-commerce being in the retail mix. It has about tripled over the last decade, and I see nothing to imply it's going to slow down. With Amazon taking the steps to significantly increase its workforce in this part of its business, it will help boost the pace of retail share e-commerce accounts for. Again, this doesn't include the growth potential it has around the world.
Source: U.S. Department of Commerce
What has stymied some of those commenting on what is perceived as Amazon's weak earnings model, is they're measuring it by the usual way tech companies perform in the early years of the business. Normally a tech company will seemingly emerge out of nowhere and disrupt a market. It isn't concerned about generating profits in the early years, instead focusing on scaling and grabbing a big piece of market share before it looks at how to improve margins and earnings.
With Amazon, that hasn't been how it has played out, and it makes a lot of analysts and pundits nervous, which has produced skepticism concerning whether or not AMZN has an earnings end game in mind.
I think the problem there has been growing market share on the e-commerce retail side is a much longer process than totally disrupting a market. Amazon isn't about to settle in and work on improving margins and earnings when it could lose its momentum on the growth side.
What I'm saying is this isn't the relatively quick play associated with the majority of tech segments. Even though the share price of the company has jumped about 400 percent since 2012, it still has a lot of growth left in it. This is evidenced by the size of Wal-Mart (NYSE:WMT). Amazon obviously gets most of the headlines because of its online expertise and moat, but the truth is as far as sales and revenue go, Wal-Mart is the far bigger competitor. Investors of course reward Amazon because they believe the e-commerce giant will continue to grow at a solid pace while Wal-Mart's best days are obviously behind it.
Amazon doesn't want to be overtaken by another competitor in the way it has started to dominate the retail industry; that's even though it only has a small piece of the overall retail market. For that reason I don't see the company starting to target margins and earnings as a priority. That's one of the reasons the market lead it has taken in the cloud services business is important. It can placate some nervous shareholders while buying it time to continue to scale the business.
One day an e-commerce ceiling will come
There will come a time when Amazon does approach the ceiling of its growth potential on the e-commerce side of its business, and I believe that's when we'll see it start to take steps to boost margins and profits. That isn't likely to come in the near future because of how much share there is left to take in the U.S. and global retail markets.
Until then, investors will just have to sit back and enjoy the long-term ride. I see no company at this time that has the resources or disruptive business model to interfere with Amazon's growth momentum and plans. That doesn't mean it couldn't happen. After all, I've followed Wal-Mart for a long time, and many believed it could never be unseated from its lofty retail market dominance. Yet, here we are, and it has been.
This is what I think Jeff Bezos and Amazon's leadership is looking at. It has to keep improving its service, which in turn grows market share for the company. The question many have is when will the tech giant start to work on earnings? My answer is not for a long time; as far as it relates to the e-commerce portion of its business.
If it were to get its focus off of improvement and scaling the business, I believe it could be outmaneuvered by a competitor. Revenue will continue to soar, but earnings will lag behind, and even more so in the next year or two as the company further solidifies its service by improving its channel and delivery system.
Once it finds itself hitting against a growth ceiling in any market, then is when it will work on areas of the company perceived as valuable by consumers, which won't mind paying more for what the company has to offer. It's another reason why it's working so hard to expand Amazon Prime.
The market unsurprisingly responded to the added costs of doing business with the large number of new hires the company will have to absorb by pushing down the share price, but that will only be a temporary situation.
What I'm looking at for the next 18 months is for the market to see how all of this will have an impact on revenue. If it sees growth during the period of time the size of its labor force soars, the company may outperform to the upside; if the pace of revenue growth is disappointing, the share price will fall.
The most probable outcome is there will be quarters that disappoint and some that do okay, which is why I see the stock being volatile during the hiring process. If the company can gain meaningful share, and as mentioned above, increases revenue, the market will reward it because it will perceive Amazon's management rightly projected the value to consumers of increasing the performance of its fulfillment centers.
If growing market share and revenue is considered to be slower than expected, the company will get punished because uncertainty will arise as to how valuable the increase in labor costs was in conjunction with consumer demand and expectations.
It appears that this is a good decision by Amazon, even at the extraordinary pace it is going to grow employee count and costs. This will more than likely be a rough year for shareholders and investors because each quarter will have to prove itself, and there will certainly be some disappointments along the way. Even so, Amazon should boost market share and revenue during this time, and once the additions are in place, it may be able to offer the type of service that causes another season of extraordinary scale and growth. And I'm only talking about in the U.S.
Amazon will remain a solid play for long-term investors.
Disclosure: I/we 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.