Back in 2017, I wrote an article highlighting Amazon's (AMZN) under-appreciated investments in AI and why is a significant source of competitive advantage. Since then, AI has become more important than ever for the company and shareholders, though the company continue to remain relatively quiet about it.
Amazon's push into the healthcare industry is well documented, however few are aware of the central role of AI technology in Amazon's push. Understanding this is more than mere academic exercise -- it is crucial to understanding the sustainable competitive advantage Amazon could enjoy in this massive market, one which Deloitte predicated will grow to over $10 trillion worldwide by 2022.
Why AI = Sustainable Competitive Advantage
It is beyond the scope of this article to go through the history and promise of AI, however it is important to note that AI is now such a hot topic due to revolutionary break throughs in artificial neural networks (or deep learning) in the 2010's. These breakthroughs enabled algorithms to "learn" and thus introduce a new level of machine intelligence never available before, enabling algorithms to accomplish breathtaking new feats such as defeating the world's top Go players and disrupting the translation industry.
Modern neural network algorithms, however, is a "centralizing" technology. For investors, the practical implication is that companies that can position itself at the center should enjoy an unusually high and sustainable competitive advantage in the niche where it gains a foothold. Companies that are mostly likely to be in this enviable position ought to satisfy three conditions.
First, there is a massive shortage of AI experts, so only very well funded companies or those with massive cash flow are capable of building world-class AI teams. In 2017, Tencent (OTCPK:TCEHY) estimated that there are only 300,000 AI researchers worldwide, far short of the millions demanded by the market. These scarce human resources are in high demand everywhere, and consequentially tech giants are emptying university AI departments with massive compensation packages.
Second, AI delivers the greatest value to companies with the greatest data assets, which correlates with the scale of the enterprise. It takes a massive amount of data to train neural networks, and naturally the best AI talents prefer to work in data-rich environments. It is no surprise than that companies that are most excited about AI are also the ones with the greatest data assets.
(Source: CB Insights)
Third, combining top AI talent and massive data to produce breakthrough products requires a management team with a strong background in engineering and computer science. This explains why Amazon, Google (GOOGL), Microsoft (MSFT) and Facebook (FB) leads in AI when other data-rich companies such as Bank of America (BAC) and Cigna (CI) do not.
Once a breakthrough AI product is produced, for example Google's AI language translation service, one that is significantly better than alternatives, a virtuous cycle begins that further reinforces the competitive advantage of the product. First, the superior product garners more users. Second, more users interacting with the product generates more data. Third, the incremental data is then used to improve the product.
This virtuous cycle sounds a lot like the flywheel that Jeff Bezos is so obsessed with. With $22 billion in cash and $31 billion of cash generated from operations in 2018, massive data assets from its leading commence and cloud businesses, and a culture of innovation, Amazon satisfies all three conditions for becoming a highly dominant AI company.
AI and Healthcare
Most heard about Amazon's push into healthcare through its highly publicized venture with Berkshire Hathaway (BRK.A) (BRK.B) and JPMorgan Chase (JPM) in early 2018, or perhaps its head-line grabbing $1 billion acquisition of PillPack in mid 2018. The casual observer may dismiss the venture as being very early stage, and conclude that the acquisition is simply a tuck-in to expand its e-commerce business. However, this view would be missing the bigger picture: Amazon is attempting to build a dominant, AI-driven healthcare business.
To understand why I believe this, we need to step back and look at the developments that received much less media coverage.
In March 2018, CNBC reported that Amazon has been meeting with the AARP since 2015 to discuss potential collaborations and share research, and it is interested in designing "technology" for aging populations. One reason why Amazon would be interested in working with the AARP is that the elderly demographic is large and growing. By 2035, it is projected that there will be 78.0 million people 65 years and older compared to 76.7 million under the age of 18.
The technology that Amazon will deploy to serve the aging population will likely be AI-based, with the prime contender being Amazon's AI assistant, Alexa. We received an explosion of evidence to support this view later in 2018:
- In May 2018, CNBC reported that Amazon is secretly building health and wellness team within Alexa to make it more useful in the healthcare field.
- In an October 2018 article, a spokesperson from Amazon said the company frequently receives positive feedback from “aging-in-place” customers who use Alexa’s smart-home features as an alternative to going up and down stairs.
- In late 2018, AAPR and Cigna both announced new Alexa skills, and Amazon filed a patent that would enable Alexa to notice a user’s illness by detecting a change in their voice.
Amazon's AI push into healthcare, however, is much broader then just leveraging Alexa:
- In June 2018, CNBC reported that Amazon has a secret lab staffed with top researchers who are attempting to apply machine learning in ways that can help prevent and cure cancers.
- In November 2018, Amazon introduced Amazon Comprehend Medical, a machine learning service that allows developers to process unstructured medical text and identify information such as patient diagnosis, treatments, dosages, symptoms and signs, and more. The service will “read” the text and then identify and return the medical information contained within it, dramatically improving upon a very manual process.
- In February 2019, Amazon broke its characteristic silence on strategy when its senior health leader, Taha Kass-Hout, talked up the company’s artificial intelligence capabilities in healthcare during a rare interview.
- In March 2019, Amazon announced a $2 million grant to the Harvard Medical School teaching hospital to experiment with machine learning and AI, specially to improve process efficiencies. This isn't the first time Amazon is cooperating with Harvard, as the two already developed and tested the new scheduling system over the past two years which increased operating room capacity by 30%.
Amazon is making massive investments in AI and healthcare, and in my view, investors should be happy to underwrite such spending. The nature of AI and the healthcare industry, as I have argued in this article, makes the risk and reward of such investment seem highly favorable. Healthcare is a massive industry and with massive inefficiencies that AI is uniquely positioned to improve. Furthermore, any initial success should garner Amazon a sustainable competitive advantage that could grow over time, making initial investments look negligible given the stability of potential cash flows.
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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.