Amazon’s Innovation Will Dominate the Future

by Trefis Team
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Submitted by Wall St. Daily using our Trefis Contributor Tool

There’s an “infographic” floating around the internet suggesting that Amazon (Nasdaq: AMZN) is an evil monopoly, dominating retailing with nefarious and unfair business methods.

Well, it is right about one thing: Amazon’s without a doubt dominating the market. In 2011, it booked $44 billion in revenue, which made up one-third of online shopping.

But contrary to the infograph’s suggestion, Amazon isn’t evil. In fact, Amazon should be held up as a paragon of innovation. In an era where large companies struggle with the ability to generate and execute big ideas, Amazon consistently releases game-changing technologies requiring a vision two steps ahead of most other businesses.

After launching as a simple online bookstore, Amazon spread into areas and products that most companies would consider a distraction from their main vision. But by taking the long view, these “distractions” have become central and integrated parts of Amazon’s business.

Let’s recap Amazon’s greatest innovations…

Amazon Prime

How can a program that loses $11 per customer be a success? It’s all about loyalty. Amazon’s Prime program offers free two-day shipping on all items – along with some other perks – for $79 per year. It costs Amazon about $90 per year.

But members who join Amazon Prime turn into Amazon Addicts. Members typically increase their purchases by 150% after joining and may account for up to 20% of Amazon’s overall sales, according to analysts. Even though Prime accounts only make up less than 4% of the site’s users.

Now the program is being copied by everyone from Wal-Mart to Best Buy. But it won’t achieve the same level of success, because Amazon – unlike its lightweight, online competitors – sells virtually every product in the world. And it’s that unmatched selection that gives the Prime program its edge.

But prior to Prime’s launch, it seemed like a tall order to get anyone to pay $79 up front for a membership. In fact, there weren’t many who did, especially compared to Amazon’s size (estimates range from four to five million). However, the project is such a huge moneymaker that objections to its viability have been completely put to rest.

Kindle

When Amazon CEO, Jeff Bezos, brought in the man who would eventually run the Kindle development team, Bezos’ first question to him was, “What should Amazon be doing in 20 years?”

It’s that kind of long-term view that’s necessary to create a product designed to completely up-end your own established business, and at the same time alienate many of your partners (in this case, book publishers). That’s what Amazon did.

E-readers had been tried before, but none ever caught on. It was a matter of marrying the perfect device with the perfect content platform.

When the Kindle was being designed, Bezos absolutely insisted that the device not use Wi-Fi (he considered it too difficult for users to set up) and that customers not have to pay to use a cellular network.

At the time, such stripped-down functionality was radical. (So much so, that when someone first explained it to me, I assumed they had it wrong.) But the result was that the Kindle became to reading what the iPod was to music, and it put to rest any arguments that “people will never give up their books.” It only took four years for Kindle ebook sales to surpass physical book sales.

Plus, the Kindle eventually led to Amazon’s next game changer…

Kindle Fire

The iPad is inarguably a great device that can do amazing things. But Amazon’s Kindle Fire does the things you actually want to do – and it does so for one-third of the price. Amazon realized that tablet computing’s real future was for reading, watching video and browsing the internet from the couch. So while Apple and others focused on hardware to provide plenty of power, Amazon made the operating system simple (a touched up version of Android), integrated all the content delivery systems and knocked the iPad off its singular throne.

Estimates put the costs of making a Kindle Fire at around $215, but it sells for $199. Much like a Prime membership, the Fire earns back that difference with increased sales. The first time a user buys an ebook for his or her Fire through Amazon, the company is in the black. And this subsidization allows Amazon to deliver a great piece of hardware at a price lower than anything comparable on the market.

Those are just a few of Amazon’s biggest, recent successes. I’m not even going to get into how Amazon morphed from a bookseller to breaking into nearly every market in retail. Or how it’s successfully branching out into its own publishing house (and is paying authors 70% of sales as royalties).

And I’m going to wait until a future column to detail Amazon’s cloud-computing services, which have completely revolutionized the infrastructure of the internet and could become one of Amazon’s largest divisions.

But here’s the question when you’re looking for an innovative investment…

What’s the Next Game Changer?

Apple (Nasdaq: AAPL) was a moderately successful computer company. But it switched to consumer electronics by introducing the iPod, iPhone and iPad. Each of those products was a game changer and each drastically boosted Apple’s value.

If you’re an investor trying to justify Apple’s $534 billion market cap, the only way it can be sustained is if Apple comes up with another hit. And another. And another.

So what’s the next hit? I don’t claim to know. But Apple evangelists keep the faith that something new will be coming from the company.

However, is Apple more likely to come up with the next big innovation than Amazon?

As far as I’m concerned, the more likely candidate is Amazon, a company that’s ventured far and wide into markets never before imagined, while making the transition seamless, effective and profitable.

As an investor, Amazon may be the only company  where I feel comfortable embracing future uncertainty and trusting that the company has another trick up its sleeve.

If there’s one knock on Amazon as an investment, it’s margins.

Due to the substantial overhead for delivering all these goods, Amazon has skated by on narrow margins in the neighborhood of 1.09%.

But as the company transitions to digital content, I think those margins will start expanding. Yes, Amazon will lower prices if costs come down, but the value that a reader will pay for a movie or book will never drop as low as the marginal cost of delivering them digitally.

I’m not suggesting it’ll happen overnight, but over time Amazon’s margins will expand. Even so, Bezos told Wired, “There are two ways to build a successful company. One is to work very, very hard to convince customers to pay you high margins. The other is to work very, very hard to be able to afford to offer customers low margins. They both work. We’re firmly in the second camp.”

While many public companies are boosting margins for next quarter, Amazon is focused on providing an amazing service to as many people as possible for a very long time to come.

When you remind yourself that a stock is a fractional ownership in a business, isn’t that the kind of company you want to be an owner of?

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