Online retailer Amazon (NASDAQ:AMZN) is facing three major challenges ahead of the all important holiday season. First, the revamped Kindle range faces competition from major rival Barnes and Noble’s Nook device range even as Wal-Mart (NYSE:WMT) takes the former’s hardware range off its shelf. Second, the company has started collecting sales tax in a number of states, including California, which is leading to higher prices. Third, it’s in the process of setting up more distribution centers to support its plan for same day delivery service, which will translate into higher capital expenditure.
Kindle battles decreased availability and increased competition
The company launched a revamped Kindle range of devices in early September. The devices came with competitive tech-specs and lower prices than those of market leader Apple‘s (NASDAQ:AAPL) iPad. The e-reader line was also refreshed with features that put it at par with Barnes and Noble’s Nook reader device. The devices were well-received and the company looked set to increase its share in the tablet market.
However, later in the month, following in the footsteps of Target, Wal-Mart decided to take Kindle products off its shelves, severely limiting the hardware’s reach in the offline market. Despite other retailers like BestBuy and RadioShack still stocking the devices, Wal-Mart’s and Target’s extensive reach means that Kindle sales will likely be negatively impacted. The second threat is from the revamped Nook device range whose launch closely followed those of the new Kindle devices. The devices match up in technical specifications putting the two on an even keel. Besides, the revamped hardware Barnes and Noble also launched a video streaming service Nook Video to directly compete with Amazon Prime Instant Video service.
We believe that the Kindle Hardware will gain market-share despite increased competition backed by its low prices, better features, an expanding video library and extensive support for the popular Amazon web-stores. If this fails to happen and the company looses market share in the tablet market, it would loose some traffic and sales from its web-stores and revenues from the ads on the device. This could severely impact the margins for the company which sells the devices at a low or below margin.
Sales tax collection could negatively impact sales
Many states are forcing online retailers to collect sales tax from consumers. With the e-commerce business now commanding a major chunk of retail sales, the states claim that they have been losing millions of dollars in revenues and hence are forcing online retailers to collect taxes on their behalf. This has resulted in prices rising by close to 10% in some cases for web based retailers. The company thus stands to lose some of the perceived cost benefit it offered its customers and this could result in people going back to shopping in physical stores. The company currently collects sales tax in Kansas, New York, Washington, Texas, North Dakota, Pennsylvania and California. The states of Tennessee, Indiana, Nevada, New Jersey, California and South Dakota are expected to join the fold by 2015.
Distribution Centers to facilitate same-day shipping
Online customers love same-day shipping and the company is moving ahead on its plans to leverage it. It is currently in the process of setting up new distribution centers in several states to enable the service. We think that fast shipping like same-day could be less important than low prices, especially since there is already a one-day shipping option for Amazon customers that pay more and may not result in the company gaining back the business it might lose as it starts charging sales tax. The initiative is not cheap for the company which is investing heavily in the fulfillment centers.
As part of the efforts to mitigate the effects of sales tax collection and capital expenditures on distribution centers, it has been trying to strike deals with states which would enable them to postpone the tax collection in return of investing in the state by setting up distribution centers. Capital expenditures almost doubled for the company from about US$ 980 million in 2010 to about $2 billion in 2011. We expect the expenditures to maintain the growth rate in 2012 and have a major impact on its margins.
We have a $222 estimate for Amazon which is 15% below the current market price.