The United States of SCAmazon
The Market Ticker - Commentary on The Capital Markets
2017-10-27 20:55 by Karl Denninger
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The United States of SCAmazon
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Refer to the table in this article -- note how Amazon is turning nearly a negative 20% margin on goods sold not including SG&A (that is, their sales and administrative expenses, such as the buildings and their employees) but only counting the cost of goods sold and their fulfillment (shipping and warehousing) expense.

I wish to note that generally cross-subsidizing is legal provided it's not done for an unlawful purpose.

For example it is legal to sell something as a "loss leader" to get people into your store in the hope that they will buy a profitable product or service (which makes enough profit to cover the cost of both), whether that other sale takes place at the same time or somewhere down the road.  There's nothing illegal about using a "teaser" product to get people to shop with you, in short.

However, if the purpose of said intentional selling at a loss is to destroy competitors in your market and you have the market power to do so that's against the law under the Sherman Act.  In fact, it's a felony.

Every person who shall monopolize, or attempt to monopolize, or combine or conspire with any other person or persons, to monopolize any part of the trade or commerce among the several States, or with foreign nations, shall be deemed guilty of a felony, and, on conviction thereof, shall be punished by fine not exceeding $100,000,000 if a corporation, or, if any other person, $1,000,000, or by imprisonment not exceeding 10 years, or by both said punishments, in the discretion of the court.

Note that you not need to do this between two or more companies -- it is entirely illegal to do so within the walls of one firm alone.

Corporations exist for one purpose alone -- to make a profit.  This does not mean that every firm succeeds in making a profit, of course.  In point of fact 8 out of 10 new firms fail within five years as they are unable to meet the essential test of "business" -- turning a profit.

But look at this, which is an extension of the table I created earlier -- it goes back more than five years and is taken from the SEC's filings made by Amazon.

DateSalesCOGSSales/Cog %FulfillmentNet% Profit
2013/Q1132711180112.46%1796-326-2.46%
2013/Q2127521120913.77%1837-294-2.31%
2013/Q3138081236611.66%2034-592-4.29%
2013/Q4210721880612.05%2918-652-3.09%
2014/Q1157051405511.74%2317-667-4.25%
2014/Q2152511339913.82%2382-530-3.48%
2014/Q316022146279.54%2643-1248-7.79%
2014/Q4231022067111.76%3424-993-4.30%
2015/Q1170841539510.97%2759-1070-6.26%
2015/Q2171041516012.82%2876-932-5.45%
2015/Q3184631675510.19%3230-1522-8.24%
2015/Q426618243419.35%4546-2269-8.52%
2016/Q120581188669.09%3687-1972-9.58%
2016/Q2211161918010.09%3878-1942-9.20%
2016/Q322339212605.08%4335-3256-14.58%
2016/Q430629289585.77%5719-4048-13.22%
2017/Q123734224405.77%4697-3403-14.34%
2017/Q224745234515.52%5158-3864-15.62%
2017/Q328768275494.42%6420-5201-18.08%

This is Amazon's sales of goods (ed: Before attacking this table, read the italicized portion at the bottom.)

Their top-line margin (simply sales divided by cost-of-goods sold) has gone from 12.46% to 4.42%, a collapse of approximately 65%, over that period of time.  At the same time their operating loss not including general and administrative costs, nor marketing -- that is, just the cost of the product and "fulfillment", has gone from -2.46% to -18.08%, an explosion of more than 730%.

The argument could be, of course, that there are "other than COGS" in that number.  Well, ok, but read on below and then keep trying to find a scenario under which that claim fits for material components of that figure.

You see, what's most-interesting in the table is that in approximately the third quarter of 2016 the company basically gave up and surrendered, essentially "throwing a switch", removing 500 basis points of markup over cost in a step function that has no rational explanation among any change in the mix of products and services sold that occurred at the same time.  I have not seen one word out of the analyst community (or the company for that matter) on this.  In fact all the analysts have been "cheering" on the "acceleration" of the firm's prospects and results, with the stock price going from $700 then to $1105 today. Yet it appears that Amazon went from losing 10% on all the goods it sold to 18% or nearly double the loss during that same time period.  The latest escalation in loss during the most-recent quarter is associated with ramping fulfillment expense (up 35% in one quarter against a 16% sales increase) which the firm tried to "dull" by taking another 110 basis points off its "cost" markup!

The company now, it appears, loses approximately one dollar in five whenever someone buys a "thing" from Amazon.

This is not some startup attempting to claw its way into relevance; it is a mature firm that employs tens of thousands of people and yet over the last five years it certainly appears it has been incapable of growing its sales of physical product without losing more and more money on each and every sale.  Instead of finding itself with a near-zero stock price both analysts and the media trumpet how "successful" the firm is at being a retailer!  Thanks in no small part to the fawning that the media and analyst community has served up upon a credulous public and their intentional burying of the truth the stock price has more than quadrupled from roughly $250 in early 2013 to over $1,100 today.

It certainly appears that Amazon has "purchased" their increase in the gross sales of goods by literally giving product away at an ever-increasing loss -- a loss that has now reached nearly 20% across the entirety of nearly thirty billion dollars in goods sold last quarter.

Given the amount of data Amazon has and the utterly-stunning percentage of loss they're taking in that regard I'm willing to bet that a nicely-aimed subpoena would show that the company is well aware that the only way they could continue to grow sales to any material degree is to displace existing retailers by intentionally selling at that ever-increasing loss -- and that this is exactly what they're done.

More to the point there is nothing else Amazon sells to consumers that can possibly make back the $5.2 billion dollars lost last quarter through this practice, so any argument that this tactic amounts to a "loss leader", given more than five years of history, is almost-certainly an easily-proved lie.  Specifically,  subscription services (including Prime membership fees, digital video and music, e-book, etc), many of which are sold to consumers, account for only $2.4 billion in gross receipts last quarter.  Amazon does not break out the cost of those services and they have always refused to itemize them but even allowing for a very large (e.g. 50% or more) margin those services cannot possibly be profitably cross-subsidizing the loss on product sales; there simply isn't enough money received from them to do so.

Therefore the purpose of such an increasing, five+ year ramping change in intentional operating losses in the company's product sales segment, assuming it is as it appears to be, has to be called into question.

The effect of these actions, however, on other companies in the consumer product space is not open to question -- witness the myriad and daily mention of various retail channels and individual retailers being "Amazoned" in the media and on conference calls.  In the latest point of attack which I assume the company will also apply this "strategy" to Amazon is apparently attempting to enter wholesale prescription drug sales.

It is perfectly legal to out-compete other sellers by doing more with less and thus having a lower cost structure in your business.  This in turn allows you charge a lower price and gain market share.  That, in fact, is exactly what innovation and competition (otherwise known as "productivity improvement" in the economic field) is supposed to do.

It is not, however, legal to cross-subsidize the sales of your products with another, disjoint services business within your company so as to allow you to sell products at an intentional loss for the purpose of putting others out of business in an attempt to monopolize sales.

The financials disclose that the funding source for Amazon's practices in general is AWS service sales, a completely disjoint service (from the perspective of the consumer who has no reason to buy or use such a service) that happens to be quite profitable on a free cash-flow basis.

Not one person within a state or the federal government has come after Amazon for this pattern of conduct in inquiry of why they are engaged in behavior that I can find no rational explanation for within the boundaries of lawful and fair competition as disclosed to both the public and regulators by their published financials and operating results.

In fact, the pattern strongly suggests that Jeff Bezos and Amazon are using AWS as a vehicle to intentionally drive competitors out of the market in the sale of goods not by out-competing them in cloud computing services but instead by destroying competing retailers of goods through rapidly-accelerating cross-subsidization and intentionally selling goods at a loss which they know their competitors cannot do.

I remind you again that attempting to monopolize trade is a felony.

Just like the medical scams that are rampant in our country and have resulted in ridiculous ramps in health insurer and drug company stocks over the last few years, all of which are based on collusive behavior that I argue amount to extortion Amazon has been rewarded for the latest display of this behavior with more than $120 being added to the firm's stock price on Friday alone, a roughly 12% increase, and has been rewarded enormously over the last five years for same with a more than 400% increase in the price of their stock.  This has inured personally to the executives of the firm, including most-specifically their CEO, Jeff Bezos who has seen his personal wealth swell by tens of billions of dollars while his company appears to have intentionally sold products at ever-increasing rates of loss and destroyed the jobs of tens if not hundreds of thousands of people along with severely damaging or destroying myriad competing companies in the retail space.

I argue the rampjob in the market in general through the mid 2000s happened because of rank lawlessness, just as I know for a fact it did in 1999 as I was running a firm in that space during the 1990s and saw both many competitors and suppliers present projections and claims that were fanciful fictions peddled not only by the firms themselves but by so-called "analysts" and the "media."  Not long after billions of investor dollars were vaporized in the 2000 crash as those works of fiction were exposed.

Eight years later the market crashed in 2008 again because it appeared the people who were scamming would go bankrupt and some might go to prison -- which, from the available evidence, it certainly appeared should happen.

The market bottomed and turned sharply upward almost to the day that Congress declared the blatantly illegal practice of calling an asset valued at whatever you wanted it to be instead of what someone would pay for it a lawful practice.  In other words, nobody was going to go broke and nobody was going to jail either despite the fact that by then we had proof of those firm's practice of selling to customers things described as "good securities" which their own employees were calling "vomit" in "private" conversations among themselves.  The price of vomit, of course, is actually negative (since you normally would have to pay someone to clean it up!)

We have witnessed an unprecedented ramp in the market over the last few years and of those firms that have risen the most I can point to companies just like this one that have no rational legitimate explanation that I can logically put together for their business decisions and behavior.  All explanations that I can analyze which are plausible in light of the public facts devolve into screwing someone, smug in the knowledge that they won't be investigated and punished for doing so, just as they weren't in 2009 and 2000.

What's worse, every bit of this is happening with the explicit complicity and even active promotion of the media, so-called "analysts" who intentionally ignore imploding margins and treat them like they're "good news" along with our own Government, including the President of the United States.

I hope you like getting screwed without being kissed first.

Editorial note: There have been raised questions about the "Cost of Sales" line and what part of services are in there. Here's the issue with that claim: When it comes to pure services there is no good bought first (in other words, cost of goods is zero because there are no goods.)  Second, AWS is said to be 11% of sales (net-net.)  Third, AWS has its operating expense broken out which are claimed to be $3.4 billion, all-in last quarter.  Fourth, for "other services" note that their cost is in fact broken out (tech & content) and that's a high-margin business, as is AWS.  Note that tech&content + G&A + other + marketing = $9.4 billion. Anyone who doesn't believe nearly all (if not all) of AWS's operating expense is absorbed in that $9.4 billion, along with the rest of the cost of other services that are sold (for which there are no goods purchased), has rocks in their head, given what AWS is (a pure service that consumes a shad-ton of electricity and tech expertise which is quite expensive to hire and feed, .vs. $10/hour warehouse peeps that are not.)  Finally, as  the son of a former CPA (now deceased) who was none-too-shy about his experience in this regard with me, never mind my observations with regard to WaMu's "accounting" in early 2007 in which they were paying dividends out of capitalized interest (an accounting entity that doesn't exist in actual cash, I note) let me simply observe that the art of accounting is that exactly how you silo various expense items is, shall we say, subject to quite a bit of "discretion" provided the amounts all total up at the bottom of the page -- and that such discretion is generally-speaking legal.  In addition and perhaps of greatest importance I note that nobody ever hides good news, which means that if that cost item wasn't nearly all COGS it would be broken out in specific detail so that the "good news" would be apparent and on paper, but if it was broken out in such a fashion and later proved to be a lie there would be criminal sanction associated with doing so.  Thus my commentary about a "well-placed" subpoena up above -- not that I believe we'll ever see one.

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