Amazon makes an astonishing amount of money. For instance, its third quarter earnings for 2017 was $43,7 billion. But the margin for an e-commerce site like Amazon is notoriously small. Not only do customers demand low prices, but the costs associated with fulfilling these orders are very high. Because of this, the company’s profit during the same period was only $347 million.
On top of this, Amazon also spends a tremendous amount of money on growth and expansion. Its third quarter revenue of $43,7 billion represented growth of 34%, but its profit dipped 40% from $575 million to $347 million. Yet, despite this drop in profitability, Amazon’s share price increased by 7%. Why is this? Investors know how and why Amazon spends money.
Since its inception, the company has focused on three things:
- Low prices
- Customer service
- Long-term success.
And it hasn’t been afraid of spending money in pursuit of this. It took Amazon six years to turn its first profit, and even after that it was rarely profitable. Only since 2015 has the company become consistently profitable.
This is not because the business model doesn’t work — Amazon would make a fortune if it squirrelled away every cent it earned — but because it is sacrificing immediate profits for long-term success. The only reason its profitability took such as dip in the third quarter of 2017 was because the amount of money the company was investing in growth had quadrupled year on year.
Yes, Amazon spends a lot of money, but here’s the interesting thing
The company is also exceptionally frugal. The important thing to focus on is the nature of Amazon’s spending. It will spend millions (even billions) to improve a fulfilment centre, and it will even slash its profit margin to offer customers better prices, but it won’t waste money on things that don’t improve the company in the eyes of the customer.
Frugality is even one of Amazon’s core ‘Leadership Principles’. “Accomplish more with less. Constraints breed resourcefulness, self-sufficiency and invention. There are no extra points for growing headcount, budget size, or fixed expense,” the company document states.
When it comes to day-to-day operations, few large organisations run as lean as Amazon. While Google builds funky offices and gives away free food, Amazon does the opposite.
“Bezos enforced strict frugality in Amazon’s daily operations; he made employees pay for parking and required all executives to fly coach,” wrote author Brad Stone in a book on Amazon called The Everything Store: Jeff Bezos and the Age of Amazon.
As the years have passed and Amazon has become more financially secure, things haven’t changed much when it comes to frugality
“Evidence of the company’s constitutional frugality is everywhere,” Stone writes about the current state of the company. “Conference room tables are a collection of blonde-wood door-desks shoved together side by side. The vending machines take credit cards, and food in the company cafeterias is not subsidised. When a new hire joins the company, he gets a backpack with a power adapter, a laptop dock, and some orientation materials. When someone resigns, he is asked to hand in all that equipment — including the backpack. The company is constantly searching for ways to reduce costs and pass on those savings to customers in the form of lower prices.”
It’s impossible to scale without spending money, but it’s important to pay close attention to exactly what money is being spent on. Scaling means more people, bigger offices and better equipment, but everything you spend money on should result in a better customer experience. Don’t be afraid to spend money on things that will improve the company, but don’t waste money on things customers will never know or care about. Even if you’re scaling quickly and making money, you should be treating expenses like a lean start-up. Don’t accept an expense without questioning its usefulness. That’s just good basic business practice.
