CXO builds on themes of growth, leadership, and profitability

Analysts with Morgan Stanley Dean Witter believe the future looks bright for, a leader in e-commerce. This analysis of Amazon, based on information from company leaders, takes a detailed look at Amazon's progress and future.

Prepared by Morgan Stanley Dean Witter analysts Mary Meeker and Mark S. Mahaney, with research assistance from Mark Trowbridge
NASDAQ: AMZNPrice (September 19, 2000): $40.7552-Week Range: $113.00-$27.88
Key points held its fourth annual analyst day in Reno, NV, near one of its distribution centers. The areas of focus included:
  • Expanded global e-commerce “platform” leadership;
  • Drive to operational excellence and profitability;
  • Accelerating improvements in user experience—Amazon’s core technology expertise, constant feedback loops, and networking effects allow these to occur at wickedly fast rates; and
  • Quality of impressive management team.
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Presentations from Amazon’s management team were upbeat, thorough, and more detailed than in years past. One of the biggest takeaways was the strength and depth of Amazon’s management team. Yes, there have been some significant management changes since the last analyst day, but across a series of functions—finance, international, product development, merchandising, operations, technology, etc.—Amazon clearly has one of the most talented and experienced management teams in the business.

The three consistent themes of the day were growth, leadership, and profitability.

On growth, the simple point is that Amazon’s market opportunity is very large and growing rapidly. If you add up all the categories Amazon is currently in, we calculate the global retail opportunity to be well north of $1.5T. As more retail categories get added, the opportunity will only expand. Further, Amazon is part of the fastest growing retail platform—the Internet—with online retail sales likely to grow at a 50 percent + CAGR over the next few years.

On leadership, Amazon has clearly achieved the leading position in a series of online retail categories. Amazon has long been the largest online bookseller and now has 4.5X the number of sales as the number two company.

Even more telling, Amazon has emerged as one of the leading booksellers—online and offline—having accounted for 12 percent of the initial print run for the latest Harry Potter book, which had the largest print run of almost any book in history. In music, Amazon is also the leading online retailer with 1.7X the number of sales as the number two company. In the DVD and Video category, Amazon is again the leading online retailer with 2X the number of sales as the number two company.

One of the key new points from the analyst day, however, was Amazon’s increasingly strong positioning in non-media products—the newer segments like consumer electronics, toys, home products, etc. The three most impressive new data points: 1) home product sales increased 166 percent from Q4:99 to Q2:00; 2) five of Amazon’s top ten selling products—including the top selling item—in August were from non-media segments; and 3) almost 20 percent of Amazon’s active customers—on a trailing, 12-month basis—purchased non-media products from Amazon in CQ2. For CQ2-specific customers, the percentage was higher.

Our view here is that Amazon is demonstrating an early ability to increase share of wallet. And with perhaps the best developed e-commerce technology infrastructure in the business—in terms of proprietary personalization tools, customer relationship management applications, etc. We think Amazon is developing a very significant, sustainable competitive advantage.

Amazon’s international growth
One of the most positive updates came from’s international business segment.Non-U.S. e-commerce is likely to grow faster, and eventually be bigger, than U.S. business-to-consumer e-commerce, and Amazon is currently well positioned.

On a pan-European basis, Amazon has the three most popular Web properties—,, and—based on the number of visitors. And in almost every major European country, Amazon is the leading online retailer. Note that just announced its 2MMth customer, and had 1.6MM customers as of CQ2.
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Perhaps the most important incremental item, however, was that Amazon’s international segment is clearly enjoying scale- and learning-curve benefits. For example, Amazon’s new French store required only 40 percent of the engineering launch costs as Amazon’s UK and German stores. Also, Amazon’s European stores are enjoying higher product gross margins than the U.S. operations, due to absent or minimal pricing pressure in those markets.

Bottom line: Amazon’s international businesses are on a faster path to profitability than Amazon’s original U.S. segments, and this will benefit the company’s overall transition to profitability.

Signs of a strong leader
All in, is showing to us the signs of a strong leader. As we’ve seen with tech investing in the past, industry leaders tend to reap extraordinary gains; i.e., the big get bigger. And Amazon is clearly big.

Finally, on the profitability theme, Amazon management expressed a strong commitment to year-over-year unit cost productivity gains and laid out a goal of double-digit productivity gains over each of the next few years. Optimized inventory practices, operational excellence, and improved vendor relations have been key areas of focus for Amazon since CQ4:99.

The new data points from the analyst day showed Amazon’s progress here were: 1) variable costs on a unit basis decreased 33 percent from CQ1 to CQ2; 2) the split trend (the percentage of customer orders that had to be filled via less-efficient split shipments from different distribution centers) has declined 35 percent from CQ4 to August; and 3) long zone shipments (inefficient shipments to customers from distant distribution centers) have declined 60 percent since CQ4.

The key ways that will drive to profitability are:
  1. Improved vendor management—still in “infant” stage;
  2. Increased product gross margins;
  3. Improved procurement;
  4. Ongoing process improvements.

The proof will be in the Christmas pudding
In CQ4:99, Amazon’s goal was to fulfill customer orders at any cost, and one of the results was a $175MM operating loss. This CQ4, with its DCs at more efficient capacity, with significantly improved vendor management, merchandising, inventory, and shipping practices in place, we believe Amazon should be able to meet our $1B revenue estimate (up 48 percent Y/Y) with significantly better operating results—we estimate a $55MM operating loss. Yes, we came away from the analyst day with greater confidence in our CQ4 operating loss estimate.

As we have stated before, Amazon remains one of the leading platforms on the Web, a technology-turbo-charged, customer-obsessive, online retail powerhouse. At this game, we believe very few will succeed. We believe—75 to 80 percent likelihood—that will be one of the companies that succeeds big. The risks are high, but so are the potential rewards.

Details from management presentations
Jeff Bezos (founder and chief executive officer)
  •’s vision remains: To be Earth’s biggest and best merchandiser ever, by obsessing over customers and offering unsurpassed selection and service.
  • The long-term growth drivers for Amazon will be 1) technology—including increasingly ubiquitous computing, increased bandwidth, and emerging wireless Internet access; 2) infrastructure and secondary effects—including last mile delivery options and improved payment forms; and 3) innovation—including personalization and visual merchandising.
  • E-commerce is still in its infant stage, akin to the very first cell phones, which were like “cinder blocks” compared to today’s light, high performance models.
  • Long term vs. offline retailers. Amazon’s economic advantage lies in the fact that its cost structure is based on technology infrastructure—and computing costs generally trend down—while offline retailers’ cost structures are based on retail rent costs—these costs generally trend up.
  • Four of the key profitability drivers for Amazon will be improved vendor management—which will in part come with scale—improved inventory management, process productivity enhancements, and increased measurement/accountability practices throughout the organization. Amazon is aiming for annual double-digit productivity improvements.
  • Amazon is also focused on expanding globally, increasing wallet share from its current customers, and incorporating more innovations into its store.
  • Jeff’s “bold bets” for the future include digital delivery of products—e.g., digital downloading of books—and wireless access and applications. In both cases, however, Jeff was guarded on the impact that these developments would have near-term. He singled out voice recognition applications as one particularly promising area.

Warren Jensen (chief financial officer)
  • The current state of’s business model rests on demonstrating and improving upon the foundations of profitability, growth, and leadership. The company’s financial priorities are outlined by the following: sharpen efficiencies, emphasize execution, committing to strong Y/Y unit cost productivity in short- and long-term horizons, and achieving triple digit returns on capital.
  • Drivers to profitability: vendor management, operational efficiencies, sharpening processes across all business units, and unique aspects to model not realized yet.
  • The advantage for is that its fixed assets are not required to be as high as traditional retailers. Therefore, can focus less on capital and more on speed and efficiency. This is shown by gains in productivity—the ratio of quarterly capital additions to incremental year-over-year revenue growth has declined from over 40 percent in CQ2:99 to less than 20 percent in CQ2:00. Notably, Amazon has strengthened its customer service call centers, and built out and fine-tuned its distribution center network.
  • Inventory turns during CQ2:00 were about 12, but the company’s goal is to expand that to the 15 to 16 range going forward.
  • In the near term (18 months), is confident about its product mix and outlook for growth; investments are in place with less capital infusion needed; and the company is highly focused on boosting Y/Y unit cost productivity.

Diego Piacentini (senior vice president, international)
  • Global expansion. Diego joined in March 2000 after heading Apple Computer’s operations in Europe, the Middle East, and Africa, and is leading’s efforts in global expansion and international operations.
  • is going global by executing on the following: building similar operational processes, utilizing’s “know-how” in technology, scaling pan-European operations, and focusing on world-class customer support and inventory management. But all the while, Amazon International has to focus on outpacing local competitors.
  • Rapid execution and success—International revenue growth has increased from $57MM in 2H99 to $149MM in 2H00 representing 162 percent growth Y/Y. Amazon is the leading retail platform on the Web in Europe with the Number one (, Number two (, and Number three ( retail sites according to Media Metrix in July 2000.
  • has 83 percent presence in global e-commerce with Web sites based in largest e-commerce markets according to IDC (U.S., UK, Germany, and France).
  • Key highlight: in the UK, Royal Mail and entered into a holiday season TV advertising partnership paid by Royal Mail, which emphasizes legitimate support from a trusted local shipper.

David Risher (senior vice president, general manager U.S. stores)
  • Number one in books— is 4.5 X larger than the Number two competitor. But as an indicator of Amazon’s growth potential, Amazon’s share of its customers’ total book spending is only 20 percent.
  • Number one in music— has 22 X greater sales growth vs. nearest competitor, and is leveraging its digital download growth (40 percent M/M) to drive music sales.
  • DVD and video—growing quickly from 1.1 percent of sales in 1999 to estimated 4.1 percent of sales in 2000.
  • Electronics/technology products—September 2000 to date, it is’s second largest business, and has been projected by the company to reach $100MM in sales in a span of nine months vs. 29 months for books.
  • Toys and home products—the company demonstrated a unique popularity engine that stimulates unique demand from new customers, which could serve as a key driver for leverage in negotiating with vendors going forward.

Lyn Blake (general manager, books)
  • Formerly a VP of Sales and Marketing at Macmillan Publishing, Lyn is striving to establish as the most profitable retailer for book publishers and distributors in the industry.
  • has implemented stricter requirements for suppliers in regard to the quality of packing and shipping care in order to eliminate the cost of shipping damaged product back to vendors. Since this effort, has increased direct purchases by 11 percent, and improved average purchase discounts by 1 percent.

Harrison Miller (general manager, toys)
  • With for almost three years, Harrison launched the toy and video game segments and was largely responsible for formulating the recent alliance with
  • brings 5MM online kids product customers to its strategic partnership, and offers 1.5MM online customers and 62MM overall customers worldwide. The benefits of the arrangement offer an unmatched global reach, product expertise, and customer service.

Mark Britto (senior vice president, marketing and cross-site merchandising)
  • Currently, is the 48th most valuable brand in the world behind AOL (Number 47), an improvement from 57th in 1999, per Interbrand’s Annual Survey. Current goals are as follows: increase conversion rates, personalize Web pages for customers, administer extensive testing on the Web site, and drive wallet share among Internet shoppers.
  • Customer acquisition costs have been stable: as of CQ2:00,’s acquisition costs per customer was $17 vs. competitors such as ($25), eToys ($72), or PlanetRx ($76).
  • Sales in non-media related products (non books, music, or videos) have been rising steadily of the past few quarters (see Exhibit 1).

Exhibit 1

Jeff Wilke (senior vice president, operations)
  • Recent highlights for Global Operations—reduction in operation’s OPEX as a percentage of revenue by 19 percent from CQ1:00 to CQ2:00, which includes distribution centers, supply chain, transportation management, and administration. also increased shipping margin from 5 percent in CQ4:99 to 10 percent in CQ2:00.
  • Variable costs on a unit basis declined 33 percent in CQ2:00 from the previous quarter due to more cycles of learning and operational excellence—fewer defects and decreased cycle time.
  • Focus on inventory optimization—balancing shipping costs with working capital—to avoid high levels of split shipments that occurred especially in CQ4:99. It is a matter of planning the inventory to their best ability in the optimal DC locations.

Bill Price (vice president, customer service)
  • is applying technologies and processes in order to improve productivity and heighten customer satisfaction. Expanding and scaling globally is key to integrating the customer service platform across all businesses.
  • Currently, there are eight CS centers worldwide ranging from Seattle, to Delhi, India, to Den Haag, Netherlands. Proprietary CS rep tools have enabled to expand quickly in new markets in order to meet demands of customers 24/7.

Rick Dalzell (chief information officer)
  • Technology focus is centered on building capacity and capability. emphasized rapid growth and international expansion, as well as scalability.
  • constantly analyzes information metrics, which can provide a critical competitive advantage in the near and long term. Data analysis drives customer service, innovation, and process improvements.

The information and opinions in Tech Stock Roundup were prepared by Morgan Stanley & Co. Incorporated ("Morgan Stanley Dean Witter") and are based on information available to the public. No representation is made that this information is accurate or complete. Morgan Stanley Dean Witter does not undertake to advise you of changes in its opinion or information. This is not an offer to buy or sell or a solicitation of an offer to buy or sell the securities mentioned. Please click here for additional important disclosure information.

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