Profitless Prosperity

If a Company is making huge profits this year but will not make any profits in the future, it is worthless in the eyes of an investor. But if it loses money this year and next year and may lose money for a few more years, it can still be very valuable in the eyes of an investor.

Amazon had negative net income in 2012 and pretty much zero net income this year to date. And yet it is worth $166bn in the eyes of investors.

This is because companies are worth the present value of future cash flows, not current cash flows, and certainly not past cash flows.

Amazon is not the only company that is plowing back all of its incremental profits into growing its business. This is very common for enterprise software companies as well. Salesforce has made or lost a small amount of money every year for the past four years but it has grown its revenue from $1.3bn to over $3bn in those four years. And its market value has gone from $12bn to $32bn in the same time frame. Workday hasn't made any profits in the last four years, in fact the net losses have been increasing. But the stock has doubled in the past year and the Company is now worth almost $14bn.

The lesson here is that you can't just value a company by taking its current performance into account. You really need to have a view towards its future performance. And you need to understand why the company is not currently profitable.

In the case of Amazon, it is making huge investments in warehouses and logistics to be able to continue to grow its retailing business and it is making similarly large investments in data centers to be able to continue to grow its AWS business. If Amazon did not want to continue to grow, it could stop making those investments and start generating profits. If you believe, as Amazon management does, that the future growth is going to be there for Amazon, then you ignore the current P&L and think about what a future P&L might look like. 

In the case of Salesforce and Workday, they are making huge investments in sales and marketing to secure additional customers. They are also making significant annual investments in R&D to maintain the market leadership of their existing products and bring new ones to market. If you think that Salesforce and Workday can continue to grow their revenues at or near their current growth rates, then you ignore the current P&L and think about what a future P&L might look like.

Profits are critical to the health of a business, but that doesn't mean a healthy business has to currently profitable. It needs to be able to be profitable if it wants to be and it needs to be profitable at some point in the future, at least hypothetically. So when you read that a company is losing money, don't read that as a bad thing. It could be a very good thing. It all depends on why. 

#MBA Mondays#VC & Technology

Comments (Archived):

  1. Dan Lewis

    I wish baseball teams understood this. Well, the Mets at least.

  2. Dave Pinsen

    In the case of Amazon, how much of the lack of profits is the result of selling products at a loss to drive out competitors (or force them up accept a buyout)? I’m thinking of the example mentioned in that recent book excerpt:

    1. JimHirshfield

      That was a great article.

      1. Dave Pinsen

        Yeah. Amazing how Stone tracked down Bezos’s biological father who had no idea Bezos was his son.

  3. JimHirshfield

    So, the 3 most important factors here are potential, potential, and potential?

    1. falicon

      I think it’s actually growth, growth, and growth…which goes hand-in-hand with execution, execution, execution…of a plan, plan, plan.It’s not the potential Amazon is valued on, it’s the execution and belief in the plan they are executing on (which all relates to growth until it’s all encompassing)

      1. JimHirshfield

        Perspective, perspective, perspective.

  4. William Mougayar

    I saw that meme develop on and I thought you would add Twitter to these examples, although you did explain that their R&D expenses were skewed by the stock options related to it.Nonetheless, what is common to all these companies is an absolute focus on re-investment to fuel further growth. So, they are doing it to secure their future via growth.But these companies can do this because they have excellent visibility into their growth potential, by seeing the demand and being ahead of serving it. Amazon was adding something close to 12,000 employees this year, and just eclipsed Microsoft in total # of employees.It makes you wonder what that strategy would do to Apple, if they re-invested more, and profited less.

    1. Dave Pinsen

      Including Twitter in this post would have been unsubtle.

      1. William Mougayar

        Twitter’s financials are a bit distorted now, due to the S1 blip.

    2. Jerome Camblain

      Twitter was in there; It was actually the topic of the Fred’s piece…eventhough I could feel it was painful for him to write such a timely post. But had to be written I guess.

      1. William Mougayar

        In this post? I don’t see them mentioned.

        1. Jerome Camblain

          between the lines!

    3. LE

      Amazon was adding something close to 12,000 employees this year, and just eclipsed Microsoft in total # of employees.Just a guess but I would imagine the average MSFT employees is paid much more than the average Amazon employee. Also amazon ramps up by season of those 12k employees I wonder how many are permanent. And what their pay level is and job description.

      1. William Mougayar

        Correction: Amazon added 12,800 employees in the past 3 months, and 28,400 in the past 12 months, so they can’t all be seasonal.

    4. fredwilson

      twitter is going public and USV owns 27.5mm shares. no way am i going to talk about Twitter right now

      1. William Mougayar

        Good point!

      2. JimHirshfield


      3. Matt A. Myers

        That’ll add up to a nice chunk.From what I’ve read of where the stock offering will be at, I feel it will go up from its starting point.I’m thinking that it’s being priced low as to share some profits and create a good feeling about Twitter – and then allowing them to sell more shares in future at a higher valuation.Not expecting a reply from you Fred. 🙂

      4. JLM

        .Good idea because your personal color palette does not work with prison stripes, no?I would still come visit though.One must behave when dealing with public companies and IPOs.JLM.

      5. Donna Brewington White

        Oh, but when you can and do, I want a front row seat.

    5. Thomas Mullooly

      (warning, potential thread drift) Icahn aside, what *is* Apple going to do with all that money?

      1. pointsnfigures

        I feel like blogging about this, and may. Buybacks don’t benefit anyone except top management. Icahn has held the stock for what a week? It’s burning a hole in his pocket. Hope they drive the stock lower so he takes a beating on this one.

        1. PhilipSugar

          Depends on management ownership. I bought back stock and it was motherloving beautiful.

      2. William Mougayar

        They could create Apple Ventures, like Google Ventures, or fix iCloud.

  5. Matt A. Myers

    A few days ago, I wrote a blog post entitled “Amazon Not Hard For Profits, Naivety At Play” in response to what I noticed as a general fear and worry of consumers that companies that aren’t profitable are somehow strained or in trying times.If anyone’s interested –

  6. Matt A. Myers

    This is why those who understand the early and true value of companies like Tesla, over those who simply go by numbers – likewise VCs who use theory and understand business models very well can understand what value a company could obtain even when it’s pre-revenue – perhaps even if it’s not even built yet.

  7. awaldstein

    I woke up to find this quote on the first piece I read:”If I were an Amazon competitor, I’d actually regard Amazon’s current run of quarterly losses as a terrifying signal. It means Amazon is arming itself to take the contest to higher ground. The retail game is about to become more, not less, punishing.”Remains of the Day is a great blog to discover when you are looking for some serious thinking on Amazon.

    1. JimHirshfield

      That’s a hard truth. And everyone in online retail is in competition with AMZN.

      1. awaldstein

        They don’t win at all of the segments but they keep coming back!They are about to be a three time loser in the online wine biz but my bet is that they will be back at it.Amazon is kinda unbeatable for things that sell themselves–a catalogue. They are really poor at selling, as are most online stores.

        1. LE

          In certain types of bricks and mortar retail discovery is the big problem.Some retailers are really good at this though. For example Walmart excels at getting people to spend money on things that they didn’t come into the store for. Ditto for Supermarkets. They tap into emotions, needs and wants.Otoh, the local wine warehouse (perhaps 3k square feet) is shelf after shelf lined with bottles upon bottles and and I have no clue what to buy other than what I’ve purchased before.Or the local chinese or sushi restaurant where you don’t know what dish you should try on takeout other than the one you’ve ordered before.

    2. PhilipSugar

      If you are trying to compete against Amazon for people that are buying things you are doomed.Those that are shopping. Nope.

      1. awaldstein

        Yup.Shopping online is a hard one on its own right.Some are doing a good job of this–fashion especially. I like and buy from LuLuLemon for workout clothes often.

        1. Andrew Kennedy

          I was told that lulu lemon’s brand with women has been badly tarnished since it broke that many of their pants are actually see through. kristin said there was a big shift as a result.

          1. ShanaC

            Agreed. I’m currently in the market (I wore out my others) and lulu lemon seems ehhhh. But I wish I knew what else to try

          2. Andrew Kennedy

            kristin rec’s Stella mcCartney for Addidas. She also likes beyond Yoga. Also GAIAM.

          3. awaldstein

            I’ll check them out and ask Lianna what she thinks.

          4. Richard

            Need innovators in this space.

          5. bethweinstein

            this is good to hear, I’m working on this! 🙂

          6. CPNY

            You could try , I have no experience with them, but seems like they work on establishing an alternative to lululemon…

          7. awaldstein

            Hmmm…I can guarantee that this is not the reality for guy’s stuff and I wear a lot of it to the gym.They do a great job with viewpoints and color displays and come pretty damn close to ‘selling’ effectively.I’m checking with Lianna on this point but for me, in the gym every day, their product does rock.

          8. Richard

            There are certain niches that amazon will have a tough time with. Higher end sports apparel for women for the wholefoods shopper is one.

      2. muratcannoyan

        Product discovery is still very time consuming and is usually better handled by sites that specialize. I would love to know how many people after their shopping experience online go to amazon to check price.

    3. Richard

      The 3 legs of value: The first component of value is assets (tangible and intangible), the second component of value is future earnings, and the third (and most overlooked) is the efficacy with which retained earnings will be deployed in the future. When you see all 3, you have something special.

    4. Elia Freedman

      I enjoyed this BusinessWeek article on Bezos and Amazon from a few weeks ago:…In it there is an interesting story about how Bezos “outbid” Walmart for that reminded me of your later comment about Amazon and wine.

      1. Nik Cubrilovic

        that BW article is an excerpt of his book, ‘the everything store’ which came out last week. it is pretty good, I couldn’t put it down when I started reading it yesterday and read it all the way through:

    5. ShanaC

      Old school retailers are already very scared or have a lot of hubris. What many don’t have is a model to not compete with amazon at its own game

    6. William Mougayar

      I received 2 free rebates from Amazon totalling about $35, in the past 2 months, and I don’t know why. If they are issuing these to million others, there goes the profit out the door.They didn’t really have to do that. It doesn’t really make me spend more or less with them.

      1. awaldstein

        Don’t know.I spend a ton (cause I buy everything through them) and to my knowledge have never received a rebate.They are the most data driven company there is. They are not doing this to you either randomly or without proof that it is doing something.

        1. William Mougayar

          They are definitely data driven. One Gift Card was $21.26 and the other was $12.93. I’m sure it wasn’t a human that came-up with these numbers. Maybe it’s related to my Amazon Visa rewards card, but it doesn’t even say that.

          1. awaldstein

            too weird.

  8. takingpitches

    #internetmetaphoroftheweek”Joey Chestnut doesn’t just wake up one day and win the Coney Island hot dog eating contest every year, he has to spend months of training to prepare his digestive system for the feat. “

    1. fredwilson

      yeah. i liked that too

    2. Donna Brewington White

      But yuck what a diet. I hope he is also working on his digestive and immune systems. Although not sure how that fits into the metaphor.

  9. youflavio

    All that is Ok Fred but do you like Bezos as a guy?

    1. fredwilson

      i don’t know him

  10. LE

    In the case of Amazon, it is making huge investments in warehouses and logistics to be able to continue to grow its retailing business and it is making similarly large investments in data centers to be able to continue to grow its AWS business.A few red flags with Amazon though.For one thing regular “investors” don’t have access to the exact detailed breakdown of all their financial data [1].That black box is like a husband and a trusting wife (that ends up getting screwed in the end). The wife knows enough to know in general the husband works hard (and it seems all the time) but she doesn’t really know if he is using some of that time to cheat on her as well.Many of the things that you mention, and that others have mentioned as far as why Amazon is not profitable, can be handled by amortization and other accounting techniques to give a truer picture of the real profit of the business. So what Amazon is doing is really trying to game the numbers but (as companies do) getting all the bad info out at one time so that in the future the numbers look better.Any expense allocated to building a warehouse or investing in AWS can be strung out over many years because that warehouse (in simple terms) will be used over many years.Employing extra salespeople (your Salesforce example) is a bit different as is advertising to gain customers.But it does seem that people are really going along with the party line as far as that Amazon could be profitable but chooses not to. Which of course could be true or could be false. Just like the husband you don’t really know unless you have access to the exact info in the black box. Bezos of course has been playing this since the 1990’s and it has apparently worked for him. And most importantly you don’t know what the future holds as far as competition and other factors. It’s not guaranteed that Amazon will rule retailing.I’ve noticed some chinks in the armour as far as my amazon purchases and how the fast growth and dominance that they have is coming at the expense of the utility of being able to buy what you want from amazon. The experience of buying something at Amazon that you don’t know about is quite difficult and takes to much time. This opens up opportunities the same way people ended up feeding off of the same types of drawbacks at craigslist.[1] From what I have read so I’ll assume that that’s true for the purpose of this comment.

    1. fredwilson

      there’s a good post on that issue which i linked to…

      1. LE

        I started to read that when it was on HN but I forked.Why?Because it gave the example of this “strange piece of machinery”.…So I thought, “how much could I buy a new one on ebay for?”. And the price was many thousands less.So then I took a product that I knew very well, a Canon DR-X10C production scanner (I own one and I have sold scanners and know the channel a bit) and it was the same thing.The Amazon price was way over the market price of this machine.But not only that it appears (and this is important) some shill companies selling it at inflated prices. Meaning something is fishy here. Not just one shill company but many. That don’t come even close to specializing in this type of gear. They don’t even have real stores or locations or addresses and they appear to sell a bunch of low price products in their stores. (That’s where I stopped doing research it was late last night). Could they just have come upon a brand new scanner and decided to sell it at an inflated price? Possible but not likely. And for such a niche product why are there so many at inflated prices?I’m not sure if these schills are actually Amazon owned or someone is gaming something. But it seems unlikely that a company selling a bunch of low priced crap would happen to have a brand new DR-X10c that they overprice and sell by Amazon.If I had more time I’m sure I could find more examples of this.Click on pictures for larger view.

    2. Humberto

      So true. I wonder why investors aren’t more adamant about getting revenue and profitability info per biz from amazon. The Internet has many examples of companies like Fred mentioned (investing “operational earnings” into growth), but plenty more bullies: Businesses it’s really hard to imagine as profitable, but easy to see how bigger companies may need them as ways to fend off competition. A few bullies even keep growing by buying smaller bullies. (I’m thinking groupon).I guess it’s never been harder to difference (online) investment opportunity from Ponzi schemes.

    3. kidmercury

      if you look at amzn’s free cash flow generation you can see it is a legit business model that can turn up profits any time they want to.

  11. Donna Brewington White

    Reading this post I am reminded of playing Monopoly as a kid with my Dad. Being alarmed as his stack of bills dwindled because he was scattering hotels around the board. And he would say in this smug voice “You have to spend money to make money.” And then proceed to take us little cash hoarders down.The older I get the more I am learning: It’s all about investment. In business. In life.

    1. fredwilson

      monopoly is a great way to learn about business. so is poker.

      1. Perry Ismangil

        Why poker?I don’t gamble, so am I at a disadvantage to poker players then? 😛

        1. Matt A. Myers

          You learn strategic thinking about how to play your hand, the cards you have in your hand – and also creating a mental model of trying to think through what opponents might do – and potentially based on the pieces (cards) currently visible to everyone; There are assumptions you can make based on the rules of the game – there are rules with business models too.

        2. Thomas Mullooly

          Chess too!

          1. Matt A. Myers

            For whatever reason I’ve never been able to memorize the rules for chess, maybe just never was taught in a way that would help me learn – through patterns, etc.. though I’ve always thought learning chess would help me significantly in structuring very defined strategy in business.

        3. pointsnfigures

          Poker is an incredibly great learning tool about probability, risk taking, bluffing, negotiating (sort of) and getting along with partners. I played poker every Friday and Sat night in high school (since no one could get or afford a date). Learned a lot around that poker table.

          1. Richard

            Studying Probabiliy is a cheap way to learn about pocker, playingn pocker is an expensive way to learn about probability.

          2. pointsnfigures

            depends on the stakes. I always found paper trading didn’t teach you anything. But, even playing cards for pennies and nickels as long as you discipline yourself is a good learning experience. My buddies and I would mow lawns, do all kinds of odd jobs just to get the dough to play cards. If we made enough, we’d either have to conserve it for the next game—or try and get a date to the $1.50 movie. I didn’t go on too many dates…

          3. Donna Brewington White

            Ha! That’s a great story. Dating is overrated BTW.

          4. Cam MacRae

            Indeed. But you’ll never forget the lesson.

          5. Druce

            There’s more than probability… there’s reading your opponents, combining the two to predict how they will behave, and act profitably… if your money (and pride, really) isn’t at risk you don’t really learn… you can study probability and volatility but in the end what makes you act is how you measure them in your gut, ie ‘vomitility’, poker teaches you to deal with that.

      2. LE

        monopoly is a great way to learn about businessA great way to learn about business is to actually either run a business or try to do actual buying and selling of something with some product or service. Even on a small scale. Why not make money and have fun at the same time?

        1. Matt A. Myers

          It’s a good way to learn about a few business models and monetary ‘rules’ or ‘laws.’ Money management too.

          1. LE

            I don’t play monopoly and if I played it as a kid I don’t remember it.So my question is (which is simplistic) do people cheat at monopoly and how is that viewed as far as winning the game?Because part of being good at business involves being devious enough to border on the illegal. And knowing that exact balance (like a man on a tightrope).

          2. Guest

            “Because part of being good at business involves being devious enough to border on the illegal.”Oh.

          3. Thomas Mullooly

            “Because part of being good at business involves being devious enough to border on the illegal.”Oh?

          4. LE

            Ethics or honesty in business is not clearly defined.For example I have a piece of property where the tenant is moving out.The realtor that is handling the property is the same realtor that is taking the tenant to their new property which was being built.They didn’t spend time actively marketing my property to new tenants because they were holding out (I presume not like they admitted this but it was obvious by several observations) in order to give the current tenant the most flexibility as far as when the fit-out on their new space would be ready.Now if they were 100% honest and ethical they would have either a) spent time marketing it to the detriment of the current tenant or b) told me “hey we don’t want to spend our time and effort marketing this property because then it will be a pain to get the current tenant into the new space”.So they acted in their own self interest without any disclosure of their motives or what was good for them (or the current tenant) as opposed to what was good for me (who hired them to market the property to new tenants).None of this surprised me nor was I upset. Of course it was not illegal and doesn’t matter whether it bordered on unethical or not.But the fact is people operate in their own self interest and push the limits of what is the probability of getting caught and what the penalty will be for getting caught. And what plausible deniability there is to their actions.Some large businesses clearly violate all sorts of rules and then use money and lawyers to clean up the mess later. That’s obvious, right?

          5. Matt A. Myers

            You can’t really cheat – I suppose unless you’re managing the bank and take more than you should for yourself. Generally you pick someone trustworthy at the beginning to be the banker.Honestly I don’t even know how you win the game anymore. :)I disagree with your conclusion though – bordering on the illegal. I would prefer bordering on morale boundaries – though those are all individually defined.

          6. pointsnfigures

            It’s great for kids. Hard to cheat if you can read the rules.

          7. Dave W Baldwin

            But you have to change some of the cards like “Doctor’s Pee’ pay $150” and so on

      3. Druce

        Poker! blogged about it a while back http://blogs.cfainstitute.o…Being able to deal with risk rationally is apparently the opposite of everything humans have evolved to do… people are either irrationally fearful and fight-or-flight… or blissfully ignorant and focusing only on the upside.Someone who is able to act rationally in the face of risk will extract value from the weaker and more fearful, and take advantage of the irrationally hopeful.

      4. FlavioGomes

        Fred, while I really enjoy a good game of poker now and then, I find its use as a business analogy to be complete horseshit. I go into a friendly game knowing that bluffing and misleading is an accepted part of the allure. But as a business reference, the vast majority of tactical poker is old school thinking. Folks who approach business as a zero sum game, and try to bluff their way through business building would be better served heading to the casino. If a customer, partner or employee approached me in that manner and I uncover their bluff….. It would be the end of them.

  12. Nicole

    It’s all about free cash flow…I think net income is almost irrelevant

    1. kidmercury


  13. reece

    this is how investors *should* think, but it’s not necessarily the standard (at least in my own experience and vicariously through founder friends)many stories go like this: startup has a business with some revenues. they’re really good, not amazing, but impressive, but in spite of being in a HUGE market (albeit one that most investors don’t understand) investors say “sorry that’s not good enough/interesting/etc.”contrast that to consumer apps and it’s somehow easier for investors to make the jump to “well, yeah if you get the audience you’ll make money on it.”****my company falls into the latter bucket, and we knew that from the get-go… just frustrates me to see friends with the former story hearing “no” for the wrong reasons

    1. LE

      Investors job isn’t to do the right thing. It’s to make money by what they feel comfortable with based on their knowledge, past investments and experience.If one decides to participate in the startup lottery one decides to accept that the outcome can be totally random and not based on merit or effort or qualitative factors.Just like if someone decides to participate in the entertainment business lottery.In sports of course this doesn’t happen, does it? I mean is there a case where a guy appears to be the fastest runner but the coach chooses the 3rd fastest runner? Because it quantitative and easily judged.

      1. reece

        sure, but you significantly increase your odds with some basically proper analysis

        1. LE

          increase your oddsI’ve always felt that the fact that there are multiple angel and VC investors in a, um, “gamble” lessens the chance that any individual investor will want to expend energy to help that startup in any significant way.After all how much can you put in (for your small percentage) knowing that what you do will only benefit you a small amount rather than a much larger amount [1].Likewise, for example, if you run a business and there are 4 partners the chance of 1 working extra hours is much less than if it’s his sole business. Unless said partner gets a bigger cut of the action. He will feel like a schmuck for staying late and working weekends if the others are off playing golf.Investors want to improve their odds? They need to band together to the common good by providing more specialized assistance to their investments not just ad hoc here and there. That would probably be difficult to pull off it’s not the low hanging fruit and doesn’t really dovetail to the way most investors seem to operate.[1] Same reasons a realtor will fold their hand in a deal where they get a small commission rather than the additional gross increase. This was talked about in one of those “books” but it’s obvious on it’s face from human nature.

  14. Jason Crawford

    As hinted at in that Eugene Wei piece, you should really think of a growing business as a portfolio of businesses. The older, more established businesses within the portfolio might be making money, which is then used to invest in newer businesses, which are still burning cash. If cash flow is managed well then free cash flow can be near zero.This can be true if a business is expanding geographically, in which case you want to look at older, established geos vs. new ones. It can also be true if a business is expanding its product line, like for example if you were a retailer who started selling hosting services and then e-readers.

    1. LE

      Otoh the world is littered with failed companies (as the saying went from “Swim with the Sharks”) that didn’t “stick to the knitting”.…Noting though that many of the businesses featured in that “fawning” Tom Peter’s book didn’t pan out over time for one reason or another. Because business changes over time.Peters of course was a writer selling books. He definitely succeeded at that.In hindsight any strategy that a company takes can appear to be the right or wrong strategy depending on the outcome. Not only that but you never have a population of like data to compare ones who did the same and failed.

    2. JLM

      .Public companies have to declare and report on “segments” if for no other reason than to comply with goodwill valuation requirements under GAAP.It takes a very careful read to understand these segments and they don’t show up in consolidated income statements, balance sheets or statements of cash flow — the capital “F” financial statements of a public company filed with the SEC.They show up in the footnotes and a careful read of the Amazon footnotes reveals some very healthy subsidiary businesses and some sick ones.The big consideration is total corporate overhead including costs of financing.JLM.

  15. Thomas Mullooly

    Fred, as an advisor, this is a really clear explanation to get individuals to understand what’s happening with AMZN. And CRM too. Thank you. Tom

  16. PhilipSugar

    Spending money on infrastructure in a low margin business which makes your COGS low = investment = win.Spending money on sales and marketing in a SaaS business where your COGS are higher than your low cost competitors like Sugar CRM (love the name) or Zoho = growing to fit the size of the acquarium = lose

  17. jason wright


  18. Mike Bestvina

    “In the case of Salesforce and Workday, they are making huge investments in sales and marketing to secure additional customers.”I’ve a bit of an issue with this. As someone with an enterprise background, I don’t believe this logic is correct. To give you some background – I’ve had such a conversation with one of the global sales director of SAP on how SAP plans to incentivize it’s sales force by selling essentially the same technology solution at a lower price (i.e. cloud vs on-premise). Without bringing into discussion the incentivizing employee aspect, it did draw out his conclusion on why cloud companies are growing with little to negative profit margins. (btw – on-premise support contracts yield a roughly ~90% gross margin, and SAP earns roughly ~20% profit margin across the board) His thoughts for the reasoning of SaaS companies’ high PE ratios was that SaaS offerings naturally reduce cost of sales. In other words, the software is easier and cheaper to sell, and becomes incrementally cheaper with every new sale. Additionally that the market is much larger. Meaning that if CRM works for a SMB in Charlotte it will work for an SMB in Sydney.My response is – wasn’t this exactly the same thought process as before? Aren’t sales and marketing variable costs, not fixed? The only difference is the money is being spent over a spread of 5 years, rather than in 1 big shot (license cost) + over time (maintenance revenue). So if the theory is that the cost of sale goes down and the market can be expanded into quicker, then how does this get the company eventually to profitable numbers. The tech companies of old (SAP, Oracle, Microsoft, etc) very quickly were profitable.Lastly, marketing dollars in a mature market (SaaS will eventually become mature) is a zero-sum game. Meaning for every dollar one company spends in marketing to try to acquire a customer, another company has to spend $2 to try to compete. This is the biggest difference between Amazon and Salesforce/Workday. Amazon *is* the distribution platform, and therefore does little (comparatively speaking) to earn new customers other than providing very good fulfillment (and therefore customer satisfaction and service)for impulse or limited decision goods. Whereas enterprise technology is an extremely complex buying habit, and requires long sales cycles.Am I missing something?Some more thoughts I wrote about this awhile back: http://www.techdisruptive.c

    1. fredwilson

      i don’t know that you are missing anything. i hopefully did not recommend any of those three stocks in my post. i was simply trying to explain why they are so highly valued even though they don’t have profits

      1. Mike Bestvina

        No worries, I didn’t get the impression that you were recommended them, but I do see them as inherently different to Amazon. Nor, was I questioning your logic, but rather what the current market logic is trying to dictate. I also think the investor expectation is set quite differently, as Amazon is mainly B2C and Salesforce/Workday are B2B. Investors for enterprise companies are going to expect to turn a profit or at least sell to a higher bidder (i.e. SAP/Oracle).

  19. Druce

    Profits are an opinion. Cash is a fact.Amazon is generating a ton of cash ($4b in annual operating cash flow)If the cash flow keeps growing and net income stays 0… at some point you start saying the net income is not really economically accurate.Suppose you get a 30% return on invested capital, but you have to expense the investment. You have cash flow this year of $1m, you reinvest the whole thing, next year you have cash flow of 1.3m, you can do that indefinitely, keep growing cash flow from operations at 30% a year, with no earnings.If you’re an owner like Jeff Bezos, you’re going to say, eff the short term share price, I’ll keep taking that deal as long as I can get it, not like I’m going to need to sell stock or bonds with this kind of cash flow.After a while the market catches on, your stock goes up. and you can borrow at 2.6% for 10 years and re-invest at an even higher rate and supercharge cash flow even more, while still showing no earnings. Which is basically what Bezos has been doing.As Warren Buffett said, all else being equal, it’s far preferable to purchase $2 of earnings that is not reportable (and taxable) than $2 that are.But the punditocracy will be confused, and in fact I have no idea what ratios to use to value Amazon. You have to estimate ‘normalized’ free cash flow, ie make heroic assumptions on how much of reported expenses are really investments, then how much cash flow those investments will generate, and how much depreciation and non-cash charges are economically justifiable before you get to earnings and valuation (and probably a lot of other assumptions).It’s not that it’s some kind of charity for consumers, it’s that the earnings are underreported.

    1. fredwilson

      cash is king

  20. rahuliffic

    “…it is making huge investments in warehouses and logistics to be able to continue to grow its retailing business…”Perhaps five or ten years from now this investment will be complete and Amazon’s P&L will start showing a healthy profit. But given his strategy so far, wouldn’t Bezos find another great new market to conquer that would require ten more years of investment? If Bezos has limitless ambition and this is his strategy, then will we ever see those future years of profit?

    1. aidenn0

      Assuming bezos doesn’t live forever, then his ambition is bounded. That means that eventually someone else will take over. If they then go on to stop expanding in favor of making profits, then it will pay out. Not that even if you are investing in a 5-10 year window, it doesn’t matter if this theoretically day they switch from growth to value happens then, or later. So long as their potential profits are growing, there will be someone else willing to take over your long position.

  21. Tom Labus

    AMZN had to endure a lot of years when the markets considered them dunces too. They were pounded and openly mocked for many of them. It is only since the Crash that they are viewed differently and rewarded in the market.You have to have strong convictions and a Board that doesn’t fire you to take that route

    1. Dani Sanders

      Disqus Commenter Online Help: What HTML tags are allowed within comments?

  22. Howard Mann

    I was in a meeting with a senior executive from Nordstrom a number of months ago and his comment told me all I needed to know about Amazon.”3-4 years ago Amazon was not on the radar. Now it IS the radar.”

  23. sigmaalgebra

    Yes, I understand that. Here’s what I don’tunderstand: For evaluating current revenue andearnings, investors in public companies have a lotof help from CPAs, the organizations that specifyaccounting standards, e.g., the FASB, the SEC, etc.And apparently commonly the resulting numerical datafrom even those means of measurement are still shortof being a very accurate picture of the health andstatus of the company.Yes, and I understand the concept of expecteddiscounted cash flow out to infinity; although Idoubt it, maybe recently someone has found a way tofind an accurate numerical estimate of that! Foranyone who believes that, I can arrange, just forthem, one on one, a unique, once in a lifetime,golden opportunity on a famous structure across theEast River.Then in contrast for when a company invests revenuein R&D, warehouses, new software, new branchoffices, ad campaigns, etc. for growing the revenueand earnings in the future, we have much lessaccurate numerical data.Sure, maybe it’s easy enough to trust Bezos to bedoing the right things, but investing in a companywith low profits based on profits in the futurewould seem to be wide open to a scam from theinvestor having very poor information, e.g,, muchless good than audited financial reports.E.g., in venture capital, as far as I can tell, themain techniques are to ignore R&D and invest only incurrent numerical measures, generally called’traction’, that are taken as important surrogatesof money and predictors of future revenues andearnings. But the implication in the post is that,in strong contrast, internal R&D is counted asvaluable with little examination.Sure, if an investor really had the details on theR&D, new products, warehouses, new sales efforts,etc., then maybe such investments could bejustified, but where the heck is an investor to getsuch information? Spend a few weeks a quartertalking to the people in R&D, looking over theshoulders of the software developers, studying theplans of the warehouses, the transshipment problem,optimization of stochastic supply chains, vendorrelations, the marketing research relevant to newproducts? Else a lot of that investment might endup just as toys for top management, baubles formistresses, Champaign showers, management off sitemeetings with truffles and Romanée-Conti, etc. Notto mention despicable cases of senior executivescommitting nepotism with both their daughter anddaughter in law at the same time!So, how the heck is an investor to evaluate suchinternal investments by public companies?



  25. len

    same applies for individuals – reid hoffman saw that every individual is a business when starting linkedin.

  26. Capitalistic

    Amazon is defending it’s market share by keeping its pricing low. It’s a capex version of a price war. It’s also not a “tech” company, but more of a logistics/distribution company comparable to Walmart and not Google.Investors value Amazon as a market leader and less for PV of future cash flows.

    1. JLM

      .The big impact that Amazon has on pricing is the leverage of its distribution model. It does not really set pricing other than its ability to buy well.JLM.

      1. Capitalistic

        Precisely.Technically, they can charge their fulfillment customers more money for their services. Logistics is a highly profitable (cash flow-wise) business, particularly if it’s asset-light or it monetizes real estate assets (i.e. storage, etc).Actually, there’s a lot more that Amazon can do with their logistics, and that’s why “investors” have priced the stock as such.

        1. JLM

          .In the long run, Amazon is not going to even take possession of anything. This is already the norm in the used book business which they almost own today.Used book dealers are selling their books through Amazon and handling the shipping IAW Amazon prescribed policies.This is where Amazon wants to get. They handle nothing but the admin. They avoid even the logistics.JLM.

          1. Capitalistic

            Sure – they don’t carry inventory, and might not ever carry inventory (if you don’t include Kindle). But they store, fulfill and “transport” inventory for their enterprise customers.The consumer-facing storage, fulfillment and distribution model is what investors are factoring.I still think it’s vastly overvalued.

          2. joeagliozzo

            I would disagree with that – I think Amazon sees huge competitive advantage in handling the goods for 2 reasons (1) customer satisfaction and experience and (2) amazon marketplace. I may have missed it but I don’t think anyone has mentioned AM yet. Amazon charges a 15% and up commission on everything sold through the marketplace and they never have to invest a dime in inventory or returns. They also make “Fulfilment by Amazon” available to Marketplace sellers and make even more $$ on that service. Walmart, Sam’s etc. may be great retailers but they don’t even have a sniff of the opportunity of enabling other sellers to access their distribution and marketing for a fee like Amazon does. Long term, I think this is as big of a story as AWS, and a great business model.

  27. JLM

    .I will take a bit of a critical view of things on Amazon. In my heart, I think Amazon IS the new paradigm and will be a huge winner but there are some facts that an experienced business person should consider.Ecommerce is, at the end of the day, just a margin business like any retail operation. You have gross revenue, cost of goods sold, overhead and NOI. It is not a huge margin business like software in which the COGS begins to approach zero the more units you sell. Amazon is still selling real stuff and it is essentially a retail sales model at its core.The rate of revenue growth is the product primarily of more customers and maybe a bit of incremental sales to the existing customer base. I buy almost everything I can on Amazon because of the competitive prices, great shipping and return policies. Go look at Best Buy and buy at Amazon. No great revelation there, no?Real estate — all the big warehouses and distribution centers — is never a great investment in a retail business. Witness that WalMart rents most of its real estate because its marginal return on invested capital in real estate is down at the T Bill ROI level. Makes sense, their credit is good and they can provide a nice well secured coupon for passive investors to clip and thus their leases trade like Treasuries.So, don’t crank up the bagpipes because a company is investing in real estate. It does not generate a high return. In fact, it generates an anemic rate of return when compared to its financial operating rate of return.Amazon has a huge cost in hardware and software that depreciates and amortizes itself not just from a financial or tax perspective but literally. Amazon has to repurchase its server and hardware base about every 3 years. This is a real cost. It is very often a hidden cost.There is some number at which the lines cross. Some level of future revenue. Revenues have to exceed expenses — all in expenses, not just operating expenses — and thereafter the company is profitable. Perhaps wildly profitable if the rate of revenue increase (slope of the line) is greater than the rate of expense increases (slope of the line).This post breakeven marginal revenue rate of return is the secret to Walmart’s success and why Walart is now walking the cat backwards into the web based retail scheme of things. Walmart recently hired a battalion or two of software engineers to reverse engineer their web based retail presence.Remember Walmart already has the distribution network that Amazon is just now building, so Walmart’s web based revenue is arguably much more marginally profitable than Amazon’s.I am certain that Walmart’s knowledge of retailing is far superior to Amazon’s. Amazon has the chops in web presence, administration, web operations, distribution and returns.Walmart has exquisite knowledge of its customers as they see them face to face daily.Amazon’s “value” as described in Fred’s analysis is a stock market price not a real DCF model. One has to assume that some smart analyst has made a DCF model and applied an appropriate discount rate to arrive at a NPV and thus a stock price.Not bloody likely as the stock trades on emotion — like much of the stock market. Not a bad thing but a real thing.In a real valuation model there would be a DCF, an enterprise valuation, a replacement valuation and only than a sense of the future opportunity value. Companies like Amazon and Walmart are getting way too big to be able to make such valuations while they are scaling at this rate.I am very, very optimistic on Amazon but am cautioned about what the stock market thinks about value at any given instant in time. That is the value of their stock not their business.Please pass the tulips, Jeff.JLM.

    1. Ciaran

      This strikes more of a chord with me than Fred’s analysis. Because what he (Fred) seems to be saying is something like “don’t worry, someone has worked out that at some point Amazon will make money”.But it strikes me that this relies on the prophetic skills of the same type of people who were caught on the hop by the implosion of 2007.

      1. JLM

        .You come out of your office one evening and the street is wet.You think: “Hmmm, must have rained today.”Someone else muses: “Hmmm. street sweeper must have come round.”Evidence supports both suppositions but only one is right.In the stock market, it is even more subtle. Sometimes both explanations are right.JLM.

        1. awaldstein

          They only clean the streets in the early morning.At least in NYC and SF and LA 😉

      2. fredwilson

        well that’s not what i was trying to saywhat i was trying to say was being profitable today is not always what is important

        1. Ciaran

          I guess my question then is when does profit start to become important? Ever? Otherwise isn’t it all just a version of the greater fool philosophy?I ask this honestly – I’m obviously not an investor. I just wonder when the average pension fund is going to start looking for returns on Amazon to make up all the cash they lost 6 years ago

    2. David Semeria

      When I was a stockbroker, one of our best recommendations was a utility company called “Autostrade” which controlled toll highways in Italy and other European countries.The big deal with this company was that its revenues were not a function of its costs. In other words, it could reduce opex and capex but revenues would not be affected (because they had a monopoly on a large number of key routes).Other companies must spend to do business (advertising, working capital, etc).When Autostrade announced an aggressive cost cutting program, it was possible to predict with a high degree of certainty that their future cash flows would go through the roof (which they subsequently did).Similarly, when Amazon is finally happy with its market dominance (ie its quasi monopoly obtained through all that cash burning) it – like Autosrade – can finally lift the foot of the gas and the cash will roll in.

      1. PhilipSugar

        And I love their coffee in their stores which bridge both sides of the roads in Italy.

      2. JLM

        .Yes and no.Amazon is selling products they do not make. Hard goods. Their COGS is not going to be within their ability to control.What folks need to look at is operating margin and overhead.If their operating margins are good, then it is simply a matter of growing revenue to a point where that margin overwhelms the overhead.If you can make overhead a declining percentage of revenue as revenue grows, then sooner or later those lines are going to cross. I have done exactly that several times. This is just garden variety breakeven or critical mass analysis.Unprofitable at $10MM, wildly profitable at $20MM. Happens all the time.Amazon may have some control over overhead and capital investment though an orderly depreciation and amortization schedule should already be taking some of that into account.This is not rocket science.JLM.

        1. sigmaalgebra

          Your analysis is okay in general, but you omittedconsideration of several circumstances particularto, maybe unique to, Amazon.The biggie is that, on several important points,Amazon is now well on the way to doing better thanany very direct competitor. So, even if theirabsolute success is difficult to evaluate,’comparatively’ they are well on the way to totallyblowing a significant fraction of retailing off thefield.(1) I will omit any claims that Bezos is a dragonslayer or more powerful than several comic booksuper heroes or Grail knight Lohengrin.(2) In simple terms, software does not wear out.Yes, most production software directly facing thereal world needs continual revision.The point here is that Amazon has a lot of softwarewritten that is powerful for their business, likelyscales well, needs to be revised only slowly, thatno competitor can easily match, and that mostcompetitors can’t hope to match.(3) The Amazon ‘selection’ is just excellent. Oneway and another they are using their software andcomputing to put before customers as much aspossible, from wherever. So, apparently Amazon goesto lots of retailers and says, “Let us handle youruser facing computing for you.”. Then that’s anoffer the retailer can’t refuse but, still, willsoon regret.(3) Amazon’s warehouses will lower shipping costswhich for many items is very important, e.g., dogfood or canned goods.Heck I wanted cans of Campbell’s Sirloin BurgerSoup, found low/out of stock at Wal-Mart and lowstock and high prices at A&P so ordered a package of12 cans from Amazon. Worked great, shipping costless than the cost of gas to/from Wal-Mart, whichdidn’t have the soup.When Amazon gets their warehouses built, they willhave much lower shipping costs than anyone else andwill be able to do same day deliveries. Then for ahuge fraction of consumers and a huge range ofitems, including dog food, Amazon will be theeasiest, fastest, and cheapest source.Of course, as I suspect Bezos knows, there’s an’operations research’ applied math problem there:How many warehouses to have and where to put them,especially considering will be growing over time(the time issue may be a reason to lease thewarehouses instead of buying them).Just the problem of how to ship at least cost fromseveral factories to several warehouses is trickyenough to have gotten a Nobel prize in economics(Kantorovich). There is a much nicer approach now(G. Dantzig, W. Cunningham) of flows on networkswith also a polynomial solution (D. Bertsekas)likely important for Bezos.The ‘least cost’ point here could be enormouslypowerful for Bezos letting him have significantlylower costs of operations than any nationwide,on-line retailer. Maybe an artisanal supplier coulddo better in a radius of 25 miles of theirproduction facility.So in the future, if there still are consumers, thenAmazon stands to get a huge fraction of the businesswith much lower costs (for both software developmentand shipping) than any other on-line retailer and,really, most brick and mortar shops includingWal-Mart. E.g., let Wal-Mart sell cans of soup onecan at at time by stocking their shelves andchecking out the cans while once a day getting thecans in order and while Amazon sells 12 cans at atime.Heck, Sam’s Club used to sell sweet pickle relish, Ilike on hot dogs, in the nice, convenient, onegallon home size, but now they have only tiny littlebottles. So, on to the Internet!Yup, I destroyed my excellent 12 quart Vollrathstock pot. So, when I get back to making stock,fish, chicken, or beef, it will be Amazon instead ofdriving 30 miles one way to my restaurant supplyshop.Wal-Mart just quit selling the 12 pound bags of catfood my kitty cat likes and is now down to 7 pounds.So, off to the Internet.Early at Amazon, Bezos was thrilled to show somepeople how he could just type in some T-SQL and getback a nice table of results from his database.How many other retail CEOs could do that?AWS? Bezos knew he needed to be able to run a bigserver farm, so, heck, why not host the cloud forall comers?

    3. PhilipSugar

      No comment on the stock price. However, their capex is their moat.

    4. fredwilson

      well said

    5. Ricardo Diz

      Great comment.

    6. fl1nty

      This is similar to how netflix is trying to become hbo and hbo is trying to become netflix? Amazon being netflix and walmart being hbo in this analogy

      1. JLM

        .I agree.JLM.

    7. Druce

      I think you’re ignoring AWS which has huge scale, network, platform effects, media distribution which is sort of a call option on the Kindle and forthcoming set-top box, they and Google may be the only ones who can challenge iTunes and iTV.

      1. JLM

        .Fair play to you. I am.JLM.

        1. Druce

          likewise! I don’t disagree with anything, not exactly a story stock but you have to believe in Bezos, massively uncertain to value .

    8. Dave White

      Its easy to argue that Amazon knows it’s customers better than Walmart does. Walmart knows only that someone bought something. Amazon knows when a specific person (or if browsing without logging in a specific browser) even looks at something, if they “wish list” it, and if buy it, and often if they bought it as a gift – sometimes even for whom they bought the gift. I agree that Walmart has an existing infrastructure, but in the world of retail building infrastructure is a known process, easier to optimize now than any earlier time. Building consumer interest databases and maximizing their analytic value is a very new process for which Amazon has a huge early-mover advantage.

      1. JLM

        .I agree with everything you say.What Walmart knows that is not known by Amazon is at the granular level — what the customer looks like, the cars they drive, how they come to the store, how they shop.What Amazon knows is the computer based data that is left behind by the digital experience of the customer wandering through their website which while related to customer behavior is not the same as looking your customers in the eye.I love their predictive buying initiatives. They are very good for me.In the end, both of these companies are going to close the gap on each other. I suspect that Walmart’s involvement in the grocery business — from scratch to the largest grocer in the world — is a harbinger of how well they will infiltrate the digital world.From scratch, Walmart is the biggest grocer in the world and nobody saw it happen. Now Walmart wants a piece of Amazon’s chili bowl and has hired 600 software engineers to help them. Wow.One more aside, retail infrastructure and site selection is a very arcane art and Walmart is very good at it. Montgomery Ward missed the turn and it killed them.JLM.

        1. Dave White

          Fair enough, but does Walmart really “know” anything more than foot traffic volume and purchases? I question how sophisticated Walmart or any b&m can be in leveraging the data by “looking the customer in the eye.” seems they’d have to use sampling and statistics on any of this data because we know they don’t have enough resources to do this for every customer (unlike Amazon). I suppose they could be tracking what cars are in the lot but do they really use this data and is it meaningful for the selling of goods? And of course they have cameras so they know what their consumer’s look like (shudder…thinking of all those walmart shopper memes) but do they and how can that data be used? Seems like 90% of it would be noise and likely misleading (book by the cover judging)… do they actually track those individual attributes through to shopping and purchasing behaviors? If they are doing more of this than I think, that would be interesting.

  28. iggyfanlo

    There are several valid comments/posts here, but we seem to be focusing on the cash flows (even though those are the hardest to estimate) rather than the more importnat factor, the discount rate.Thanks to Ben B and central banks gone wild, we find ourselves in a world where rates of return are artifically low; so that’s driving valuations more than anything to do with competition or investment in capital and warehouses.On top of that the market is now rewarding Jeff B for making the stock go up, not for generating free cash flow as he has always professed. Which in the end is a circular argument and what casued the dotcom bubble. I always respected Jeff B greatly for telling investors to focus on free cash flow. And FCF at AMZN has been growing very slowly (even after you take out cap ex and depreciation. So a 50-60X multiple on FCF is crazy.The market in the past dozen or so years has changed its valuation of AMZN from $100 –>$1–>$300… that 2+ orders of magnitude… anyone who thinks markets are short term efficient isnt looking at the tape. An even more bizarre example is NFLX.Let’s face it, the market grossly overshoot, maybe for momentum investing, maybe for our emotional amygdalla driven biases, but right now, let’s jsut celebrate that as investors and entrepeneurs, we are long and LUCKY, and not try to rationalize or justtify valuations that wll make no sense in 3-5 years

  29. FlavioGomes

    As always…it comes to balance. By all means, sow as much as you can for future growth. But the wisest business builders always leaves just enough to wet the investor whistle. When in doubt, cash flow positive for the win!

  30. Bear

    I am sure my thinking is simplistic, but a you say focus on future earnings (fair enough). So, a few comparisons:Apple PE – 13.14WallMart PE – 14.8Apple Net Income Margin – 26%WallMart Net Income Margin – 3.4%I think we can agree that Amazon’s Net Income margin is going to be closer to WallMart than Apple (they generate a huge portion of their revenue from essentially retail or comoditized offerings), So, you are talking about a company that if it was trading at a PE similar to Apple with a Net Income margin equal to that of WallMart, Amazon would need to generate $12 billion in earnings on $400 billion in revenue to justify its market cap.At current revenue growth rates, you are talking 7-8 years to reach the $400 billion in revenue. Of course, Amazon has never shown an ability to actually generate profits, but we are giving them the benefit of the doubt on that.So, the question – how far out should we be looking for Amazon’s future performance and if your answer is 5 years, what would your answer have been 5 years ago?People seem to think Amazon can simply “flip a switch” to generate profits, but, is it really that easy?

    1. Jaime Pan

      All good points no one could respond

  31. Pramod

    I have trouble comparing Amazon with Enterprise companies like Salesforce and Workday. In a enterprise company, you spend the R&D, make the product stable and erect barriers to entry or you spend on Sales & Marketing and lock up the customers. After that you are almost printing money, the cost of goods sold is minimal and depending on network effects and speed at which disruption happens in that space, you are good for 10-15 years. Microsoft, Intel, Adobe, Oracle are examples of that.Amazon uses technology to sell stuff online. It does not sell technology. It is fundamentally a retail company. Sure they have good technology and they have sold a bit of that (Amazon Web Services) but majority of the revenue comes from the retail business. By building warehouses, it is creating operating leverage and in a downturn it will really get affected. Even in a good economy people will go and buy premium stuff in the malls. Amazon is a great company, but I feel it might end up disappointing investors in the end.

  32. kidmercury

    as a couple others have noted here comparing salesforce to amzn is misguided. amzn is legitimately investing in futures grwoth. crm is taking profits that should be awarded to shareholders and giving obscenely large stock options to management, and then hyping non-GAAP earnings to obfuscate what’s actually going on. here’s a nice article on that:…also, i don’t think stock price is relevant here, or in most situations. amazon is not a $300+ stock if it weren’t for macroeconomic factors. in other words, the value assigned to amazon by the market does not legitimize its strategy.

  33. Stephen Konig

    Great post. It reminds me of something I learned in business school–dividends are a sign of weakness, because it means management can’t find anything more valuable to invest its cash towards.But I do think it’s important to distinguish between a company that could be profitable but chooses not to because it want to invest for the future (Amazon) and one that can’t be profitable even if it wanted to be (

  34. Abdallah Al-Hakim

    I have heard the same arguments but made about companies such as Twitter. No one doubt that Twitter is growing but they apparently are still operating a loss. So it is really growth and profits that one needs to look at for some cases. Mark Suster wrote an excellent post about Growth versus Profitability and it is a companion to this post

  35. judy shapiro

    History is a great teacher since memory is often adaptive. Let’s recall in Amazon’s first 5 -6 years it was largely ridiculed as a potentially failed experiment. I really wonder if Amazon would make it if it were a startup today. We’ll never know since I seemed to misplaced my portal into alternate universes 😉