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Copyright 2011 by John T. Reed
Amazon.com is physically located in a number of states. Its headquarters is in Seattle, WA.
It is the world’s biggest online retailer. Layman typically think that means it is a big success. It started in 1995 and made its first profit—1¢ per share—in the fourth quarter of 2001. I am skeptical that Amazon’s business model makes sense and that they have earned, or will ever earn, a respectable return on investment (ROI). In the first quarter of 2011, they earned 44¢ per share on a stock price of $179.25. That is a .44÷179.25 = .0031% return on investment.
What a financial genius! Your money would earn more in a bank checking account.
They seem to be satisfied with fame and hyping their stock price and not much interested in real performance like an above-average ROI. Don’t bother telling me you like them and buy books from them. So do I. But that not only does not mean they are well-run, it may be evidence that they are poorly run—selling their products and services too cheaply. Some industry experts have said Amazon’s business model is to sell dollar bills for 90¢. That makes you popular, but not a well-run business.
I have described Amazon of 1999—the year Amazon founder Jeff Bezos was named Time Man of the Year—as Sears Roebuck 1899, only with the orders coming in by Internet rather than snailmail. Both Sears 1899 and Amazon 1999, received orders for products then mailed those products to the customers worldwide.
Anyway, one of Amazon’s competitive advantages is that its customers avoid paying sales tax in most states. This displeases the states that have sales taxes (all but AK, DE, MT, and OR; NH’s sales tax only applies to restaurant food). It is virtually always illegal for residents of a sales tax state not to pay sales tax on purchases from out-of-state vendors, but as a practical matter, it is impossible for such states to collect the so-called “use” taxes.
Amazon’s failure to collect sales taxes also displeases it brick-and-mortar competitors who have physical retail stores in the sales tax states and collect the taxes on both in-store and on-line sales.
States tried to force out-of-state retailers to pay sales taxes on sales to in-state addresses, but they lost in the U.S. Supreme Court. [Quill Corp. v. North Dakota and National Bellas Hess v. Illinois both prohibit states from imposing a sales and use tax collection obligation on out of state sellers with no physical presence in the taxing state.]
In recent years, cash-strapped states have tried to claim affiliates and subsidiaries were physical presence’s in the taxing states. For example, Amazon’s Kindle operation is in CA, but it is merely a wholly-owned subsidiary so Amazon claims it is exempt under the above U.S. Supreme Court decisions. Those legal theories have not reached the U.S. Supreme Court yet.
In a number of states, like TX and CA, Amazon reacted to such laws by ending their affiliate relationships there.
In the case of CA, Amazon did that plus it began a political campaign to put a referendum on the CA ballot that would repeal the new sales-tax-paid-by-out-of-state retailers law.
On 9/7/11, Amazon and the CA state legislature announced they had agreed on a deal. Amazon stops pushing the referendum to repeal the sales tax on Amazon and promises to build two facilities that will provide 7,000 jobs and CA postpones the effective date of its new law by one year to September 2012.
1. The governor Jerry Brown would have to sign this law and he won’t commnet.
2. It must pass with a 2/3 vote in each house of the legislature and that is dubious.
3. I did not go to law school, but Jesus H. Christ!?
a. Since when does the California state legislature negotiate with a private corporation from out of state? What part of the state constitution gives them the authority to do that?
b. Are either or both parties—Amazon and the state of CA—guilty of extortion? Amazon seems to be telling the state either repeal your law or we will spend millions supporting a referendum that bans it, thereby making it harder for CA lawmakers to pass such a law in the future. CA seems to be saying to Amazon, either start paying sales tax, perhaps pursuant to a future federal law on the subject, or we will pursue you in court perhaps in violation of the controlling 1967 and 1992 U.S. Supreme Court decisions.
c. Is Amazon openly bribing CA with the promise of two facilities employing 7,000? Is the state of California some Middle Eastern rug merchant who trades laws or repeal of laws for corporate favors? Suppose Amazon builds the facilities and the state reneges? They are nothing but a bunch of lying politicians after all. In what court do they sue to enforce the contract? Would Amazon’s contract with the legislature have a legal purpose, an essential element of an enforceable contract?
d. What happened to equal protection of the laws (14th Amendment)? How does Amazon get a special law for itself that does not apply to other business selling to Californians? By offering bribes or by threatening the state legislature with referendums?
e. Are Amazon and California legislators openly conspiring against the citizens of California? The legislature is supposed to represent California residents. Those have two interests: they like not paying their sales taxes when they buy stuff and they want maximum revenues to pay for state obligations. Those California residents who are retailers do not want to compete with a retailer—Amazon—who is exempt from charging sales tax. Amazon wants to keep its competitive advantage of not having to charge sales taxes. How can the state legislature ethically bargain away their fiduciary responsibility to some or all of its citizens? How can Amazon waive its constituitonal rights to support a referendum and its right to equal treatment in such a negotiation?
f. How can legislators of a democracy not want the people to speak their wishes in a referendum? I can understand how they might want the referendum to be voted down, but this deal seems to be aimed at stopping the people of California from having a chance to speak at all on the matter! This deal is anti-democracy. Why would Amazon want to publicly be anti-democracy?
Going back to my statement that Amazon’s business model has always been suspect, can Amazon make a profit if it has to collect sales tax in 45 states?
According to Huffington Post, they earned $201 million on revenues of 9.86 billion. $201,000,000 ÷ $9,860,000,000 = 2% profit margin. Sales tax in the U.S.ranges from 2.9% in CO to 11.5% in IL. You do the math. Roughly speaking, having to collect sales taxes of 2.9% to 11.5% on something like 95% of their sales would wipe out Amazon’s 2% profit margin and then some. It appears to be matter of survival for Amazon to avoid paying those taxes.
Being forced to collect sales tax would cost Amazon much or all of their competitive advantage. As a result, their gross sales would fall. Many would prefer brick-and-mortar immediacy, lack of shipping, and personal relationships to Amazon if they could not save that 2.9% to 11.5%.
Currently, brick-and-mortar stores competing with Amazon have cut prices to try to compete. They would raise those prices if Amazon had to collect sales tax.
California legislators think this law will get them more tax. Maybe so, but not from Amazon. I expect if it is not invalidated by the courts, it will wipe out Amazon and any increased tax revenue will come from more in-state brick-and-mortar sales, not from checks written by Amazon.
California consumers will be hurt by the deal by no longer being able to avoid sales taxes on out-of-state purchases. Because of pacticaliy, if not legality, taxing Amazon sales is a tax increase on CA consumers.
Jeff Bezos is so rich that he has his own personal manned space program. Even the U.S. government no longer has one of those. A recent Bezos space shot failed. Lovely public relations for his upcoming sales tax fight with bankrupt California and other states.
John T. Reed
Here is an email comment with my response in red.
I share your skepticism of Amazon's business model. I didn't think they would survive that 2000-2002 recession and tech crash but they proved me wrong.
Two issues with your statement:
1) I don't follow your math on their ROI. I see they earned 44 cents a share in the first quarter of 2011 but that is just three months earnings and like most retailers earnings are lousy the first quarter of the year. I believe it would be more accurate to say they earned $2 or $3 a share for the year and had an ROI of 1% or 1.5%. [I’m okay with multiplying te 44¢ by four and getting an annual of $1.76 ÷ $179.25=.98% return on investment.That is still small checking account size interest. I assume their sales will increase in the Christmas quarter, but I will not assume their earnings will. When they report their annual earnings we’ll see.]
Even this is an unfair statement. Investors have bid up the price of Amazon's stock. The last three full years they have made a net profit of $645 million, $902 million, and $1.1 billion. That is the part they can have some control over through efficient operations, business strategy, and so forth. [Irrelevant to the issue of whether Amazon is well run. I have said many times including in this article that Amazon seems to be more in the business of hyping their CEO and stock price than making a profit shipping commodities. I am not alone in that.]
The fact that the public has bid the market capitalization up to $93 billion is something they have no control over and shouldn't bother worrying about. If I were a stakeholder in Amazon (I would just sell my stake, but if I couldn't) I would want them to make good business decisions about things they can control and try to increase their profits. They shouldn't and can't be concerned about their stock's P/E ratio. You state that "Your money would earn more in a checking account." Like it or not, Amazon stock is up 50% in the last 12 months while the overall market has been roughly flat. Their balance sheet has $6 billion of cash and zero debt. I don't like and have never owned Amazon stock and doubt I ever will, but I have to grudgingly admit their business has performed decently and their stock very well. [I commented on the Amazon business model, not the irrationality of stock market investors.]
2) I think you overstate the effect sales tax would have on Amazon. Just because their profit margin is below the sales tax rate doesn't mean that sales tax would wipe them out. They could raise prices a little and still be ok. [They sell commodities. In that business, the low-cost seller wins. Every percent they raise their prices will lower their sales and there is a tipping point at which people would rather buy best sellers at the grocery story or B&N, which did NOT go bankrupt.] As an example, my latest Amazon purchase was a book. My options were Barnes & Noble, Borders (whoops they're bankrupt and gone [that was Borders]), and Amazon. At B&N it cost $14.95 and at Amazon it was $8.30. Even with sales tax I would have bought it from Amazon. Even if Amazon raised their prices a little I would have bought it from Amazon. [I have lately bought two books from B&N.com and they cost less than if I had bought them from Amazon, to my surprise.]
More from Johnson:
Last year Amazon and pretty much every retailer made more in the 4th quarter than they did in the 1st quarter. But that isn't my main point. [We all know that Christmas gift retailers sell more during holidays. But they have to hire more people and work overtime and all that. Whether they net more with temps and overtime remains to be seen.]
I don't dispute that Amazon stock is overvalued but your article makes it sound like you are holding that against them as a business performance issue. [If you pay $179.25 a share and they earn $1.76 per share, you earn less than 1% on your investment. Doesn’t matter who set the stock price or why. Investors give Amazon credit for the stock price increasing. You say they are not responsible for that. I think they are trying to hype the stock price as high as they can. They are certainly not talking it down. But it is what it is. And the ROI for recent investors is what it is. Both the investors and Amazon would say they are not looking at ROI. They are looking at the stock price appreciation to justify their claims to competence at managing and at investing. Amazon is not a business, it is a buzz-iness. If it were a privately-held candy store, Bezos et al. would be fired. The investors who pay high stock prices based on some vague notion that Amazon earnings will eventually justify the stock price—who knows why that would happen—are nuts and Amazon executives keep their jobs only until investors come to their senses.] Say your publishing business made $200,000 last year and someone decided to way overpay for it and gave you $1,000,000,000 for it and kept you as an employee. Next year you write new well-written books, market and execute the business decently well and the business makes $250,000. Is the business a turkey? After all its ROI in this hypothetical is 0.025%. I would say that has more to do with the absurd price than the underlying performance. In this contrived example, the business is actually doing pretty well growing earnings 20-25%. [The investors would be mad at me for not making an ROI that was much better than CDs unless even greater fools came along and paid $2,000,000 for their stock. In which case, they would think I was a genius, like Bezos, when in fact all that happened was that investors got even dumber.]
Sorry my wording was unclear. I meant Borders was bankrupt and gone and my options were Barnes & Noble and Amazon.
The fact that their profit margin is lower than the sales tax rate is a red herring, not a smoking gun. It's true but irrelevant. Say the average sales tax is 6%. You make it sound like their margin is 2% and they would have to pay all of that and more in sales tax and go out of business. The customers pay the sales tax. Charging sales tax would certainly lower their sales and you could argue how big an impact that would have on their business but it's inaccurate to say sales tax would wipe their profit out. Walmart's profit margin is 3.87% and they almost certainly collect and disburse more in sales tax than their net profit. Walmart is still a reasonably successful company. [If Amazon has to raise their prices 2.9% to 11.5% for customers in the sales tax states, a large percentage of those customers will abandon Amazon. To prevent losing all of them, Amazon would have to lower its prices to compensate at least partly for the taxes. Amazon sells nothing but commodities. Every Amazon customer can buy the identical product elsewhere and will unless Amazon offers them significantly better prices to compensate for the waiting time to get it. Amazon is a one-trick pony: cheap. No cheap, no pony. Paying sales tax either lowers Amazon’s profit margin or lowers their sales. Companies whose stock price is based on never-ending sales growth cannot show negative sales growth and maintain their stock prices let alone increase them. Having to pay, say 6% greater costs as a percentage of sales will chop that dollar amount off Amazon net income. Your statement that they will simply pass it on to the customers suggests customer behavior will be unchanged when customers suddenly have to pay 6% more to buy from Amazon. No way. Lack of sales tax is probably a crucial competitve advantage to Amazon. Without it, I wonder if they even continue to exist. We’ll see if and when they are forced to pay sales tax in 45 states. All they are is Sears Roebuck 1899. Sears has not done so well lately. And in 1993 they got rid of the part of the business that Amazon is imitating: general merchandise direct mail. When computers were new and dazzled stock market investors, and the same was true of fast-food companies, a columnist wrote a hoax column about a new IPO called “Computer Fried Chicken.” The public went nuts demanding to get the new stock. Many angrily ended their relationships with their long-time brokers who swore they could not sell them part of the “Computer Fried Chicken” IPO because it did not exist. Amazon is nothing but Computer Sears Roebuck or Internet Sears Roebuck or Sears Roebuck dot.com. If and when the USPS goes bust or gets privatized, shipping costs will go up for Amazon and that will also hurt them dramatically vis a vis brick-and-mortar stores. Amazon is nothing but a semi-Internet middleman (incoming orders only; outgoing products are mail just like 1899) and since the Internet’s main feature is it eliminates middlemen, Amazon’s business model makes about as much sense as a screen door on a submarine.]
We agree that Amazon stock is priced for perfection or beyond. I believe investors who pay $211 for Amazon stock have overpaid and will be disappointed. Of course I thought that at $75, $100, $120, $160, and $180 and so far I have been wrong every step of the way.
The investors in my example should not be mad at you for your business operations. The business operations were good and improved markedly. The problem was they paid $1 billion for something worth perhaps 4 or 5 million. One can use the price paid to evaluate the merits of the *investment* but not to evaluate the merits of the business operation.
We disagree on the impact having to charge sales tax will have on the viability of Amazon. You state it would likely be a death blow, I think it would impact them but they can still operate and profit.
Some of the criticisms levied at Amazon are out of date. The selling dollar bills for 90 cents is no longer true. The argument they are unprofitable or barely profitable is out of date. I was one of those who thought they would never make a dime and I was wrong about that. I also believe the "one trick pony" accusation that all they do is sell merchandise cheapest is no longer true. As a counterexample, they have manufactured and sold a lot of Kindle reading devices. That is a new technology and distribution channel, not just being an internet middleman.
You accuse Amazon of being Sears Roebuck in 1899. Sears Roebuck in 1899 wasn't a bad thing to be. They were the dominant retailer for at least 50 or 60 years from that point. They also used some of their profits to diversify into other businesses. A shareholder in Sears back then would have profited enormously from the retail operations as well as the spin-offs in insurances (Allstate), credit cards (Discover), and financial services (Morgan Stanley) before receiving cash and stock in Sears Holdings in the merger with K-Mart. [Johnsen makes a lot of statements in this email. I will address two. Kindle is a commodity piece of hardware destined for the same fate as the IBM PC for the same reason. Anyone can make hardware and it will fall to the lowest price producer like Dell and various Third World countries. Bezos has made the same mistake as IBM when they hired Bill Gates. They had no interest in software. They only wanted the hardware. IBM is no longer in that business. Amazon trumpets that Kindle is doing great but won’t release the sale or cost figures.You bought the trumpet. Show me the numbers. Furthermore, Kindle software has no great distinction over competitors. Plus, Amazon sells everything. The notion that they are a book seller—Kindle sales—is out of date. They are a $10 billion company. Kindle could not much affect their bottom line no matter how well it did. Amazon is famous for being state of the art. Sears was state of the art in 1899 because they invented the mail order catalog business. Your suggesting it is okay for the supposedly state-of-the-art Bezos for substituting email-style ordering for snail mail and otherwise running a nineteenth century business model is goofy. Amazon is about one thing and only one thing: being the low cost seller of all the products they sell. That, in turn, depends heavily on their avoiding charging sales taxes. Amazon has been levitating in defiance of the laws of economics for about 15 years by blinding people like Johnson to what Amazon really does. Amazon is trying to be Wal-Mart/Costco/Target only without sales tax. Those companies are well-run and know how to sell cheap even while charging sales tax. When they have to pay sales tax, Amazon will be revealed to not even being in the same league as Wal-Mart, et al. in terms of being the lowest-cost retailer.]
With regard to Amazon, this shouldn't be a discussion of either or when it comes to brick and mortar versus Amazon - they both have their place as well as their advantages. [Amazon has no place. They are an Internet middleman and the Internet eliminates middlemen.] For example, I think Amazon is at a major disadvantage against companies/places like Sams Club, Costco and BJ's in some respects. Even though the aforementioned places must pay sales tax in whatever state they are located, there are still reasons why I use them for some items and Amazon for others. Typically, if I have to buy something big or something perishable, like a freezer or a twenty pound bag of rice, Amazon either doesn't sell those things or if they did the shipping costs would defeat the purpose of getting it sans sales tax. I live in NH so this is kind of a moot point for me, but you see what I mean.
I do use Amazon for books, mostly, and occasionally small electronic accessories and other odds and ends. Though price is a factor, the major value added feature for me is their customer reviews, which I use even when choosing to buy a product locally, at a place like Sams or elsewhere - even at Barnes & Noble when browsing books. Not all of the reviews are helpful, but generally I get a lot of useful pre-purchase information that doesn't cost me a dime, but keeps me coming back to Amazon (eventually) for purchases. I don't get that same kind of experience from Barnes & Noble, either virtually or at the brick & mortar stores. [Mildly interesting but not a protectable competitive advantage. This is a free service that the public can use without paying Amazon a dime, like people using stores to visually inspect before they order online. Amazon providing free reviews is a caigslist business model. Time and again when I discuss Amazon peopel say they buy some stuff from Amazon therefore I am wrong about Amazon. No, I’m not. Amazon gets and has gotten a ton of favorable PR They are like a political candidate with name recognition. But ohter than saving sales tax in 45 states, and selling at unsustainably cheap prices to build stock price, they have no viable business model. They are buying the business, which is a form of slow business suicide.]
However, I still like Barnes & Noble for the obvious advantage of being a place to go for a coffee and to physically browse, something Amazon will never replace. [I just ordered the book Grand Canyon One Best Hike: Amazon price, $11.21; Bn.com price, $10.21. Amazon can’t even replace Barnes & Nobles’ online price.] There are a few independent shops that can do this too, but expecting them to replace Amazon is unlikely and probably undesirable. You should not underestimate Amazon turning itself into a "Facebook" of retailers when you add in the review factors. Nor should you forget the second and third order effects on increased shipping statistics and the concomitant taxes on UPS/Fedex facilities, gasoline, trucks, payroll, etc. The economy is shifting to different areas and it's not fair to blame Amazon for everything negative. [Facebook’s business model also makes little sense because they have no ability to stop imitators. I have no understanding of the shipping comment.]
The worst part - listening to yet another cadre of state bureaucrats moan and groan over not having something ELSE to tax - is getting tedious. We all know, just like an alcoholic who promises he's going to change, next time it will be different, etc., these bastards will be back in six months to tax something new to pay off the public sector unions breathing down their necks over underfunded pensions. Remember the big tobacco settlement? Where States held the tobacco companies hostage, took their protection money and were going to use that money to fix health care costs of cancer patients? Yeah, how's that one working out? All the money got blown in their respective general funds. Same will happen here.
So no, I have very little sympathy for California or any profligate state government (most of them), and kudos for Amazon for being in a position to bargain versus beg. This really isn't all that different than what happens at the municipal level every time a developer meets with the mayor and the chamber of commerce to decide if/how he'll be building a new mall, etc. The real problems California has will not be addressed until the politicians have the guts to face down the utterly unsustainable commitments made all over the bluest areas of the state. I'm not holding my breath for that.... [“what happens at the municipal level evry time a developer meets with the mayor…” is unconstitutional. In one Supreme Court decision, Justice Scalia called this nonsense an “out-and-out plan of extortion.” Mayors have absolutely nothing to do with developers other than to hit them up for bribes. It is sad that so many Americans have lost sight of the Constitution and now see municipal extortion as normal and proper.]
- name withdrawn
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