The Internal Economics Of Amazon's No Profits Growth Model

There’s a very good little piece looking at the internal economics of how Amazon runs its no profits growth model. It’s by Benedict Evans and it can be found here. There’s more charts and graphs there than you could shake a stick at so obviously great fun for those who like that sort of thing. There’s two points I’d like to pick up on: one a theoretical one about firm structure and the second more a point about British political economy.

That first is to think about Amazon and Ronald Coase on the reason that a company exists in the first place. That “Theory of the Firm” was one of the (two, the other being his work on pollution and externalities) reasons why Coase got the Nobel. And his basic point was to wonder why firms exist in the first place? The answer being that it’s sometimes more efficient to do things as a series of separate entities (anything from a few separate firms cooperating all the way down to simply a network of individual contractors swapping work around) and at others, or in different situations, to be just the one organisation. These things change over time and depend to some extent on the level of technology but in the end we’ll see firms where it’s more efficient to be a firm and we’ll not see them where it isn’t.

Of course, this is somewhat stylised: the real world is a little messier than that, things that should be single firms might still be fragmented (and thus they provide an opportunity for someone to do a “roll up”, buy up all of the little players and forge them into the larger whole, the profit coming from the way that the whole is more profitable than the parts) and things that should be in many pieces might still be in one (and thus corporate raiding and asset stripping of conglomerates). But as a theoretical underpinning it’s obviously correct.

So what’s this got to do with Amazon?

Amazon is in fact organized not just in these segments, but in dozens and dozens of separate teams, each with their own internal P&L and a high degree of autonomy. So, say, shoes in Germany, electronics in France or makeup in the USA are all different teams. Each of these businesses, incidentally, sets its own prices. Meanwhile, all of these businesses are at different stages of maturity. Some are relatively old, and well established, and growing slower, and are profitable. Others are new startups building their business and losing money as they do so, like any other new business. Some are very profitable, and some sell at cost or at as loss-leaders to drive traffic and loyalty to the site.

Ben also adds that Amazon is very careful indeed to make sure that there’s no great chunk of profits at the end of a quarter. Instead, there’s an insistence that money that is made in one area, one of those mature areas, must be spent on one of those start up areas. In that manner there’s no profit to then be taxed away. Money gets spent on developing the firm not on paying for diversity advisers after it’s been washed through Westminster or WashingtonDC.

However, think back to Coase there. It’s certainly true that some of Amazon’s activities should be in the same company. Selling audio books is an obvious add on to selling physical or e-books. We wouldn’t expect someone to set up an entirely new company to move from one of those three into two or more of them. But it’s not equally obvious that selling movie subscriptions is the same business as selling books. Maybe we might expect that to be a separate company? More efficient as a separate company? Yes, obviously there are some synergies but Coase’s point is that at some point the difficulties of running a large organisation overcome such synergies and it would be more efficient to have separate companies.

And here’s my addition to these little ruminations: it’s exactly the tax laws that create one of those synergies that keeps Amazon as the one single company (even if with many different divisions and P&L centres). Because if it were a series of separate companies then those mature businesses, the ones making profits, could not simply switch their profits over to the subsidisation of those newer businesses. Instead, they would have to declare those profits, 35% would float off towards Uncle Sam and thus there would be less of that free cash flow to invest in those newer businesses.

The way the tax laws work are what keeps Amazon from splitting out those profitable businesses from those ones not yet mature enough to be making a profit.

Which brings me to the second point, one more about British political economy. We have a prolific commentator over here who insists on two separate points. I’ll not name him in order to spare his blushes but he’s often referred to as the UK’s leading tax expert. The first thing he insists upon is that Amazon doesn’t pay very much corporation tax (entirely true) but also that it ought to. The second is that many companies have vast amounts of cash, profits they have made in the past, which they don’t know what to do with. Those cash reserves should therefore be taxed away so that they can be spent on what our tax expert thinks are good uses for other peoples’ money. What I enjoy so much about this is that he manages to believe both things together. A company like Amazon, which obviously does know what to do with its free cash flow, should be taxed more. And companies that don’t know what to do with their free cash flow should also be taxed more.

It’s as if the only answer to anything ever is higher tax rates. Rather like if all you’ve got is a hammer then everything gets treated as a nail. I can’t help thinking that the views of a leading expert in anything, let alone tax, ought to be a little more subtle than that.