How much longer can Jeff Bezos sustain his fantasy?

AMAZON.COM IS NOT only the biggest e-tailer on the Internet, it's also the biggest economic mystery in the stock market. Start asking brokers about the company's actually worth and answers will range wildly, from five times its current value to 10 times less its current value. And most of them will say they are baffled by a company that posts loss after enormous loss on its quarterly statements, yet has a stock value that only seems to rise.

Dozens of stock market gurus think Amazon is a house of cards waiting to collapse, and dozens of frighteningly plausible reasons sustain their fears. But before we get into those, let us ponder this question: What would the implosion of that electronic retailer perched on Beacon Hill bring to our little throbbing tech neighborhood?

Maybe you don't think that Amazon has its tendrils wrapped around your legs. But listen to this story: An acquaintance who works at KCTS TV was selling his Wallingford bungalow earlier this year. He signed a purchase and sales agreement with a young guy who had worked for Amazon for the last couple of years. The buyer was going to use his stock options for the down payment; but on the eve of closing, the seller got a frantic phone call. Amazon's stock had dropped 20 percent since the buyer had made his offer on the house. He couldn't come up with the required down payment—could they postpone the closing for a week or two?

The would-be seller acquiesced, and the buyer was eventually able to produce the down payment. But it makes you wonder: Just how much of that wealth we see stacked up on the 520 bridge, chowing at Palomino or Wild Ginger, and toting bags out of Anthropologie is stock option wealth? And how much of it is teetering on the financial future of Just what would happen if Amazon failed to live up to expectations? Could its stock drop to perhaps a tenth of its present value? Could the company fail entirely? And if so, what would the local economic consequences be?

Over the summer, local economists proclaimed that high tech makes a larger contribution to our regional economy than manufacturing. Of course, you can correctly argue that Microsoft is a much bigger contributor than Amazon: Microsoft has five times as many employees, its average wage is much higher than Amazon's, its role in the local economy is much larger.

But here's why Amazon's fortunes are as crucial to us as Microsoft's: While Microsoft is a mature player in an established business, Amazon is the Holy Grail of Internet retail commerce. Whatever happens to it bodes well or ill for all the other Internet peddlers. Jeff Bezos' ideas on how to run a consumer-based Internet company have become the business model for Internet retailing. Pretty much everyone who starts an Internet retailing company has Amazon in his or her head—from to to N2H2. If Bezos's model fails, it won't just unravel the bankrolls of the 4,000 people who work for Amazon; it's going to shake every company, here and elsewhere, based on his vision.

IN A SENSE, Pugetopolis is like a medieval town where tears have been seen on the face of a Madonna. We're fervently placing our faith, along with a lot of cash, in the Internet's role as the business and consumer medium of the future. It is a wholly unproven wager, and Amazon is the biggest part of the gamble.

"Will the business model work?" asks Eric Von Der Porten, who runs Leeward Investments, a small stock fund in San Carlos, California. "That's the $21 billion question." ($21 billion was Amazon's market capitalization the day we spoke.) The question has gotten a bit more attention since Von Der Porten published a study in August showing that the amount people spend when they shop at Amazon's Web site has dropped by 18 percent over the past two years, from $35 per customer to $29. When Amazon spokesperson Bill Curry disputed Von Der Porten's conclusions, saying the way he calculated spending per person was inherently unfair, Von Der Porten defiantly answered, "Amazon loves to tout the number of customers and the amount of revenue, and they say, 'Don't worry about losses—they'll go away with time.' But if you say that's true, the revenues per customer don't look so good." His conclusion? "I continue to be mystified by Amazon's stock valuation, how anyone thinks that a low-margin retailer in a highly competitive market can be worth that much."

Jeff Bezos sold his company vision to investors on a few simple ideas: An Internet retailer has no need for a retail space, and there's no need to build up a distribution warehouse system. Amazon's costs would be minimal; manufacturers would store the products until Amazon had an order. The company would then act as the middleman, ordering the item from the manufacturer and shipping it to the customer. Profits would be small at first, and it would take a couple of years to actually see them.

It was a killer idea that would make Internet retailing much cheaper than "real-world" retailing. And it worked well when it was limited to books and the company was small. But Bezos turned out to have bigger ideas. He wanted Amazon to become a one-stop shop for virtually anything you could buy on the Net. This was the strategy all along, and even when the company was young he made it clear that books were just a good beginning. Bezos wanted to build an enormous customer base before other Internet entrepreneurs wised up.

As the business has grown, though, the stakes have gotten larger and the potential for problems has increased. First of all, Von der Porten says, "Amazon has to be the best in all these areas, and that's not easy." Also, in practical terms, Amazon has grown to the point where it needs to build its own warehouse and distribution system. This year alone, the company is adding three million square feet of warehouse space in Kansas, Georgia, and Nevada. That's expensive—the company plans to spend at least $300 million to mechanize its shipping operations.

This also puts Amazon in direct competition with other highly experienced and highly successful warehouse distributors. It is no place for amateurs—profit margins are razor thin in the retail business. Can Bezos—the Internet genius with no background in distribution—create an enormous distribution system that is also efficient enough to make money?

Developing a smooth warehouse and distribution system is no simple task. Amazon hired Jimmy Wright, a warehousing wiz, from Wal-Mart stores last year to oversee shipping and distribution. Wright lasted just one year, "retiring" in August. He has said his jumping ship is no big deal, but it has raised questions about just how Amazon is making the transition from an Internet company to a warehouse and distribution company. When asked about this by a Wall Street Journal reporter, a company official gave an answer that is alarmingly vague: "This is complicated stuff. It's challenging. It's all about execution."

WHILE IT PURSUES Internet dominance, Amazon asks investors to engage in a philosophical act that Soren Kierkegaard would enjoy—suspending disbelief. As the company grows, so do its losses, and Amazon also keeps pushing back its timetable for showing a profit. "I don't think the market is looking at the fundamental economics of Amazon," says Eric Von Der Porten. "A year ago, Amazon said its losses in 1999 would drop to $42 million. Now people expect losses of over $300 million!" And what about the idea that if you sell enough stuff, eventually you'll start to make money? "In theory, if you're able to sell enough goods, even with thin profit margins, you could be okay," Von Der Porten answers. "Look at Costco, for example. But the dilemma with Amazon is that so far its margins are so low, you wonder how the company can ever expect to make money."

In fact, Amazon's financial statements acknowledge that while its gross profit is increasing, its gross margin is decreasing—about 5 percent lower this year than last. This, the company states, is due to discounting prices, which is "essential to our business strategy." Part of the strategy: Amazon is currently offering best-selling books to first-time buyers for a penny in an effort to increase customer base.

These losses, of course, are amplified by the buying frenzy Amazon has been engaged in over the last two years—snapping up companies left and right. Amazon's acquisitions now stretch a long way into the Web infrastructure. In the past two and a half years, Bezos has bought into a stunning list of companies, including (54 percent stake, paid for in cash and stock), (35 percent stake, paid for in cash and stock), and (29 percent stake, paid for in cash only).

In addition, Amazon issued four million shares of stock and paid a total of $597.7 million in stock and cash to acquire three companies: eNiche, which develops Internet marketplaces;, which specializes in person-to-person and consumer-to-business transactions; and Alexa, which develops Web navigation software. In the past year, Amazon also bought Livebid (live Internet auctions), Sage Enterprises (address books, calendars), and three Internet businesses in the UK and Germany.

All this expansion means Amazon is a notoriously hard read when it comes to really assessing how much the company is worth, how rapidly its business is really growing, or what the prospects for the future are. The company posts its total sales and the cumulative number of customers to its site each quarter. But its acquisition of smaller companies at a frantic pace and constant addition of new products to its virtual sales floor make it almost impossible to judge Amazon's real growth. Take all the expansion noise out of the analysis and, according to a Hank Greenburg column in the Internet investment magazine, Sears grew faster than Amazon in the last quarter.

Here's another worry: Amazon's prospects are very sensitive to changes in the interest rate. As overseas markets begin to recover—as Japan's is slowly doing—the Federal Reserve may be forced to raise interest rates to keep foreign money flowing into the US. Higher interest rates have a negative effect on consumer spending, as well as on stock prices, and Amazon is vulnerable on both counts.

However, Bezos has a remarkable ability to keep his company one step ahead of the doomsayers. Just when the book-selling bubble is about to burst, he waves his virtual wand and turns Amazon into an Internet Wal-Mart—with toys, sporting goods, music, movies, auction houses galore. Then, when the Wall Street worriers catch on to just how hard it is to build a profitable warehouse and distribution system, Bezos inaugurates the "z-shops," virtual spaces for other retailers to peddle their wares, and effectively says "Shazam!--now Amazon is a portal operation, an Internet mall that can carry everything, and it doesn't need to worry about distribution."

But a look at the raw figures makes this dance even more astounding. The company lost $143 million in the second quarter of 1999, seven times its loss of $22 million in the second quarter of 1998. How long can this go on? The company now suggests that profitability won't occur until several years into the new millennium.

According to Michael Butler, who runs Cascadia Capital, a Carillon Point venture capital company, a lot of people in the investment community are losing patience. "There's some real disenchantment with Amazon," he says. "The company has made a lot of promises and may not be able to keep them—and that has made it more difficult for other consumer-based businesses to get funding." And while those stunning quarterly losses look OK while the stock price is rising, if the stock price falls and the losses continue, it's going to take more cajones than brains to stay with the company.

Amazon continues to insist that volume is everything, and Bezos is quite clear about company strategy to trade its potential current profit for new customers. Projections for Christmas spending on the Internet look rosy—up 30 percent from last year. But for Amazon, the day of reckoning is approaching. You have to wonder: Is Bezos building a bigger company or just pumping air into a leaky balloon?

What if? It's not easy to project just what the consequences of an Amazon collapse could be. Certainly the public-private partnership that occupies the old US Public Health Service building on Beacon Hill would evaporate. Dick Conway, a regional economist, isn't predicting Amazon's end—but he also says, "If you want to see what happens when a substantial sector of a regional economy tanks, look what happened to the 'Massachusetts Miracle' when the minicomputer business hit the skids in the late 1980s."

Massachusetts went from boom to bust in a period of a couple of years, the disaster amplified by an overpriced real estate market that squeezed out first-time buyers. Sound familiar? If Amazon does go south, Conway says the initial impact would be the loss of jobs. "The second impact is on wealth—all the people who have stock or stock options. Since Amazon is local, you can bet its wealth is concentrated here." Stock option wealth can evaporate quickly, though, and Conway continues, "With a market value of $21 billion, the company is no slouch. Boeing's cap value isn't much greater. While it's important for the region to promote high tech, it's not without risk."

What could be most at risk is the raft of young companies riding on the tide of Amazon hype—companies modeled on the Internet-as-consumers'-ultimate-shopping-playground paradigm. The Microsoft story is now old hat—it's Amazon that new netrepreneurs want to emulate. Also in jeopardy is the region's undercurrent of optimism, which fuels the real estate market, the car dealerships, the fine dining—all the varied ways we are enjoying our assumed wealth. Pull that assumption out of the regional economy, and what's left is a pretty big crater. In a sense, Jeff Bezos has invited us all into his shopping cart. Now we just have to hope he doesn't leave us in the parking lot.

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