GROUP ASSIGNMENT on

CASE STUDY: AMAZON (2018)

BUSINESS & FINANCIAL STRATEGY

EMBA 632 – Strategic Corporate Finance

Semester (III)

By Group 2

M. F. M. Fasileem 2019/EMBA/WE/02

W. A. N. Perera 2019/EMBA/WE/04

Yang Yingtao (Grant) 2019/EMBA/WE/10

M. H. I. M. Aththanayake 2019/EMBA/WE/11

Executive Master of Business Administration (EMBA) – 2019/2021

Programme

Postgraduate and Mid-Career Development Unit

Faculty of Management & Finance

University of Colombo

Date: 18/07/2021 Word count: 3457

Table of Contents

Table of Contents ................................................................................................................ 2

1. Introduction ................................................................................................................... 3

1.1 Amazon Vision ....................................................................................................... 3

1.2 Amazon Strategy & Management Principle ............................................................. 3

1.3 Amazon Main Products Segments ........................................................................... 4

1.4 Product Market Strategy.......................................................................................... 6

1.4.1 Geographical vs Product Segment vs Organizational function: ............................ 6

1.5 Financial Strategy ................................................................................................. 10

2. Profitability Analysis ................................................................................................... 13

3. Ratio Analysis .............................................................................................................. 17

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1. Introduction

Amazon is the world’s largest retailer by 2017, with an annual turnover of around & 178 billion.
Starting with its humble beginnings as a tech disruptor seeking to digitize the traditional
publications market with e-books & e-reading solutions.

Today it has evolved from its original vision to become the leading online retailer in its home
market of North America & abroad, further expanding into segments such as tech hardware
manufacture, cloud/web hosting solutions provider to one of the leading online content
providers with its Amazon prime services.

Being part of the Big 4 tech companies commonly known as GAFA (Google, Amazon,
Facebook, Apple) it has garnered wide recognition in the investment market shown through its
high market capitalization $ 566 billion in 2017. In this analysis we see what it its strategy as
a company & how it is supported by its financial strategy. We evaluate its performance basis
the last 5-year financials to see how it is reflecting actually as an outcome in financial terms.

1.1 Amazon Vision

“Customer obsession rather than competitor focus, passion for invention, commitment to
operational excellence, and long-term thinking”

1.2 Amazon Strategy & Management Principle

Summary of its business strategy is as follows,

• Achieve long term market leadership & create an enduring franchise, bringing higher
revenue, profitability, increased ROC and shareholder value.
• Relentless focus on customers. True customer obsession.
• Aggressive investments to expand customer base, brand, and infrastructure, irrespective
negative short-term investor sentiment
• Lean & cost-conscious culture

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1.3 Amazon Main Products Segments

Amazon today operates in many diversified segments. They can be categorized as follows,

• Online Retailer – Sells virtually all product categories (Books, electronics, Clothing,
Homeware, Food etc. – over 250 million product categories in its catalogue 2017).
This is the main revenue generator with over $108 billion generated accounting for
over 61% of its total turnover.
Online retailer:
- Accumulated growth for last three years (2014 – 2017) is 58% (Exhibit 3,
table 1).
- Cost of goods sold in the P&L as 94% of sales.
- Amazon manufactures and sells electronics devices and develops and
produces media content.
- Retail strategy focuses on selection, low prices, and convenience.

• Marketplace or 3rd party seller services – Sale of 3rd party goods for a premium.
Accounting to almost 50% of its total 4 billion items sold per annum. It also provides
wide range of facilities such as shipping, web marketing, customer service channels
etc. for a fee.
- 2 million sellers from 100 countries sell their products through Amazon
marketplace.
- Amazon offers third party sellers, like web, marketing fulfillment
(logistics, transportation…etc.)
- Revenue from third party is $32 billion or 18% of Amazon’s total sales
and growing very fast.
- Accumulated growth for last three years (2014 – 2017) is 171% (Exhibit 3,
table 1).
- Higher operating profit in its marketplace then with its own products sold.

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• Subscription services – Includes its suite of content services categorized under the
Amazon Prime umbrella. Services such as book reading (Audible), Prime Music,
Prime Video, Prime services account for this category.
- Annual/monthly fees associated with the Amazon Prime membership,
audiobooks, e-books, digital video, digital music, etc.

• Amazon Web Services – World’s currently leading web solutions services provider.
Represents 10% of its total revenue in 2017. Showcasing the highest growth rate
among all product segments.
- Offers broad set of global computing (Cloud service), storage, database,
and other services to companies and institutions.
- In 2017 10% of total revenue ($17 billion) and having operating profit
(EBIT) of $ 4.3 billion, (105% of total EBIT of Amazon)
- Highest growth that is 122% from 2015 to 2017

• Content Creators – Through its digital & physical distributions network Amazon
provides musicians, authors and content creators a platform to share & sell their
content at a premium through its Amazon Kindle & Prime services.
- Publish and sell content using content creator platform.

• Physical Stores – Established in 2017, includes bookstores, pop-ups extending its

digital online retailing to the physical world in its home markets. Account for 3% of
its sales mix.
- Established in 2017 and it includes bookstores, pop-ups, and amazon 4-
stars, represents 4% of Amazon’s sales mix and $ 6 billion.
- With the acquisition of whole foods, Amazons intends to move in to
grocery stores.

• Other – Represents all other income categories not covered above. Includes the like of
advertising services, co-branded credit card facilities etc.
- Products are advertising services and co-branded credit card agreements.

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1.4 Product Market Strategy

Based on the above product categories Amazon is seeking to maximize its market leader
position in all these segments. Already in online retailing, Web/cloud services it is the market
leader. Other categories also they are a close Market challenger or follower, hence we can see
that they are true to their product market strategy.

Below we have analyzed the different categorization for the Amazon business based on
product segment. Then gone to analyze based on geographical location, income segment etc.
Our observations basis the data is given below.

1.4.1 Geographical vs Product Segment vs Organizational function:

Having six (6) different products, market place, AWS and Others has given a better sale
compared to retail on line and retail physical stores. However, major portion of the generated
from retail on line, market place and AWS.

Net sales or revenue: better growth in sales averaging at 24%. However, “how much profit a
company makes is based on its cost of sales”. As OPEX growth shown 34% profitability may
continue to decline in the future.

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Also, overall company is not getting better profit as EBIT/Sales shows 3% in 2016 and 2% in
2017.

Predominantly US has given a better sale compared to other countries and second-best sales
growth is existing in Germany compared to UK and Japan. However, there is a potential sale
in rest of the world as it hits 10% of the sales.

Comparing by product key product segments/focus areas. North America, international &
AWS Amazon web services, where North America has given a better sale. However, AWS
has given an excellent accumulated growth and it shows there is an opportunity for further
growth.

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Even though Amazon has overall better sales it can be noted that AWS has given a better EBIT
compared to North America and international segments. Hence the real growth can be expected
in this segment, which Amazon needs to focus in the future.

Another important point is that international segment has given negative value for operating
income and it has increased over the period significantly, required serious attention. Amazon
needs to cut its losses & exit markets which are not profitable. Especially in developing nations
where counterfeit products & content piracy prevalent most of its products will not do well.
Hence unless strong regulatory framework & government support is prevalent it needs to exit
such markets & focus on the ones with the right conditions.

Total assets by segments are showing better growth in line with their business strategy.
Corporate is having 45% assets and second highest asset is in North America. However, when
it comes to ROA international results in negative growth of assets whereas AWS leads with
the highest positive growth. However, consolidated view shows decreasing trend in ROA,
which is mainly due to AWS. Therefore, better to have serious review on the international
segment as discussed earlier.

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When considering the overall retail industry, most significant sales are still generated from
store-based retailing. Yet the growth is stunted & the expansions is indicated in internet
retailing with over 58% growth as compared to store-based – 6% (USA and world). Hence
Amazon needs to capitalize on its online retailing strength & invest more in that segment in
strategic markets internationally which deliver the optimal revenues.

In comparison to its competition in the US, Walmart has better sales comparatively other
leading US retailors, but Amazon has shown better CAGR SV as 26% comparatively others.
Amazon’s market capitalization also higher compared to other retailers. However, Amazon is
having poor net-come and ROA but carrying better assets. Unless a calculated decision to retain
profits the low net income is indicating a worrying trend of escalating costs which is
contradictory to its strategy of becoming a lean, cost effective enterprise.

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Amazon leads the internet retailers globally also, comparing and contrasting with other retail
giants in the world, having larger asset base & market capitalization. When it comes to ROA
amazon shows lower amount and other having better income. Hence again reinforcing the fact
that it needs to focus on controlling its costs.

In the technology company sphere, Apple has shown better figures in terms of all the categories
and leading the market in terms whereas market challenger after Amazon would be google as
their sales & other figures are shining. Positive part of the Amazon is that it’s having better
sales, assets and market capitalization, but poor ROA.

1.5 Financial Strategy

Amazon’s Financial strategy is created to support its vision & business strategy. It can be
summarized as follows,
• Focus on long-term, sustainable growth
• Low COGS through direct sourcing & discounts from suppliers
• Quick turn inventory
• Invest efficiently in technology and content

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Although above is the stated strategy we can see that in some areas it has defaulted in its
purpose. Refer below,
• Long-term, sustainable growth –
o This is evident from its steady investment in capital YoY increasing its asset
base to support its growth trajectory. Yet eroding profitability due to the faster
increasing Cost of Sales (34% vs 24% growth in sales) questions its
sustainability.

• Low COGS through direct sourcing & discounts from suppliers -

o Although one of the key business strategies to have a leaner enterprise YoY
we see the Cost of Sales increasing at an exponential rate. It could be seen as
a tactic to retain cash in the company yet the thin margins derived speak of an
underlying trend of increasing costs. The record high payables & accruals
recorded in 2017 ($ 47 billion) speaks about a good management practice
where a significant portion of tis cashflow financing is done via its suppliers.

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 • Quick turn inventory –
o The very low inventories maintained ($16 billion out of total $60 billion total
current assets - 26%) showcase a good management practice where the
inventory turnaround seems to be high reducing/limiting the exposure of the
company.

• Invest efficiently in technology and content-

o The high non-current assets ($71 billion vs total Assets of $131 billion – 54%)
indicated its commitment to building technology & content, which has proven
profitable through the growth observed in new segments such as AWS
(276%), Subscription services (118%) etc.

Also, in terms of its financing strategy Amazon seems to be highly geared company with a
Debt/Equity Ration of 1.57 in 2017 showing its reliance on borrowings. In a market downturn
this would leave the company exposed, yet given that it is more serviced through long-term
debt ($ 38 Billion) vs short term debt ($ 6 Billion) puts Amazon in a relatively safer position.
The added advantage of such strategy is that it doesn’t dilute the majority stake of its
shareholder, where we still have Jeff Bezos maintaining his controlling stake to date.

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2. Profitability Analysis

2.1 What does it sell? – Growth, Profits and profitability

Amazon’s main business can be divided into five categories as explained earlier, Online
retailer, marketplace or Third-party seller service, subscription service, Amazon web service,
physical stores.

The net sales of Online retailer achieved 58% accumulate growth from $ 69 billion in 2014
to $ 108 billion in 2017 and contributed 61% of its Sales Mix in 2017; while Market place
and third-party seller services got 117% accumulate growth from $ 12 billion in 2012 to $ 32
billion in 2017 accounting for 18% of Sales Mix in 2017.

The accumulate growth for the net sales of Subscription service and Amazon web service was
118% and 276% respectively from 2014 to 2017, taking up 5% and 10% of the Sales Mix in
2017. The segment of physical stores was created in 2017 and represent 3% of Amazon’s
sales mix in 2017.

Accordingly highest revenue is generated from its retail business supporting the absorption
of its overheads stemming from its corporate assets. Yet highest growth is recorded in AWS.
AWS revenue seemed to have almost doubled in 2016, but at the same time the Non-Current
Assets seemed to increased significantly overtaking current assets.

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This could be due to the high investment required for large-scale data centers etc. Although
information is lacking to say exactly it is good to investigate if AWS is having a higher
profitability parallel to its high growth.

2.2 Where the company does makes Money?

Amazon mainly makes most money from the two segments, retail on line and Market place
& Third-party seller services.

In term of the geographical markets, 68% of Amazon’s net sale came from United States in
2017, 10% from Germany, 7% from Japan, 6% from United Kingdom and 10% from rest of
the world.

P&L Ratio 2013 2014 2015 2016 2017 Average

Product gross margin % 11% 11% 10% 7% 6%

Gross Margin/Sales 27% 30% 33% 35% 37% +10pp

Also considering product segments/categories, from above table, we can see the product gross
margin % is less than Gross Margin/Sales in each year from 2013 to 2017, which indicate the
Service gross margin % is much higher the Product gross margin % and higher than Gross
Margin/Sales, so it demonstrates that Service segment contribute more to margin than
product.

2.3 Is the business profitable?

In general, Amazon’s business is profitable from 2013 to 2017 except 2014. Its net profit
from 2013, 2015, 2016 and 2017 is 0.3 billion, 06 billion, 2.4 billion and 3.0 billion
respectively, it suffers a loss of 0.2 billion in 2014.

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2.4 Sales Growth – Product vs Services

P$L Ratios 2013 2014 2015 2016 2017 Average

Product sales growth 18% 15% 13% 19% 25% 18%

Service sales growth 45% 40% 47% 49% 43% 45%

Total sales growth 22% 20% 20% 27% 31% 24%

Looking at above it is clear that higher growth is coming from the services segment. Products
such as Kindle, Amazon Prime plus AWS & its data hosting/cloud services seems to be fastest
growing. This is where Amazon is attracting new customers with its unique products.

2.5 Operating Expenditure

P&L ($ Bn.) 2013 2014 2015 2016 2017

Marketing 3 4 5 7 10

General & Administrative 1 2 2 2 4

Technology & Content. 7 9 13 16 23

R&D
Fulfillment& Other 9 11 14 18 25
Operating Expense
OPEX 20 26 33 44 62

We can see OPEX was increasing year by year from 20 billion in 2013 to 62 billion in 2017,
the main incremental are from the expense of R&D, Fulfillment and other operating expense.

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2.6 Profitability - EBIT and Sales, ROS (Return on Sales), ROE (Return on Equity), Market
Capitalization

P&L ($ Bn.) 2013 2014 2015 2016 2017

Sales（Revenue） 74 89 107 136 178

EBIT 0.8 0.3 2.2 4.2 4.1

EBIT/Sales 1% 0% 2% 3% 2%

ROS(Income/Sales) 0.4% -0.3% 0.6% 1.7% 1.7%

ROE 3% -2% 4% 12% 11%

Marketing Capitalization ($ Bn.) 183 144 318 358 566

The table shows both Sales and EBIT rising year on year from 2013 to 2017, while
EBIT/Sales did not experience the same increasing trend in the same period. It even drops to
0% in 2014. Also, EBIT/Sales were very low which show the cost was too high causing the
lower profit.

ROS was very low from 2013 to 2017, all were below 2%, even experience -0.3% in 2014,
which shows the total cost was too high so than the profit margin was low.

In general, ROE experienced an increasing trend from 2013 to 2017 from 3% to 11%, with a
drop to -2% in 2014. We can find out the profitability of Amazon was increasing in this
period; the quality of the equity was improving.

The market capitalization was continuously rising from $ 183 billion in 2013 to $ 566 billion
in 2017, which show the investors’ confidence to the development of Amazon was high.

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3. Ratio Analysis

3.1 Current Ratio / Quick Ratio

Current Ratio = Current Assets / Current Liabilities

The current ratio is used to measure the ability of an enterprise's current assets to be turned into
cash for repayment of liabilities before the maturity of short-term debts. Although the higher
the current ratio, the greater the liquidity of enterprise assets, but the ratio is too large indicates
that the current assets occupy more, will affect the operating capital turnover efficiency and
profitability. Liquidity ratio is generally considered to be above 2 is ideal. The current ratio of
Amazon from 2013 to 2017 was consistently maintaining at around 1, which show its Current
liabilities was too high in this period. Higher the liability as opposed to its liquid assets more
chance the company would be in trouble during adverse economic conditions.

Quick Ratio = Current Assets less Inventories / Current Liabilities

The level of quick ratio can directly reflect the short-term solvency of an enterprise. It is a
supplement to the current ratio and is more intuitive and credible than the current ratio. If the
current ratio is high, but the liquidity of current assets is very low, the short-term solvency of
the enterprise is still not high. The quick ratio has to be greater than one normally. If it is greater
than 1, it indicates that the company don’t have pressure to pay current liability. If it is less
than 1, it indicates there is difficulties to pay the current liability.

Balance Sheet ($ Bn.) 2013 2014 2015 2016 2017

Total Current Assets 25 31 36 46 60

Inventories 7 8 10 11 16

Total Current 23 28 34 44 58
Liabilities
Quick Ratio 78.26% 82.14% 76.47% 79.55% 75.86%

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From the table, we can see the Quick Ratio of Amazon from 2013 to 2017 were all less than 1,
it shows Amazon is insolvent and needs to reduce its debt.

3.2 Working Capital:

Working Capital: (Current Asset – Current Liability) = Working Capital

If the ration comes below one (1), it means that negative and above one (1) shows positive
working capital, which can be utilized for operations and invest in future business. But better
no to have high capital reserves, which results excess inventory.

Over the period working capital is positively resulted and exceptionally increased in 2014.
Since value is above the one (1), it can be noted that Amazon has better working capital.

3.3 Leverage:

Leverage Ratio: (operating income / interest expenses) = Leverage Ratio

This formula tries to provide the figure to understand “the company’s ability to make interest
payment” and it is advisable to have 3.0 or higher is desirable, but it is depended on industry.

Leverage ratio also steady and shows in better position from 2013 to 2017. Since it is above
3.0, it can be noted that company is maintain it at a steady level. Also, the majority of liability
as explained earlier coming from long term debt is a better strategy in a high leverage scenario.

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3.4 Dupont Leverage:

What is DuPont Analysis?

In the 1920s, the management at DuPont Corporation developed a model called DuPont
Analysis for a detailed assessment of the company’s profitability. DuPont Analysis is a tool
that may help us to avoid misleading conclusions regarding a company’s profitability.

Formula and Calculation of DuPont Analysis

The Dupont analysis is an expanded return on equity formula, calculated by multiplying the
net profit margin by the asset turnover by the equity multiplier.

DuPont Analysis = Net Profit Margin x AT x EM

Where,
Net Profit Margin= Net Income/ Revenue
AT=Asset turnover
Asset Turnover= Sales/Average Total Assets
EM=Equity multiplier
Equity Multiplier= Average Total Assets/Average Shareholders’ Equity
ROA= Net Profit Margin X Asset Turnover
Leverage= EM
Dupont Formula= ROA X Leverage

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As per Exhibit 01

Dupont value increased during 2013 to 2017 from 0.0287 to 0.1081 It’s a sign of a good
company management.

Since ROA is also increased it indicates that the company is doing a good job of increasing its
profits with each investment

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