Revisiting the Early Days of Amazon.com
I get it - I am a little late to the party here. Amazon has proven itself as a brilliant company, and has earned a market valuation that is approaching two trillion dollars. I don’t need to convince anyone of the viability of Jeff Bezos’ business idea for an online bookstore. Cut me a little slack though, I was 2 years old when Amazon was founded and 5 years old when the company went public.
Amazon went public so quickly that the S-1 (an initial registration form filed with the SEC before an IPO) contains all of its financials since the business was started. This is unique, and provides us with an opportunity to see how the business was funded in its early days. This happens to be one of my favorite topics in business.
Amazon filed its S-1 on March 24, 1997. In case you are the one person who hasn’t shopped on this website, Amazon.com was the leading bookstore on the ‘World Wide Web’. At the time, the company was almost exclusively selling books. It had just started offering music and videos as well though. Jeff Bezos owned 43% of the stock. His family, who put in some seed money at inception, owned an additional 10% stake, so the Bezos family controlled the company leading up to the IPO. This could be an important reason why Bezos was able to focus on the long term and sustain losses for a while.
The company was founded in July 1994, but didn’t start selling products on its website until the following year in July 1995. The company spent that first year building the site and getting the infrastructure ready. Amazon spent a total of $52,000 in fiscal 1994, with $38,000 coming from product development and the other $14,000 spent on general and administrative expenses. Once the company launched its website, sales reached $511,000 in fiscal 1995 from July to the end of the year. Amazon reported a net loss of $303,000 that year.
In 1995, Amazon’s operations were funded with $977,000 of equity capital. This capital consisted of about $1.1 million in money raised from investors offset by $248,000 in accumulated losses. Most of this equity was kept as cash to provide flexibility for its extreme growth. Amazon had $996,000 in cash at the end of 1995, along with $57,000 in equipment, $17,000 in inventory and $14,000 of other assets. Interestingly, Amazon had $99,000 in accounts payable on the liability side. This was an early sign of Amazon’s unique working capital situation, as payables were almost 6 times higher than inventories.
In terms of working capital, Amazon’s customers paid upfront using a credit card. This meant that Amazon quickly received funds from customers upon payment. The company would then source its inventory from book suppliers such as Ingram or Baker & Taylor. Amazon might have 30 days or more before it had to pay its suppliers. This mismatch in timing between when funds came in and when they went out resulted in what the insurance industry calls “float”. It allowed Amazon to operate with negative working capital, except for the cash it kept on hand for growth. The business model of Amazon was very efficient in terms of invested capital.
In 1996, Amazon had 180,000 customers in more than 100 countries. The firm offered customers more than 2.5 million book titles. The average physical superstore stocked 130,000 titles. Amazon clearly had an advantage in terms of selection. Amazon’s customers appeared to be happy, as repeat customers accounted for over 40% of orders. This number would have likely been higher if it wasn’t for the fact that Amazon was growing so fast. The International Data Corporation estimated that there were only 35 million Web users by the end of 1996. This was very much still the early days of the internet.
Amazon raised another $8 million in 1996 through the sale of preferred stock. Once again, the company kept most of these funds on the balance sheet as cash. Inventory grew to $571,000 while accounts payable amounted to $2.9 million. Sales grew 2,981% to $15.7 million. The growth of the business, along with its negative working capital cycle, meant that the company had negative cash flow from operations of only $1.7 million despite its reported net loss was $5.8 million.
The float of Amazon was on display in 1997 and 1998. Revenue increased by 838% in 1997 to $147.8 million. The company reported a loss of $27.6 million though. However, cash flow from operations turned positive that year. This was because of the float it generated. Accounts payable increased by $29.8 million, which was enough to swing the cash flow situation positive. In 1998, revenue increased by 313% to $610 million. The company reported a net loss of $124.5 million. Just like the previous year, cash flow from operations was positive since accounts payable increased along with Amazon’s sales. The float of Amazon was an important reason why the company was able to scale its business so fast. Without funds being generated from negative working capital, Amazon would have been forced to raise a lot more money in the public markets, and there is no guarantee that financing would consistently be available. The ability to self-finance is important for the long term stability of a company. You don’t want to be dependent on outsiders for your survival. Despite its reported net losses, the more Amazon grew, the more cash came its way.
Amazon reported a net loss because it was investing for growth. When a traditional brick-and-mortar retailer decided to invest for growth, the effects were seen on the cash flow statement and on the balance sheet. Growth expenses for a traditional retailer are typically in the form of capital expenditures for property and equipment, as well as additions to inventory. These expenses are capitalized, which is the accounting profession’s attempt at spreading out the cost of an asset over its useful life. When Amazon invested for growth, its income statement was heavily affected. This is partially due to the extreme growth rate of Amazon, but also due to the characteristics of the internet. Amazon had to hire a large number of well paid software engineers in order to support its online infrastructure. It takes time to hire and train employees. Since the company was growing so fast, Amazon would have to begin hiring employees immediately for staffing levels they might not actually need for a handful of years. Amazon had 151 employees at the end of 1996. If it knew it would stay at only $15.7 million of sales forever, then it could have operated with a much smaller staff. With sales growing at an exponential rate though, the level of employees had to keep up too. Amazon’s employee count quadrupled in 1997. Salaries for these employees would hit the income statement immediately.
Barnes and Noble, which claimed to be the world’s largest bookseller in 1996, had revenue of $2.4 billion that year. The company had inventory of $732.2 million, which means that its inventory turnover was 3.34 in 1996. The company had a meaningful level of accounts payable, which helped reduce its working capital burden, but not on the same scale as Amazon. Barnes and Noble still had positive working capital, as its inventory was almost double that of its payables.
In 1996, Barnes and Noble had inventory turnover of 3.34. Walmart, for comparison, had net sales of $104.9 billion in fiscal 1996. It had inventory of $15.9 billion, which means that its inventory turnover was 6.60. Amazon’s revenue of $15.7 million against just $571,000 of inventory meant that its inventory turnover was 27.58. This is materially higher than Barnes and Noble or Walmart, two of the best retailers in America at that time.
Let’s dig in more on the structural economic advantages that Amazon claimed in its S-1. As discussed above, the inventory turnover was excellent compared to the toughest of competitors. Additional advantages include the fact that it would have less need for expensive real estate, and that it would have lower personnel requirements.
In terms of real estate, traditional bookstores had to be in desirable, high traffic locations. Barnes and Noble operated large superstores that consisted of many square feet of retail space. Amazon, on the other hand, would eventually need to grow its distribution centers and warehouse capacity. However, its warehouses could be in far less desirable areas since the space did not need to attract customers. The price per square foot Amazon would pay for its warehouse space would be much lower than what Barnes and Noble paid for its stores. Barnes and Noble operated 431 superstores in 1996, and also had an additional 577 mall-based stores that year. The company had 11.5 million square feet of total retail selling space. However, it also had a certain amount of warehouse space as well to service its stores. In 2000, Amazon had 4.5 million square feet of warehouse space. Not only was the price per square foot of real estate cheaper for Amazon, but the total amount of physical space needed was also lower.
In 1996, Barnes and Noble had revenues of $2.4 billion and it operated with 24,000 employees. In 2000, Amazon employed 9,000 people when it reached $2.8 billion in sales. A portion of Amazon’s staff would be highly paid software engineers, likely costing more than the average Barnes and Noble employee. At the same time, hopefully the skills and expertise of each software engineer could be put to greater use developing new products and services for customers. The productivity of a highly skilled and motivated software engineer can be extremely valuable to a company.
Amazon’s IPO fetched $18.00 per share for its stock at the time, which would be equivalent to $1.50 per share today on a split adjusted basis. This valued the company at $413.2 million at the time. This valuation is quite a bit smaller than what many companies go public with today. Rivian Automotive, for example, recently went public with zero dollars in sales and already has a valuation approaching $100 billion. Maybe Rivian is a bad example here, as the situation is just pure madness. However, many other companies are delaying their IPO as venture capital funding has been easier to access. Many investors dream of finding the “Next Amazon”. While this is extremely unlikely for a number of reasons, including how unbelievable Amazon’s execution was, it is rare to have the opportunity to invest in a great business as early today. The runway for early individual investors of Amazon was much larger than usual, as Amazon started out as a small-cap stock while its total addressable market was huge since it operated in the retail industry.
After reading the early filings of Amazon, I just wanted to report back to all of you that Mr. Bezos did a really nice job.
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