The Three Profits
Last week, Eugene Wei, a former Amazon employee, posted an excellent article called the "Amazon profitless business model fallacy." Eugene was debunking the prevalent belief that Amazon seems to be highly value despite its not making a serious profit.
To my mind, however, Eugene isn't debunking the "profitless business model" fallacy, he is debunking the "pundits actually know what they are talking about" fallacy.
There are actually three kinds of profit in business:
- Gross: This is what is left after you sell each item. Sell a book for $3 that cost you $2 to buy, you have $1 in gross profit, or a 33.3% gross margin. Without this kind of profit you are doomed, unless you can get it gross profit at scale and are growing quickly to get there.
- Operating: This is what is left after you have taken all of your gross profits from all your item sales, then subtract your fixed operating costs - headquarters, administrative staff, R&D, etc. If you have negative operating profit, you need to cut fixed costs or grow your unit sales until your gross profit exceeds your fixed costs.
- Scale: This is my own term, and it describes what is left after you reduce most of your operating costs, but exclude reinvestments into rapid growth. If you have gross profit and scale profit but not operating profit currently, then you really are profitable but are choosing to reinvest your profits (and more) into future growth.
As long as Amazon is:
- Profitable on a gross margin basis; AND
- Growing at a pace, either in its current businesses or in new ones, that it could immediately dial back that growth and become nearly-instantly highly profitable on an operational basis; AND
- Those investments in growth are paying off in providing even more revenue that is gross margin positive...
then Amazon is not a profitless business model. It is a highly "scale profitable" business model that could become very operating profitable the moment it chooses to do so.