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On the current price war in retailing

Posted by John T. Reed on

Black Friday’s Wall Street Journal had an article comparing prices for certain toys at Target, Wal-Mart, and Amazon during recent days. They were bouncing around but tracking and matching each other to the penny.
So if you believe that Amazon is aways the cheapest, you have been successfully conned by Amazon.
Secondly, these three companies have gotten themselves into a horrible Hobbsean conundrum. With the internet letting people always find the lowest price, retailers are forced to offer it or lose the sale.
Retailers who sell products that cannot be bought anywhere else make their living off branded products which means high profit margins.
But if you sell products that can be bought from other sellers, your profit margins will suffer as people buy your products from the cheapest source.
What’s worse is many products are used as LOSS LEADERS to get people into the store or web site. Those are deliberately being sold at a loss in the hopes on of selling other profitable products in the same order. So Amazon et al. may lose even profitless sales to those who sell those same products at a loss.
All three companies need to find a way out of this death spiral. And the manufacturers can make it worse by selling direct to consumers.
Here is what is happening behind the scenes. The manufacturers like Mattel with the Barbie Doll, want to maximize their profits. They do that by either raising prices or lowering manufacturing or distribution costs or both.
The retailers—Amazon, Target, Wal-Mart—also want to maximize their profits, albeit not so much with Amazon, because they are more in the business of selling the shares of their company than the products at their web site.
How do retailers increase profits? By raising their prices, but that would mean losing sales to their competitors, Or they can lower the wholesale prices they pay for the products like the Barbie Doll. But that lowers the profits of Mattel and the other manufacturers.
So notwithstanding the nice, friendly images all these companies present to the public, behind closed doors, they are cursing at each other probably something like this
Manufacturer to retailers: You guys have lost your minds. You’re destroying our brands and destroying our businesses.
Retailers (Amazon, Target, Wal-Mart) to manufacturer: This probably isn’t the best time to bring this up, but we actually need you manufacturers to lower your wholesale prices to us because our margins are under pressure because of the price war.
M to R: Lower them more!? You’ve demanded we lower them every year. Go to hell! We’re done lowering them. We are not a charity like Amazon. We have to sell each item at a profit. We can’t lose money on sales and make it up by selling our stock for a ridiculous price. News flash! We are looking hard as self-distribution. We have the most popular doll on earth. Let’s see how much your damned stock price goes up when the news is you now longer have Barbie Dolls.
A to M: And let’s see how many fewer dolls you sell when people can’t get them on Amazon.
M to A: Beats going bankrupt selling them to Amazon at a loss.
So I left out most of the profanity that is likely being said.
And today’s Wall Street Journal says Amazon’s stock price hit a record high.
How can a stock price go up when the sale prices of the company’s products are going down?
1. The most ignorant laymen think if they like buying products from Amazon that its stock must be a great investment. The opposite is true. What they mainly like is the low prices and low prices mean low profits. I buy from Amazon for the low prices, but I do not buy their stock because I know they have lousy profits.
2. The most ignorant laymen think if a company has a great TOP LINE—sales—they must have a great BOTTOM LINE—profits. Not if the company in question is “buying the business,” that is, increasing sales by selling cheaper than everyone else.
Isn’t it true that if you sell cheap you will lose profit margin on each item but you can make up that lost margin per item by selling more items? Yes, but there comes a point where your profit margin goes to zero in which case more volume accomplishes nothing regarding profit. And when you start LOSING on each item, more volume just means more losses.
3. Some investors who are more aware than ignorant laymen buy Amazon’s explanation that their profits are only lower than comparable companies because they are reinvesting profits to get humongous profits in the future. That is bull, an old dodge known as the hockey stick. It just says we are going to have extraordinary profits in the sweet bye and bye. Talk is cheap. The phrase “pie in the sky” was created as a parody of the phrase “sweet bye and bye.”
The phrase [“pie in the sky”] is originally from the song “The Preacher and the Slave” (1911) by Swedish-American labor activist and songwriter Joe Hill (1879–1915), which he wrote as a parody of the Salvation Army hymn “In the Sweet By-and-By” (published 1868). The song criticizes the Salvation Army for focusing on people’s post-death salvation rather than on their material needs while they are alive:
You will eat, bye and bye,
In that glorious land above the sky;
Work and pray, live on hay,
You’ll get pie in the sky when you die.
Amazon’s promise of extraordinary profits, but not just yet, is almost certainly pie in the sky.
Older investors like me remember this jive from the conglomerate era when corporations grew at a great rate by acquiring other firms. The hockey stick rationale was that the combining of big corporations would produce “synergy.” The conglomerates would get economies of scale by combing HR departments and bigger volume discounts on raw materials and would have greater sales by cross-selling between corporations.
Sounds logical, like the current Amazon song and dance, but it just did not happen. There are also diseconomies of scale like cost of converting corporation A to corporation B’s accounting system when the two become part of the same big conglomerate. And cross selling is easier said than done.
A paraphrase of another old saying applies: A profit in the hand is worth two in the bush. Companies like Target, Apple, and Wal-Mart have profits now and in the past. Amazon mainly has them in the future. Talk is cheap. And what is the basis for the vague notion that Target, Apple, and Wal-Mart will have somehow smaller profits in the future. Something like suggesting that the Patriots will lose a lot of games in the future because they won a lot in the recent past. They may lose a lot in the future, but it will not be because they won in the past. The more likely scenario is that winners like Wal-Mart will continue to win and BS artists like Amazon will continue to BS.

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