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Amazon's Supply Chain, Part 2

Updated: Dec 22, 2019

About two months ago, I posted an analysis of Amazon's supply chain in the form of a downloadable report. I am now following up with a post that provides some insights and commentary on Amazon's supply chain and why it is the critical financial flywheel that will allow Amazon to keep growing, albeit with increasing risks.

Amazon is the juggernaut retail corporation of our day and there is much interest in how they do things. Just about every retailer in the world has had to come to grips with how to address Amazon's onslaught. Walmart, the world's largest retailer, is bound and determined to not have Amazon do to them what Walmart did to Sears, Kmart, and others. Retailers lament that Amazon runs a high-growth, zero-profit business model, and is rewarded for doing so by the investment community, while these same retailers are held to a different set of rules by the same investment community. Amazon's answer to this is that they just focus on customers, providing ever more innovative ways to serve customers; everything else just flows from that focus. The investment community says that Amazon could turn into an incredible profit engine at any time. But is this true, and if so, how will they do it? This was some of the curiosity that led us to develop the report.

Here are some key takeaways from the report:

1. Amazon loses about 2 cents of operating profit for ever dollar of sales on its original inventory-owned business model, but makes about 15 cents of operating profit in its services business, which includes fulfillment by Amazon (FBA), Amazon web services (AWS), and other services. This implies that the original inventory-owned business model is substantially the same, while the profit engines of today, and perhaps tomorrow, are the innovations off of the original business model.

2. While Amazon's revenue was $136B in 2016, the gross product flow through its supply chain is estimated to be $204B for 2016. Gross product sales were estimated to be 54% third party sales, and 46% Amazon-inventory-owned sales.

3. It is estimated that fulfillment by Amazon (FBA) yields about 21 cents for every dollar of third-party gross product sales.

4. Shipment and fulfillment costs are growing significantly faster than overall revenues primarily because of a) significant growth in third-party sales; and b) increased cost in sortation centers for local and last-mile delivery.

5. Amazon had 160M square feet in fulfillment and data center space (a very high percentage of this is fulfillment) at the end of 2016. Analysis suggests Amazon drives about $1300/year in gross product revenue per square foot of fulfillment space.

6. Amazon spends little to no time talking about gross margins, which is a traditional key measure in the retail business. From a financial perspective, it focuses principally on cash flow. In fact, as services has grown to be a significant part of Amazon's business, gross margin discussions have become even less relevant.

7. Amazon's cash conversion cycle was minus 35 days. It pays its suppliers in approximately 104.7 days, carries about 47.4 days in inventory, and has about 22.4 days receivables. This represents about $13B in cash (on an end-of-year revenue basis) that it can use to invest (overall operating cash flow had a 33% five-year CAGR, while overall revenue had a 23% CAGR). This float on cash is one of the critical elements of Amazon's business and a powerful statement for how superior supply chain management can build a business juggernaut. This business approach is also not unlike the float on insurance premiums that Warren Buffet has historically used to invest and grow his business (Buffet's recent letter to shareholders values Berkshire's float at $114.5B for 2017). It is furthermore a classic example of using other people's money to build a behemoth.

The full report can be downloaded here. Let me know if there are things you see that could improve the report. Amazon has recently published their 10K for 2017, so the 2018 version of this report will be published in the next two months. Going forward, as Amazon integrates Whole Foods, and as its services business swallows the original business, it may be more difficult to decipher how its supply chain operates.

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