Dumping is a term used in international trade that depicts the unfair practice by a company or country of selling its products in a foreign market at a lower price than it sells at home, or a lower price than it actually costs to produce the product. Such practice is deemed illegal by the World Trade Organization and International Trade Association/Commission as long as it is shown that such practice by foreign producers/countries is resulting in a negative effect on domestic producers. In essence, it enables the perpetrator to gain unfair market share. Furthermore, according to Investopedia, predatory dumping is:
A type of anti-competitive event in which foreign companies or governments price their products below market values in an attempt to drive out domestic competition. This may lead to conditions where one company has a monopoly in a certain product or industry. Antitrust or competition laws forbid predatory dumping in many countries such as the U.S. and the European Union.
In this article, we have placed the term “dumping” in the title in quotes, because we are in essence examining the practice of gaining “unfair” market share, irrespective whether it involves international trade or not, by selling products at unfair prices, and ultimately driving out competition and gaining a monopoly. At the end of the day, does it really matter whether it is a foreign entity or a domestic entity that is gaining “unfair” market share, when the end result is the same, driving companies out of business and gaining a monopoly?
When it comes to Amazon (NASDAQ:AMZN), it is a known fact that it sustains substantial losses on its Prime program, whereby its shipping revenues represent a small fraction of its shipping costs. According to Geekwire, Amazon has lost over $12.2 billion on shipping in 2015 and 2016.
Amazon shipping costs / shipping revenues – Source: Geekwire.com
Currently, Amazon recovers only about 53.3% of its shipping costs, while in recent years since 2010, such a ratio has fluctuated between 36.2% and about 61%.
Amazon shipping revenue as a percent of shipping costs – Source: Geekwire.com
What is an unfair price?
Naturally, consumers are always better served in the short run by paying lower prices. Hence, in international trade, although consumers will benefit in the short run from paying lower prices due to the foreign entity providing artificially low prices, predatory dumping is still illegal because it has social and long-term implications: (a) driving companies out of business leads to unemployment, and stagnating wages (b) once companies are driven out of business, the perpetrator establishes a monopoly, ultimately setting higher long-term prices (c) as the new monopoly gains scale, it results in steep barriers to entry for competitors to re-enter when prices move higher.
In this article, we are strictly examining the pricing effect of shipping. Is the shipping price an integral part of the cost of a good or service? It is a debatable issue, but we would say yes it is. According to the U.S. Department of Transportation:
When the entire economy is taken into account, transportation services contribute more than 5 percent to the production of GDP (USDOT BTS 1998). For-hire and in-house trucking accounts for more than one half of this contribution. The importance of transportation varies by economic sector. For example, $1 of final demand for agricultural products requires 14.2 cents in transportation services, compared with 9.1 cents for manufactured goods and about 8 cents for mining products. An increase in transportation cost affects lower margin bulk commodities more than high-value, time-sensitive commodities that have higher margins. In either case, an increase in transportation costs will ripple through all these industries, affecting not only the cost of goods from all economic sectors but also markets that may remain open for the goods.
Hence, between 8% and 14.2% of $1 of final demand for a product, depending on its sector, is attribute to transportation costs. Meanwhile, conceptually, we believe that “$1 final demand” for a product that is delivered to one’s doorstep should also incorporate the cost of final shipping to the consumer as part of the cost. Physical stores that sell in-store have to pay rent, utilities, etc., in order to provide a marketplace to deliver their products to consumers, and such costs are ultimately taken into consideration into how the final prices are determined. In other words, such marketplace, the physical store, is the logistic of how the product is delivered to the final consumer.
If a physical store is unable to recover such costs from its final prices, then such a store will ultimately shut. If Amazon did not subsidize its shipping, and offer other free perks through Prime, then it would have to price its products higher, and would be less competitive with physical stores. Hence, a price for a product that is delivered to a consumer through shipping, without recovering the cost of shipping, is an “unfair price” (to the competition, but not to the consumer).
Amazon’s hold on logistics
The logistics of delivering physical goods to consumers and businesses is either through shipping or through a marketplace. The logistics of delivering digital goods is through cloud computing platforms and/or data centers, such as Amazon Web Services (AWS). At the outset of the internet age, such platforms primarily consisted of web hosting facilities. Cloud computing platforms are in essence a rebranding, advancement and expansion of web hosting.
Amazon is in the business of providing the logistics for delivering goods and services, irrespective whether such goods are digital or physical. However, when it comes to AWS, and as we have experienced over a decade ago when multiple hosting companies went out of business, the re-branded cloud will get competitive, and margins will drop. According to the Motley Fool:
Meanwhile, cloud infrastructure is going to get a whole lot more competitive, as both Alphabet (NASDAQ:GOOG) (NASDAQ:GOOGL) and Microsoft (NASDAQ:MSFT) have both placed high priority on their cloud businesses. It’s not insignificant that Google Cloud beat out AWS for the massive Snap deal, especially since Snap’s embrace of third-party infrastructure is unique in scale.
Meanwhile, when it comes to physical goods, we believe that there will come a day when regulators will indeed examine “fair” vs. “unfair” pricing, when it relates to the implementation of final shipping costs into the price of goods, and whether such practice leads to an unfair advantage, monopoly and negative effect while driving companies out of business. If not, once higher margin businesses, such as AWS, confront competition and experience a drop in their margins, then there will also come a day where it would prove to be too challenging for Amazon to be able to continuously sustain higher shipping costs than shipping revenues, without having to raise prices (or possibly venture into another business to subsidize it…).
Amazon Stock Valuation
Amazon Stock price 1 Year – Source: Yahoo Finance
Amazon shares are up 36% during the past year, with TTM P/E ratio of 189. Shares reached an intraday high of $949.50 today (4/28/2017) following Amazon’s earnings report, whereby it reported net earnings of $1.48/share vs. estimates of $1.12/share. With forward earnings estimates of $7.44/share for this year, and $12.44 for next year, Amazon has forward P/E ratios of 131 and 76, respectively. By all measures, such valuation is quite expensive, while simultaneously, the relative strength index is currently at 71 (such momentum index, which can range between 0 and 100, indicates a buy signal when it drops to 25 or below and a sell signal when it rises to 75 or higher).
Amazon currently has Q1 2017 operating margins of 2.8% for North America e-commerce (down from 3.5% for Q1 2016) , -4.3% for international e-commerce (down from -1.2% for Q1 2016), and 24.3% for AWS (up from 23.5% for Q1 2016). Hence, once AWS margins start coming under pressure due to competitive factors, with dismal e-commerce margins and shipping costs exceeding revenues (and potentially the subject of unfair competitive and monopolistic debate), we believe Amazon shares can experience substantial downward pressure.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.