Amazon.com achieved what many observers thought was a pipe dream for the online retailer: a profit in fourth-quarter 2001. After the Jan. 22 earnings announcement, Amazon Chief Executive Jeffrey P. Bezos spoke with BusinessWeek Senior Correspondent Robert D. Hof about how the company did it. Bezos also outlined his still-ambitious vision for Amazon's future. Edited excerpts from their conversation follow:
Q: The net profit was a surprise, but one that Amazon wouldn't have achieved without some unpredictable events, such as a favorable exchange rate on the euro. Should investors continue to be wary?
A: The thing to be more focused on is the size of the pro forma operating profit of $59 million [more than 10 times higher than analysts' estimates]. That's what we're very proud of. And even the pro forma net profit was enough to cover a half a year of interest expense, not just the quarter. GAAP [generally accepted accounting principles] earnings in our case are very, very complicated and not predictable. So I wouldn't read too much into that.
Where we are focused for the coming year is achieving operating cash flow. It's just as aggressive a goal as the one we set a year ago. Maybe we will even get free cash flow.
Q: Why are those metrics so important to you, given that investors keep looking for consistent net profits?
A: If you look at academic studies, you can see that stock prices are most closely correlated with cash flow. It's such a straightforward number. Cash flow is what will drive shareholder returns.
Q: What accounted for most of the bottom-line improvement?
A: Without a question it was the very significant reduction in prices that we put in place in the fourth quarter. We had always had low prices, but in the fourth quarter we really lowered prices -- for example, 30% off on books over $20.
That had a substantial effect on volume. You can't do that until you have the operating efficiency to afford to do it. We just saw it a little bit faster than we expected.
Q: In fact, you're expanding this strategy by now offering free shipping on all orders over $99. Why would you do that when you're still struggling to earn net profits on a more regular basis?
A: While it's expensive in the short term, we have a reasonable understanding of price elasticity with respect to free-shipping offers. Every time we have done a short-term price promotion, we have been able to record the results. Over the years, we've built up an understanding of how customers respond. It is a bet. We just think it's a good bet. We think it will pay off in the long term.
Q: Some folks might ask why you don't keep prices fairly constant and get to full-year profits faster.
A: Both strategies do have viability. There's one strategy, like some department stores, where you put the piano player in the stores to justify a price premium and work very hard to raise prices. There's a second model -- which usually leads to a larger, more important company but is very hard to do -- where you work just as hard on lowering prices. We have made the decision that we are going to be that second kind of company.
Q: How sustainable are Amazon's results?
A: On the cost side, that is sustainable. In fact, they're more than sustainable. We are expecting to be able to further improve that. But we're at a point now where our unit volumes more or less cover our fixed costs. Assuming we can hold our costs mostly fixed, which we believe we can do, then increases in unit sales have a very important effect on the bottom line.
On the revenue side, there's obviously seasonality, and our revenues in the first quarter won't be as large as they were in the fourth quarter.
Q: With partners such as Target and Toys 'R' Us selling on your site, Amazon isn't simply a retailer anymore. What is it?
A: It is genuinely something new. It's very difficult to find a perfect analogy in the physical world because what we're doing is a new kind of thing. Online, this new kind of thing is what will best serve customers.
Q: So Amazon reported its first profit on the same day that Kmart filed for bankruptcy protection?
A: There is some irony there. The lesson I take away from that is how fundamental the customer experience is.
Q: Will this profit showing change investor attitudes toward e-commerce, which seem to be in a nuclear winter lately?
A: It's not so much a nuclear winter as you might think. We're seeing it through the lens of 1999, which was a very anomalous period. By historical standards, it's hardly a capital crunch.
Q: What was your reaction when you realized you would earn the profit?
A: It feels good. It has been six years. And I don't think the next six years will be any easier. I hope not. So far, I've been so busy, I haven't had much time to reflect on it. We were certainly giving each other high fives in the halls.
Q: No champagne?
A: We will celebrate, but quickly.