Finding Sustainable Profitability in Electronic Commerce

Warren Buffett, the president of Berkshire Hathaway Inc. and one of America’s most storied investment managers, remarked last year that if he were teaching an MBA class on finance, the final exam would have one question: “How do you value an Internet company?” He said anyone who turned in an answer would fail. Clearly, it is extremely difficult to value e-commerce companies on their assets or profits, because most of these companies have little of either. Indeed, even multipliers of revenue are difficult to assimilate into any sensible financial valuation model. Yet, the price appreciation of e-commerce stocks in the past two years has been phenomenal, reaching a one-year gain of nearly 100% and a five-year gain of 1,100%, creating market capitalizations surpassing even some of the most widely held and admired growth and retail companies on the New York Stock Exchange.1 As of April 20, 2000, the market capitalization of Amazon.com Inc. was a stunning $18.3 billion — even though the company claims merely $1.6 billion in annual revenue and has never earned a profit. EBay Inc.’s market value was $19.6 billion, despite its unremarkable $11 million profit on merely $225 million in 1999 revenue. To put these dot-com valuations in perspective, consider the mere $14.2 billion market value of Sears, Roebuck and Co., which last year garnered more than $1.3 billion in net income on annual revenue exceeding $32 billion. Similarly, Federal Express Corp., a traditional “heavy asset” company, was valued at only $10.9 billion, even though it boasts almost $700 million in profits on nearly $18 billion in sales and will almost certainly earn more by delivering the goods ordered up during the dot-com revolution. Indeed, these market data suggest that even after this spring’s market shakeout, investors would prefer to own a small and unprofitable e-commerce company such as Amazon rather than Sears — a profitable company 20 times the size of Amazon and one of the world’s most respected retail outlets. It is easy for managers to ignore such stock valuations as whims of the market, venture capitalist hype and day-trader craziness. However, billions of dollars are riding on such whims, hype and craziness. Moreover, thousands of the nation’s brightest business and engineering minds have chosen to ride the dot-com wave.

Read the Full Article:

Sign in, buy as a PDF or create an account.

References

1. Hambrecht & Quist, Internet Index, January 2000. H&Q (www.hamquist.com) tracks a number of Internet stocks, which are placed in its Internet Index. The Chase Manhattan Bank completed a purchase of the San Francisco-based H&Q in December 1999.

2. “Doing Business in the Internet Age,” Business Week (June 22, 1998): 121-172.

3. Note that these categories are analogous to the production processes outlined 15 years ago in: R. Hayes and S. Wheelwright, “Restoring Our Competitive Edge: Competing through Manufacturing” (New York: John Wiley, 1984).

Continuous flow, assembly line, job shop and project. Another way of thinking about these categories is in a cumulative manner: commodities are differentiated in one attribute (price); quasi-commodities are differentiated in multiple attributes, one of which is price; look-and-feel products are differentiated in multiple attributes, including quality; look-and-feel with variable quality products are differentiated in multiple attributes, including quality, where there are differences within category. Each successive category requires more and more experience with the product.

4. Gomez.com survey from Spring 1999.Gomez.com rates Web sites.

Acknowledgments

I would like to thank Erik Brynjolfsson, Henry Chesbrough, Ely Dahan, and participants in the MIT E-Business Research Seminar for their helpful comments.

2 Comments On: Finding Sustainable Profitability in Electronic Commerce

  • Randy@Guitar Slides | August 22, 2010

    Given that this post is 10 years old, is it still relevant. eBay and Amazon are still very huge online success stories and I’m sure by now Amazon has turned a profit.

  • Randy@whats-hot-weekly.com | August 22, 2010

    I also didn’t realize that Warren Buffett was president of Berkshire Hathaway.

Add a comment