AMZN: Amazon Store Is a Failure in the Making

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There’s a fine line between “creative” and “desperate.” And Amazon (AMZN) just crossed it.

Amazon store AMZNThe world’s most prolific e-commerce company is getting into the bricks-and-mortar retailing game by opening a pilot store in Manhattan. AMZN stock owners, while cautious, also seem enthused regarding Thursday’s announcement of the impending Amazon store, which will be open in time for this year’s Christmas shopping season.

But shareholders might not want to get their hopes up that physical retailing will rekindle the company’s glory days.

In fact, realistically (and perhaps even hopefully), the Amazon store experiment will end badly enough that the company will kill the program before it gets rolling in earnest and really starts to crimp the value of AMZN stock.

The Amazon Store Is Unveiled … From a Distance

Amazon plans to open some sort of physical retailing presence in Manhattan (at 7 W. 34th St., across from the Empire State Building in Midtown) before gift-buying mania starts this year. Other than that, the details are few and far between.

The only other nugget we learned from the Wall Street Journal article that first reported the news was that the Amazon store would basically serve as a mini-warehouse, offering limited inventory for same-day delivery in the nearby area. The Amazon store also would facilitate product returns/exchanges and pickups for orders placed online.

It seems brilliant on the surface. Any chance to deepen a relationship with a customer and/or engage them in a way you haven’t been able to yet is just good business.

But there’s one key flaw that AMZN stock holders might want to consider before deeming this Amazon store a future boon:

Physical retailing is not nearly as cheap as it needs to be for this venture to thrive.

Scary Numbers for AMZN Stock Owners

The math of retailing isn’t particularly complicated. You sell goods at a price higher than what you paid for them (cost of goods sold). The difference between the sale price and the cost of goods sold is your gross margin, or gross profit. And it’s from that gross margin that you pay for the rent, employees, store maintenance, etc. The number you get after that is your net margin.

Generally speaking, gross margins for brick-and-mortar retailers can be as low as 22.8%, as it was for Best Buy (BBY) last year, or as high as 30%, as it was for Target (TGT) in fiscal 2013.

However, net margins for Target over the course of that 12-month span were a paltry (though not atypical) 2.7%. Best Buy only cleared about 1.6% of its sales as net profit in fiscal 2013.

Where’d all that gross profit go?

The bulk of it was spent on paychecks for store employees, corporate support staff and maintenance. While BBY cleared almost 23% in gross margins, nearly 20% of the revenue Best Buy generated last year — and again, this isn’t unusual — was spent on the “selling/general/admin” line of the income statement. And while Target cleared 29% of its 2013 revenue as gross profit, it spent 21.1% of its revenue on selling and administration expenses like paying in-store workers. That only left about 8% of revenue to pay all the other bills and still leave something for shareholders.

And how much does Amazon clear as gross margins in any given year? It’s not a perfect apples-to-apples comparison, but it’s still something for AMZN stock owners to mull — Amazon has only cleared about 1% of sales as net profits when all is said and done for the past three years … and the net profit margin figure has been shrinking for several years now.

To be fair, Amazon only spends about 17.2% of its revenue on administrative and general workers like warehouse pickers and packers, which is below the norm for the average brick-and-mortar retailers.

On the other hand, Amazon hasn’t had to pay for any store expenses yet — and as AMZN will soon learn, that can get unwieldy without much warning.

The warehouse workers and company administrators aren’t going to go away when stores open. All of them still will need to be paid in addition to whatever staffing needs and rent payments the typical Amazon store may have. And it’s unlikely AMZN will be able to staff and maintain its stores any cheaper than the likes of Target or Best Buy can.

The Counter-Argument Doesn’t Hold (Much) Water

The counter-argument is that an Amazon store/warehouse won’t require the same degree and type of staffing that a traditional brick-and-mortar store would. And, to the extent operating a store may inflate expenses for AMZN, they’ll be offset by an incremental increase in sales.

That’s dangerously wishful thinking, however.

While a physical presence may spur some additional sales, the retailing venture will only really make sense if there’s a lot of new sales, and if all those sales are ones that wouldn’t have been created any other way.

That seems an unlikely end result. In fact, the retailing rationale at work here is almost backward.

Anybody who chooses to place on order online (barring an oddly urgent shopping emergency for an unusual item) probably isn’t interested in physically traveling to a brick-and-mortar store to retrieve the item. The whole point of online shopping is not going to a store.

Or in cases where a shopper is willing to travel to retrieve a purchase, that shopper could just as easily visit one of Manhattan’s traditional retailers. There’s a Macy’s (M) one block away from where the Amazon store will be located that not only can offer a variety of same-day purchases, but also allow the buyer to browse before buying.

But what about niche items not found in a nearby store yet found at Amazon.com? If it’s truly a niche item, it likely won’t be kept in stock at the nearest Amazon warehouse. The warehouses tend to focus on keeping on hand the standard goods that sell frequently. Amazon probably won’t have same-day pickup for the odd item only available online, because it might not be available at the nearby warehouse.

In other words, the logistics and the marketability are all wrong.

Simultaneously, while an Amazon store might draw some foot traffic due to sheer curiosity, the company has already acknowledged the in-store inventory is going to be limited. That’s not exactly the kind of marketing message that inspires the casual shopper to step into your store and browse, particularly if staffing is kept to a minimum to keep expenses low.

Shoppers want/need some degree of service no matter how great the prices are.

Bottom Line

As it seems now, the Amazon store is going to be nothing more than a very limited warehouse and distribution center — a particularly expensive warehouse at that, given the prime locale.

But it doesn’t actually replace a “real” AMZN warehouse. It just gives delivery trucks another stop in the delivery chain.

For the stores to be self-sustaining as anything more than a pickup center and a place to market its own so-far-lackluster electronics like the Fire, it would need to keep staffing at inadequate levels (by retailing standards) and/or sell merchandise at higher retail prices — something that’s just not going to happen. There’s simply not enough profit margin built into Amazon’s cost structure to maintain a store.

Never even mind the fact that the company has no real retailing experience and will be competing against companies with a ton of retail experience.

AMZN stock owners need not get excited. This pilot program isn’t apt to go any further than the beta test.

(Side note from author: I have a unique perspective on this matter. While I’ve been a financial journalist and analyst for years, in my early professional life I worked for two different department stores as in-store management. I’m all too aware that from the outside, the way things seem like they are for a retail operation and the way they actually are on the inside are two very different things. Amazon is in for an eye-opening headache.)

As of this writing, James Brumley did not hold a position in any of the aforementioned securities.

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Article printed from InvestorPlace Media, https://investorplace.com/2014/10/amazon-store-isnt-reason-buy-amzn-stock/.

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