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Study looks at Amazon's future

Amazon.com must generate $1 billion in annual sales simply to break even, according to a new study by e-commerce consulting firm IceGroup.

Amazon.com must generate $1 billion in annual sales simply to break even, according to a new study by e-commerce consulting firm IceGroup.

After studying Amazon.com's second-quarter 1998 financial results, IceGroup concluded that one of the main barriers to profitability the company faces is its high operating margins.

The study, called "Amazon.com: Prototype of a New Millennium Company?" points out that most computer users believe--incorrectly--that online merchandise orders are cheaper to process than those placed through traditional distribution channels.

"Taking a closer look at Amazon's numbers reveals a complex, new-millennium business problem," the study states. "Based on the numbers provided, Amazon.com's average order costs the company $40.81 to process, yet its average order size is $35.59--essentially creating a loss of $5.22 for each Amazon.com order processed."

But Terry McCrary, an analyst who follows Amazon.com for Waldron & Company, disagreed with that analysis. "They must be putting all kinds of overheads into that figure," he said. "That is not an accurate allocation of those expenditures."

The report calculated the average order cost by dividing the $16.99 million quarterly operational loss by 3.26 million orders, resulting in a loss per order of about $5.22. That figure then was added to the average order price of $35.59, resulting in the $40.80 figure for the company's average cost to process an order.

"We haven't had a chance to look [the study] over, so it is difficult to react to it," said Amazon.com spokesman Bill Curry, noting that the company had no hand in commissioning the report.

The study also concluded that the common perception that it is cheaper to keep an existing customer than it is to find a new one is misguided, arguing that marketing expenses associated with luring new customers may not be recouped on the first order but likely will be recouped on repeat orders.

Amazon.com stated in its most recent earnings report that 63 percent of its revenues came from repeat orders. Such a high figure normally would be interpreted as a positive indicator of a company's financial health, but according to IceGroup's study, repeat Amazon.com customers spend less per order than its first-time customers.

"If a new customer goes on a shopping spree because they've found this great new site and buys 8 or 9 books, that is going to be a very profitable trip for Amazon," said McCrary. "But basically every transaction is going to be profitable to some degree."

McCrary added that Amazon.com's current profit margin is 25 percent, compared with Barnes & Noble's 28 percent.

"Three percent is a fair amount, but they can make it up," he said. "As they move up to economies of scale, their profit margins will improve. This will give them the flexibility to either have better profit margins or to improve pricing, or both."

Amazon.com currently makes "$8 per new order while losing $10 per repeat order," the study said, adding that the company either must increase revenue per repeat customer or reduce the average cost per sale going forward.

While Amazon.com has expanded its product offerings to include music and video, the diversification may not translate into higher sales, according to the IceGroup study. Instead, it suggested, the company should focus its efforts on reducing its cost per transaction.

In addition, the study stated that Amazon.com made the right choice in appointing former Wal-Mart executive Jimmy Wright its chief logistics officer, noting that Wright's retail experience will be crucial to the company's efforts to achieve profitability.

Finally, the study concluded, if Amazon is able to significantly reduce its cost per transaction, the company won't need to generate $1 billion in sales to reach profitability.