Column - Amazon, drones and low returns: James Saft

Tue Dec 3, 2013 12:04pm IST

Amazon CEO Jeff Bezos speaks at a news conference in New York, September 28, 2011. REUTERS/Shannon Stapleton/Files

Amazon CEO Jeff Bezos speaks at a news conference in New York, September 28, 2011.

Credit: Reuters/Shannon Stapleton/Files

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REUTERS - Jeff Bezos' plan to deliver Amazon.com packages by drone isn't just an idea which skirts the line between satire and reality.

It is also a neat little illustration of how technological innovation may be lowering overall investment returns.

The online retailer is testing delivery by unmanned flying vehicle, Bezos, Amazon.com (AMZN.O) founder and CEO, told CBS TV show 60 Minutes on Sunday. Drones, heretofore best known for their military uses, could be useful for packages up to 5 lbs in weight, a segment which comprises 86 percent of Amazon.com deliveries, he said. (here)

The goal, according to Amazon, is to have a system in place by 2015 which can make residential deliveries in under a half an hour by drone.

Putting aside the fact that drone use is currently strictly controlled, not to mention issues of cost, it seems that in coming years when you see a drone in the sky you'll think "my house" and "extra virgin olive oil" rather than "high explosives" and "Taliban".

That in itself could be accounted progress in human terms, but this project raises some investment issues, ones which are not new to Amazon.com shareholders.

Using drones is best seen as a logical extension of Bezos' business philosophy, which keeps prices low and customer friction at a minimum, almost without reference to expense. His fanatical dedication to building customer loyalty, and scale, comes at a price. Profits at the company, famously, have failed to materialize, even as revenue soars. In the last quarter Amazon.com revenue was $17 billion, up 24 percent, but resulting in a loss of 9 cents per share. That's because Amazon.com invests, plowing revenues into new warehouse fulfillment centers with ever-better technology.

Both the low prices and the imperative to invest in what may be low-yielding technological improvements may well be a hallmark of the modern economy. You cannot put the genie of Internet price transparency back into the bottle, nor can you afford to skimp on technology, as the Obama administration has found in the healthcare arena.

So far, Amazon.com investors have done marvelously in capital appreciation terms, with the stock soaring despite the lack of profits. Investors may well be reading this correctly; the new economy is a winner-take-most economy, with disproportionate rewards to those who lead. Better to be Amazon than your local (now likely vanished) bookstore, but profits in retail overall are now harder to find.

PROGRESS AND PROFITS

Even if Amazon profits do come through, the question becomes, in an age of huge technological turnover, how sustainable are they? And, almost more importantly, how much ongoing profit, in investment terms, will this new world generate?

William Bernstein, of investment advisory firm Efficient Frontier Advisors, wrote a piece recently describing what he called the "Paradox of Wealth," a tendency for economic growth to give rise to low returns.

Bernstein argues that this happens for a combination of factors: because richer people defer consumption more willingly, leading to a surfeit of capital; because these low returns themselves tend to encourage speculation (hello, Amazon.com investors?); and because technological innovation speeds up.

This last point is the one which Amazon so well illustrates.

New technology, be it drones or automated warehouses, don't just denote improvements in service or productivity. They also represent the obsolescence of all sorts of technologies and investments in which companies have sunk costs. Companies must invest or die, and to invest they issue shares, diluting their existing investors. One study found share dilution of 30 percent per year in fast-growing Asian nations.

"As technology makes the world ever more wealthy, the returns on both riskless and risky assets will of necessity fall. Pray that the naysayers are wrong, and that both processes continue," Bernstein writes. (here)

So Amazon, and drones, may represent a more prosperous world, and perhaps one in which human wishes, at least material ones, are more easily fulfilled. But at the cost of lower returns.

Bezos' strategy makes good sense, given that reality. If you are going to live in a world where you must invest or perish, and must accept lower returns, far better to be the company which invests first and gets the most out of the adoption of new technologies as they arise.

Unfortunately, we can't all get rich off of Amazon.com shares. The big issue in all of this is what happens to any number of plans, from when you will retire to how you will pay for healthcare, when your portfolio fails to deliver that 7 or 8 percent you are banking on.

That whirring noise you hear may not be a drone delivering olive oil but your investment profits being cut down to size.

(At the time of publication, Reuters columnist James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund.)

(James Saft is a Reuters columnist. The opinions expressed are his own)

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