Historians will define the current epoch in technology, and indeed business, culture, and society generally, as the era of the shift, a seemingly constant dispensing with traditional boundaries and notions of how things are done.
Retailing has shifted to the web; so has watching movies; workers have shifted from their desks to their mobile devices; computing has shifted from the raised-floor data centers once built inside corporations to a handful of enormous cloud computing operations sucking up more of the world’s databases and applications. Expert judgment has shifted either toward the wisdom of the crowd or the trial-and-error brute force efforts of artificial intelligence.
Everyone’s favorite example of the shift is Amazon.com (AMZN). It’s clear that founder and CEO Jeff Bezos had the vision to shift the world to his way of thinking, a willingness to entertain any opportunity as long as there was a pile of money to be shifted, without respect for the niceties of traditional profit and loss.
Bezos has overturned industries by not caring that convention said they couldn’t be invaded and shifted out of their orbit. And he’s having the last laugh: Amazon stock rose 5% Thursday evening as the company’s profit trounced the Street’s expectations, thanks to expanding profit margins in several parts of its business. That was despite missing revenue expectations by 1%.
“Profitability has admittedly been…uneven” at Amazon, was how Mark Mahaney of RBC Capital Markets, a bull on the stock, summed up most of Amazon’s history. “But now, it’s uneven UP, thanks to what we view as the best revenue-mix shift story in tech,” he added in his recent report. Positive profit surprises are increasingly the norm at Amazon as it develops new, higher-margin businesses than its traditional razor-thin retailing margins.
Amazon is dominant in cloud computing, which has an operating profit margin of 26.9% versus Amazon’s corporate average of 5.6%. Its newer advertising business is on pace to reach $8 billion to $10 billion annually, according to Youssef Squali of SunTrust Robinson Humphrey. Amazon doesn’t disclose financials for the ad business, but Squali believes it “operates at a very high margin,” and Amazon’s CFO, Brian Olsavsky, has made a point of saying it is helping to boost profit.
Everyone in tech who’s not Amazon—every company that follows the logic of neatly staying within its bailiwick—will have a hard time trying to adapt to the changing rhythm. Rather than shifting the world on its axis, as Bezos has done, they often are trying to move themselves out of a tight spot to some more promising place.
Facebook (FB) is one example. Its stock was punished Thursday with a historic pummeling. Facebook offered a drastically lower revenue growth outlook after saying it will shift attention to an online advertising opportunity that pays less for each ad. “Stories,” as they are called, are users’ short videos on Facebook that vanish after 24 hours. They take over the screen of a device when one is watching them. Advertisers find that less attractive than traditional Facebook postings, so the attempt to change that relationship with ad buyers is a tough sell.
Others are having mixed success as well. Apple (AAPL) still benefits from selling the device for which many of the world’s wealthy information workers are willing to pay upward of $1,100.
As one of the largest buyers of semiconductors in the world, Apple can shift the manufacturing priorities of the industry to make sure the iPhone has first dibs on new capabilities. The “Face I.D.” function that unlocks the iPhone with a gaze is a first on a mobile device, and Apple was at least a year ahead of competitors, thanks to getting its orders for the underlying components filled first.
At the same time, Apple has been trying for years now to shift into being a software and services company, with only modest success for its stock. Its forward price/earnings ratio, based on next fiscal year’s projected earnings, is 14.5 times, without adjusting for cash. That’s up just a bit from 14 times at this time last year. The small gain belies the fact that Apple’s services business is gigantic, at a projected $37 billion this year, and is rising by double digits. Services represent an increasing percentage of sales, currently 15%, and have a higher margin than the rest of its businesses, so you’d think investors would assign the company a richer multiple. Apple hasn’t spent its life like Amazon, moving and changing. The shift is an awkward and sudden jolt to investors who believed they could count on Apple to be a high-growth maker of widgets rather than a services provider.
The examples of other large tech companies are even more awkward and test investors’ patience. AT&T (T) is shifting to be a media company. Intel (INTC) last week said its gross profit margin will decline this year by about two percentage points. That’s because Intel has little pricing power as it shifts its attention to new markets outside its traditional PC and server business. Despite being in a hot data-storage segment, Western Digital (WDC) last week indicated that competitive price pressure has gotten worse, crimping its profit outlook.
Chalk up all this change and dislocation to what economists call low switching costs. It’s increasingly easy to change a provider of this or that good just as easy as flipping from one web page to another.
The tech world doesn’t have an alternative at the moment to Amazon’s relentless pursuit of the next opportunity for disruption. If you can’t beat it, then try to be just as bold, just as disruptive, however belatedly and awkwardly. As long as low interest rates keep open a window for borrowing, companies large and small will spend to keep ahead of the wave, including through capital investments and M&A. Better for every ambitious tech company to make bold moves, without permission, and to ask Wall Street’s forgiveness later.