VIRTUAL RETAIL: AMAZON

In the
Amazon, Inc. 2004 Annual Shareholders Report,
founder and CEO Jeff Bezos
provides a textbook explanation of “free cash flow” to enlighten shareholders about
his company’s financial strategy.
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Amazon has done with online retailing what Dell
and Wal-Mart have done in terms of structuring business operations to optimize use
of vendors’ cash float.
By bringing buyer and seller together in a virtual store,
collecting the buyer’s funds when the order is placed, and maintaining advantageous
payment terms with suppliers, Amazon is able to grow its free cash flow as
revenues increase.
The technology of the Internet and its availability in the homes
and offices of target buyers combine with electronic transactions for ordering, billing,
and collection to revamp a traditional and stable business: the bookstore.
Small, brick-and-mortar bookstores cannot measure financial performance based
on free cash flow unless they have the buying power to demand product on consignment
from the publisher. As the product ages on the shelf and payment terms are
reached, capital is required to stock the shelves with product (books). The sales
cycle is unpredictable. Compare this to the Amazon model: the product is described
at a user-friendly Web site, a few pages are digitized for the customer to “flip”
through, reviews are generated by the customer, and only a minimum of capital is
expended for the computer system that delivers the information worldwide. Once
the critical systems are in place for serving the customer base, there is only a minimal
incremental cost associated with increasing the product offering by 10, 100, 1000,
or 10,000 titles. Inventory turns are maximized and capital requirements minimized
by keeping on hand only the most popular titles while developing a supply network
that requires the seller network to maintain product until it is purchased.
CEO Bezos states it clearly: “Our most important financial measure is free cash
flow per share.” This is Amazon’s techonomic metric constructed from financial
terms. The free cash flow is enabled by wise use of technology. Additional capital
expenditures can be analyzed according to how they will impact free cash flow. Free
cash flow includes consideration for inventory turnover, payment terms from customers,
payment terms to suppliers, and revenue growth in addition to other, less
dominant factors.