Jude Wanniski
March 2, 1999


Memo To: Thomas L. Friedman, NYTimes
From: Jude Wanniski
Re: Amazon's market value

Your column of Friday, February 28, indicates you do not have enough to write about in the area of foreign policy and national security, in which you are expert, and are now delving into serious commentary on the stock market, in which your expertise is limited. Your discovery that someone has opened an Internet bookstore in competition with Amazon, and the fellow operates out of his extra bedroom, leads you to believe that Amazon is vastly overpriced, and will soon be overtaken by millions of people who have extra bedrooms, time on their hands, and $150 in start-up capital. As chance would have it, the question of Amazon's market capitalization came up in a discussion I initiated recently between two men who have divergent views. Professor Reuven Brenner of the McGill School of Management is in my view among the best business economists around, and Marc Weiss of Amerindo Investment Advisors is a skilled analyst of the technology stocks in general, Amazon in particular. Here for your amusement and edification is the cross-talk between them by e-mail, after I asked Brenner his thoughts on Alan Greenspan's congressional testimony on this topic last month. Obviously, the subject is still open. Brenner has the last word here, but Weiss promises to add to the exchange in the near future:

JUDE to BRENNER: In his Senate Budget testimony this morning, Greenspan said that the stock market has some of the aspects of a lottery, which account for stocks being overpriced at times. He says people will buy lottery tickets even though their chance of winning is so small. This irrational behavior carries over into the stock market, he thinks, and helps explain why the Internet stocks are so high. What do you think?

BRENNER: He is right for some stocks. The Internet today, obviously. You look at trading patterns: a very small number of stocks rapidly changing hands -- obviously there is no analysis. People bet on "opportunities." Amazon's valuation assumes 60% growth until infinity. With a lot of other assumptions thrown in. (And that when the electronic book is already beyond prototype, only for the moment expensive, which is completely neglected in the evaluation! How can you when you trade every few seconds? Not to mention that by now there are 15 bookstores on the Net, and Amazon is not exactly efficient, does not deliver on time). Remember Nifty fifties, nifty seventies, electricity, etc. People confuse the fact that everyone may use this -- so indeed there would be a huge market -- but that there are no barriers to entry. I do not see them anyway. Remember airplanes: Passengers certainly exploded, but the airline stocks were bad investments.

WEISS: Barriers: If there were no barriers those with the most to lose would have already squashed Amazon (Barnes and Noble, and Borders). Why haven't they? They have not figured out all the little things that Amazon has.

BRENNER: I am not convinced that this is the answer. B&N went into it recently, and more prudently. As I read, and you can re-check, Amazon does not deny it loses money on every book it sells. So why would one rush and replicate? The fact that the market value is sky high, is for two reasons: People sometime buy into concepts (and the concept is right, to sell books over the Net, but it can be a commodity business nevertheless, unless you convince me that there is a LASTING value added here, somewhere - what are those little things?), and then the money will flow to that business. Remember that in the 1970s, "conglomerates" were the concept, money flowed for building them up; they employed the "smart people." And then it all crashed (with GE's Jack Welch the exception).

WEISS: B&N is in fact falling further behind Amazon on-line. Lets not forget the intangible of Brand.

BRENNER: Don't you contradict yourself? After all, Amazon built up a brand name in a flash. Barnes and Noble was the brand name on which it could build. But if it is so easy to build a brand name, why cannot one build another, and destroy someone else's name. Easy come, easy go. Yes, brand names can be barriers (not in fashion, sport etc.) - but on the Net I do not see it. Netscape almost lost it; and in an other field Apple, one of the best brand names around, almost lost it.

WEISS: CD/Now and N2K are on-line retailers but they can't attract online buyers like Amazon (The merged CD/Now and N2K still have a much higher customer acquisition cost than Amazon) Why? Brand.

BRENNER: As I wrote: CD is a very low margin business anyway. So again, I have no doubt that one can get market share. But market share without profits - what's the point? Show me where will the money come from? I am not saying that I am right: This is all new, and we are working with limited information. But I just cannot see the lasting profits. There is also something new in the way these shares are traded: not only is the number of shares exchanged small, but the daily turnover is very high. Now, if I were in my 20s-30s, why not bet a few thousand dollars on this stock? I lose it, no big deal, I can recover the mistake. So for the moment the valuations of these stocks seem to me closer to gambling than anything else. Not that there is anything wrong with that.

WEISS: Also let's not forget the technology issues. When technology seems easy it is because someone went through the complexities for you. Building Amazon's site is not trivial and gets harder to replicate everyday given the volumes that they are handling. Most web sites (including mighty Yahoo) still have not figured out the one click buying feature that Amazon has.

BRENNER: OK. I do not know this technology part, and I do not know how much people are willing to pay for it. Or how much costs it saves.

WEISS: Finally, a bunch of college kids that are eager, which may have been the secret to success two years ago on the net, is no longer sufficient. Now it requires a young, but not too young of an A-team of technologists, direct marketers, logistics people, and CEOs who know how to cut deals in Internet time. The best people in this game of course are the ones currently working at Amazon, Ebay, and Yahoo. The cumulative experience of this small set of people as to what works and what doesn't and what should be tried next should not be under-estimated.

BRENNER: Absolutely. That is why I believe that the U.S. on the whole has a huge advantage. But look at Silicon Valley. It does not work according to what you describe above, that an A-team stays rigidly together. They are in a flux, move in and out from firms, VC firms, etc. So the ideas and knowledge and experience are circulating much faster.

WEISS: Youth and energy enables the 18-hour work days, but experience is the real secret sauce. Given the scarcity of these people, it seems pretty difficult task to re-create what Amazon has done. It is not impossible, but there are barriers.

BRENNER: Someone made a vague calculation that at 15% capital costs, the present valuation of Amazon requires 60% annual growth rate for eternity. I just cannot see where that long lasting advantage will be coming from.

P.S. TO JUDE FROM BRENNER: I have been in touch with Andrew P. Carlton, a London based entrepreneur (who reacted to my Forbes, WSJ etc. pieces). See what he says about Amazon in our last correspondence, in the last paragraph.

CARLTON: Reuven, I couldn't agree more with you. This very same topic has been a research subject of mine for quite some time (some 7 years in fact). A book by Richard Sennet called The Fall of Public Man covered, among others, the issue of mass merchandising and how - slowly - the product expertise that the merchant held was eroded as sales assistants came to the fore. It would simply have been too expensive to train and educate these people with the same level of knowledge that the owner may have had.

The Internet (as well as other technologies) may finally revert this century-long trend. The push for "self-service" on the Internet is a representation of this. Provide as much information about a product/service so that people are able to make an "informed" purchase. To this point, I am a great believer in the "informationalization" of these products/services and people such as Regis McKenna (pre-Internet) and Evan Schwartz in Webonomics raised these very same issues.

Also, Sennet delved into the issue of "Manufacturer Suggested Retailer Prices" or how the price of goods came to be "homogenized" at large merchants. As you know, the merchant could no longer trust a large employee base to be able to negotiate prices as effectively as he was and hence he was forced to set "a" price for all goods. At the time, I was surprised to learn that previous to this there wasn't a single product that you could purchase without having to haggle! Naturally, this issue also indirectly touches on the subject of price differentials that we have discussed before.

On the issue of informationalization, here's another thought for you. Remember what Intuit did with Quicken? It developed a software that allowed people to "manage the information" relating to their financial transactions. Although consumers were the natural "owners" of this information, banks did not think it worthwhile to give them access to it, to play with it. Intuit meanwhile made millions of dollars and millions of consumers began to better manage their personal finances. The banks totally missed out.

I have been exploring other industries where information about the interaction with products and services could be repackaged and managed to provide consumers/clients with value-added information products and services. A complex example would involve a supermarket chain providing me with a web page where all my yearly purchases are catalogued, where recipe suggestions are made on the basis of my last purchase, where I could explore product information and promotions...In many respects this is why leads the pack in online book retailing. Namely, it has (until now) the best "book information management system".