As brick & mortar retailers file bankruptcy, the plight of small manufacturers becomes much more perilous. They won’t be able to survive selling on Amazon. Here’s why and it exposes a big weakness about Amazon.
The Contest
My partner and I are having a hypothetical contest. We each get $100,000 to invest in one stock, and evaluate whose choice increases the most in value by the end of 2021. We were not allowed to do any research. We just had to pick. And we have to pick in one minute. It’s called a paper trade.
Thankfully, we have a professional money manager at Morgan Stanley (MS) that manages our portfolio very well. Although I understand both business and economics, and even started my career in investment banking, and my partner had a robust career in fintech, I would never buy my own stocks. Mostly because I don’t have the time to peruse 10-Ks and 10-Qs and properly gather information and analyze data on companies; it’s not my business. So we hired someone who does that for a living. Our contest was just for fun.
I read the book, “Rule #1: The Simple Strategy for Successful Investing in Only 15 Minutes a Week!,” by Phil Town. In a nutshell, the author says that the number one rule to investing is, don’t lose money. He goes into great length about it, so if you’re interested, buy the book. But he also gives two other rules: buy the stock of a company whose products you like and use, and buy it at a discount.
The first company that popped into my head was Berkshire Hathaway (BRK.A). But one share of their A stock is nearly three and a half times more than $100,000, so that leaves them out of the equation. I could choose Berkshire Hathaway B (BRK.B) shares, but I already own those and they quite famously don’t pay dividends and like Warren Buffet, I like dividends very much.
Then, I thought of five others often referred to as FAANG.
- Facebook (FB). A big no. I use it, he doesn’t, but I don’t really like it. They’re facing all kinds of antitrust problems right now along with a pissing match with Apple. So, “no”.
- Apple (AAPL). We both use and like their products, but I feel like they’re vulnerable. Too dependent on hardware. Not diversified enough. Late to the game in the entertainment business. And, I doubt they’re trading at a discount.
- Amazon (AMZN). I love Amazon, but they have a serious issue right now that gave me pause. More about that below.
- Netflix (NFLX). I’ve watched more television during the pandemic than the last four decades of my life combined. I find Amazon Prime, ironically because of this article, to provide much better programming and a better lineup than Netflix.
- Alphabet (GOOG). Other than using their Google search engine and Gmail product, I really don’t know enough to make a quick decision to invest in them.
And then I thought of a company I’m really passionate about. They are recently public, located right here in Los Angeles (El Segundo), and I am head over heels in love with their products. They are also good for the planet and good for people’s health, not to mention good for animals: Beyond Meat (BYND), which produces plant-based meats. So I chose them. My partner chose Amazon (AMZN).
I’m sure he’ll win.
Of course he thinks so, too. He foresees a stock split rather soon. Please know that we’re not licensed stockbrokers and are not giving any investment advice herein, just sharing our opinions and a fun exercise.
The whole contest got me thinking about Amazon (AMZN), and their fundamental weakness that no one in my orbit seems to be talking about, and here it is:
Amazon does not buy inventory.
This little nugget of truth may not seem like a revolutionary reveal; the website Amazon.com is just a selling platform after all. Understand, I’m not talking about some of their recent acquisitions like Whole Foods, but Amazon itself does not in any significant way hold inventory. Well, inventory they pay for. In fact, they help finance delivery drivers, vans and fleets, but they don’t pay for that either. You can put your inventory in an Amazon fulfillment center, free of charge even, but it’s still your inventory. You bought and paid for it. And you have to wait to sell it to make money on it. Do you have enough cashflow for that? Maybe, if you’re a big corporation. More difficult for a small business, especially a small manufacturer.
Why is this a problem?
It’s all about cashflow, the lifeblood of most businesses. To sell on Amazon, you have to manufacture and/or import your products. Products made/purchased and not sold are called inventory. When you make inventory you have to pay your vendors and suppliers. If you’re importing, you usually have to arrange a Letter of Credit which needs to be collateralized with hard assets like cash. If you’re producing domestically, you need to buy all of your raw materials and component parts, as well as pay for labor. Labor is usually paid every week or every two weeks. You’re lucky if you can get 30 day terms on your raw materials. If you’re a startup, you may have to pay COD. All of this eats up your cashflow faster than a Monte-Carlo croupier.
Another issue with inventory are minimums and the cost of molds and dies. Let’s say you’re making plastic toys. You have to pay for the molds to make the toy. They are expensive. You might have to pay $50,000 for one relatively small mold. With that expense, you will need to manufacture a certain amount of toys to make it worthwhile to cut the molds. Dies cost less, but are still an investment. With other types of manufacturing, you need to meet MOQs or minimum quantities for raw materials especially if they are unique to you. If you are making clothing and you have designed a really cool, unique fabric, you probably need to buy 2,000 yards. If you are screen printing T-shirts, akin to molds or dies, you have to pay to cut the screens. And then you have to order minimum quantities of T-shirts. You get the point. MOQs just means that you may spend even more money than you first thought.
Let’s say you get an order from Walmart and they commit to buy a prepack of your product for all of their stores. Today, Walmart operates approximately 11,500 stores under 55 banners in 26 countries and eCommerce websites. Hypothetically, if you sell one prepack of six items to 11,500 stores, that is 69,000 products. That will assuredly meet any MOQs. If each product costs Walmart $15.00, that is over a million dollars in sales. If you sell two products? Double that. You’ll get paid in 30 – 60 days from Walmart. In this example, you will only have to finance your inventory for roughly 15 – 45 days.
To put that product on Amazon.com, you will get nothing unless you sell products. You have to finance your own inventory. You can store a small amount in Amazon’s warehouses. But Amazon is not going to pay you for your inventory. And they’re not going to buy 69,000 pieces. And the only time you’ll get your money is when the products sell on Amazon.com.
If your gross profit margin is 50%, you need to come up a large chunk of change to make your inventory and hold it for an indefinite time period. It could be years. Let’s hope your product isn’t seasonal.
In general, excess inventory is often a reason why companies go under and you can see why. They spend too much of their cashflow on inventory and they don’t have enough money to run their business. For these reasons, startups and small manufacturers with limited capital really have to sell to traditional retailers in addition to Amazon. And what if those traditional retailers go out of business? Then what?
How the pandemic has exacerbated this problem.
This problem has become particularly onerous during the present pandemic with many retail stores and malls on lockdown, or shut down. The only place for customers to buy safely is online. But that becomes destination shopping which is fine if you are selling commodity type products. But if you are a manufacturer who sells unique or new products, it’s hard to get noticed. If your products were in a store, and people walked in and saw them, they might say, oh, that’s really cool. I want to buy that. But how is that going to happen online? Additionally, since many brick and mortar retailers have gone out of business, that gives small manufacturers less customers to sell to. They may not meet their MOQs.
So who sells on Amazon.com successfully? According to an analysis by Marketplace Pulse, nearly half of the number of top Amazon.com sellers are based in China and only 47% are U.S.-based. There are a lot of reasons for why Chinese companies account for such a large percentage of sales on Amazon.com, but one of them is that they are companies who can afford to finance their own inventory. Many of the smaller U.S.-based sellers are retailers who are already buying products from other manufacturers. But as a manufacturer, how many Amazon sellers can you sell to? Are you going to sell one prepack of items to 11,500 different Amazon sellers? No.
On September 1, 2020, an Amazon press release stated that they are on track to invest US$18 billion in 2020 to help small and medium-sized businesses grow their sales. Much of this investment is for “new tools and services this year to help sellers manage and grow their businesses, including new ways to connect brands with customers.” Help with marketing and brand building is great, but it’s just not the same as buying inventory.
Sorry, Jeff Bezos. If you really want to help small businesses in this country, then buy a healthy inventory position from them and market it yourself. You would be my Superhero. I’ll do you a solid. You can use my company’s “Made in the USA” products as your guinea pig. That would be a good investment for us both.
