Amazon.

com Profits and Revenues Analysis Compilation of My Facebook Posts

This is a compilation of the recent posts on my Facebook page on Amazon.com which has received Likes from some of my FB friends. Dear All: Yesterday I read an annoying article about all the annoying things we do with Facebook and other social media. Anyway, one of the pet-peeves of this author is the increasing "likes" she sees for corporations. I have noticed that too, over the last month or so, since I ventured into FB.

****************************************************************** Keep it under wraps says the author.

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Now, take a look at the table (given as a photo) with the revenues (x), profits (y) and the profit margins data for Amazon.com. The company has shown phenomenal growth in revenues ever since its inception in 1995. But, take a look at the profits. It was in the negative until 2002. It finally started reporting profits in 2003. But, look at the profit margins (ratio of profits to revenues, converted to a percentage). In 2011 it was only 1.31%. The best ever was 7.05% in 2004. Amazing Amazon!
VLike Share Promote 40 minutes ago

Vj Laxmanan Best Buy data reveals a much more worse situation! 38 minutes ago Edited Like Vj Laxmanan Do you see any other trend other than the two obvious ones? a) Revenues growth year after year and b) dismal profit margins. Depending on the response, I will add some additional points. What would you do with this information if you were a student of calculus, or a science or engineering student? Instead of revenues and profits, what if the same numbers x and y represent voltage and current? Or temperature and pressure? Would you just calculate the ratio y/x and be done with?

Further Analysis of Profits-Revenues Data

Dear All: In elementary calculus we learn about the important concept of the rate of change. If y increases as x increases, the rate of change of y with respect to x is the slope of the x-y graph, i.e., the derivative dy/dx, of the function relating x and y. Here we have a table of x and y values, where x is revenues and y is profits. A student of science and engineering, when confronted with a table of x and y values would instinctively try to prepare a x-y graph to see if there is any underlying trend. Although the y/x ratio varies widely, it is clear that the profits, y, are increasing as revenues, x, increase in a systematic manner as confirmed by the profits-revenues graph in Figure 1.
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1.40

Annual Profits, y [$, billions]

1.20 1.00 0.80 0.60 0.40 0.20 0.00 -0.20 -0.40 0 10 20 30 40 50 60

Annual Revenues, x [$, billions]

Figure 1: The profits-revenues graph for Amazon, for the period 2002-2011. Although revenues have been increasing year after year, since its inception in 1995, the company reported its first profit only in 2003. The single data point in the negative region of the graph is the profits-revenues data for 2002. All the other data reveals a nice upward trend. The data for 2011 (highest revenues) and for 2004 and 2005 (the two highest profit margins reported, when profits y were also higher) lie below and above this general upward trend. The next step is to fit a mathematical equation to describe this trend. The simplest equation relating profits and revenue, based on the above would be the equation for a straight line, y = hx + c where h is the slope of the line and c is the intercept made on the y-axis (the profits axis) when revenues go to zero. It is clear that profits were negative at very low revenues and this means a non-zero value of c (in this case a negative value of c).

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Annual Profits, y [$, billions]

2.50

2.00
1.50 1.00 0.50 0.00 -0.50 0

y = 0.043x 0.227 = 0.043 (x 5.285)

10

20

30

40

50

60

Annual Revenues, x [$, billions]

Figure 2: A simple linear relation between profits and revenues is revealed here by the data for Amazon.com (2002-2011) which can be shown to be consistent with the breakeven model for the profitability of a company. The slope h and intercept c of the best-fit line through the data points can be determined using classical linear regression analysis which yields the following numerical equation relating revenues and profits for Amazon. y = hx + c = h(x x0) = 0.043x 0.227 = 0.043 (x 5.285) with r2 = 0.976 Here r2 is the linear regression coefficient, which is a measure of the strength of the correlation between x and y. If all the (x, y) pairs fall perfectly on a straight line, r2 = + 1.000. The very high positive value here means that the above relation is statistically significant. If revenues increase by x, profits increase by an amount y = hx. Fluctuations from this general trend are due to sudden changes in the constants (a, b, p) in the breakeven model. The (x, y) pairs for 2011, 2005, and 2004 were excluded from the above analysis since these points are obviously what statisticians would call outliers.
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The numerical results here show that the company would report a profit only when revenues exceed a minimum or the cut-off value x0 = - c/h = $5.285 billion. This is the situation since 2003 when the Amazon.com has been reporting profits consistently.

Brief Discussion
As discussed in more detail in another recent article on Amazon (click here or see http://www.scribd.com/doc/106881274/Amazon-Profits-Revenues-Data-Analysis ) the linear relation revealed here can be understood using the breakeven model for the profitability of a company. Profits = Revenues Costs ..(1)

Imagine a company producing and selling N units of a single product. The total costs C is the sum of the fixed cost, say a, and the variable cost bN, where b is the unit variable cost. Thus, C = a + bN. If p is the unit price, the total revenues generated is R = pN. Hence, the profits P = R C = pN (a + bN) = (p b)N a. Now, eliminate N using N = R/p and we get the following equation relating revenues and profits. P = R C = [(p b)/p] R a = hR + c ..(2)

This means that the profits-revenues graph is a straight line with slope h = 1 (b/p) and intercept c = - a. This explains the simple linear trend observed here with the profits-revenues data for Amazon.com Slope h = 1 (b/p) Intercept c = - a related to unit variable cost b and unit price p negative of the fixed cost

As reported earlier, in several articles, this simple law is also confirmed when we study the profits-revenues data for many other companies.

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The more general law is the nonlinear law, see equation 3 below, which reveals a maximum point on the profits-revenues graph. This has also been confirmed, as we study the financial data for mature companies, like the old General Motors, Ford Motor Company, or Yahoo (click here or see http://www.scribd.com/doc/120324960/Money-in-Economics-is-Just-like-Energyin-Physics-Extending-Planck-s-law-beyond-Physics ) y = mxn [ e-ax/(1 + be-ax)] + c ...(3)

Please note that the constants a and b in equation 3 are NOT the same as the constants a and b in the breakeven model just discussed.
For n = 1, a = 0 and b = 0, equation 3 reduces to the straight line y = mx + c. For nonzero n > 1 or n < 1, the graph is a curve with an increasing slope for small values of x and a negative slope for larger values of x with a maximum point at some finite value of the revenues, x. This too can be understood, as discussed in the article cited above, using a generalization of Plancks ideas (regarding how to calculate the average value of some property of interest for a complex system) which led to the birth of modern quantum physics. The success of the predictions made by scientists and engineers, based on their analysis of empirical observations (such as the profits and revenues data of a company in the above example) is due to the application of the methods of calculus and their recognition of the meaning of the rate of change. Unfortunately, financial analysis has, to date, entirely been on based on the use of ratios such as the profit margin (y/x), the ratio of profits to revenues, or earnings per share (ratio of earnings per share E of a company to its share price P) and so on. The ratio y/x is not a true measure of the rate of change. The derivative dy/dx, or the slope of the x-y graph is a true measure of the rate of change.

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The significance of the difference between the two ratios y/x and dy/dx has not been fully appreciated outside science and engineering. This may be appreciated by considering the simple case of a straight line with a nonzero intercept (due to nonzero fixed costs as revealed by the breakeven model). If The ratio y = hx + c y/x = h + (c/x)

The ratio y/x, or the profit margin, if x is revenues and y is profits will keep on changing as revenues x increase (or decrease) because of the nonzero c (or fixed costs). The maximum value of the ratio y/x = h, the slope of the straight line. Thus, by studying the profits-revenues data, we can also deduce the theoretical maximum value of the profit margin. The slope h is the theoretical maximum profit margin. Unless there are fundamental changes in the cost structure of the company (revealed by the three constants a, b, and p in the simple breakeven analysis) the profit margin can never exceed this theoretical maximum. This also explains why many companies ultimately fail to meet the expectations of the Wall Street analysts. Unfortunately, instead of recognizing that the ratio y/x has hit the limiting value of h, the slope of often seen straight line relation, the blame game begins and we search futilely for the reasons for not meeting expectations. The answer is simple. Just look at the profits-revenues graph for a period of 5 to 10 years, or the quarterly profits-revenues graphs for several quarters.

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