Tax Doomsday Is Coming for Amazon

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On Tuesday, Amazon.com (AMZN) shocked and dismayed its shareholders. Reporting earnings for the final quarter of 2011, Amazon admitted that despite 35% sales growth, profitability had headed in the entirely wrong direction. Operating profit margins got cut in half, while net profits were down 57%. The culprit: massive spending on a number of initiatives -- everything from building new warehouses, to subsidizing "Prime" membership, to selling Kindles at a loss -- which decimated the company's profit margin.

Investors are now wondering whether all the investment Amazon has been doing lately is worth the cost. If the whole idea behind Amazon is that it's supposed to be a virtual store, free of the fixed costs of ordinary retailers, then why spend money building warehouses? Why invent the Kindle Fire, if all Amazon intends to do with the thing is sell it below cost?

Fans of the company will tell you this is all part of Amazon's grand plan, to invest and accept low profit margins today, in order to set the stage for monster revenue growth and fatter profit margins tomorrow. And that is the plan ... in part. But the truth is actually bigger than that.

The truth is that unless Amazon.com makes the investments it's making today, its business could be in serious trouble within just a couple of years.

What Makes Amazon Great

It's true that Amazon has a big advantage in not operating physical stores. It also has great customer service, superior search and interface, and any number of other advantages.

Perhaps its biggest advantage, though, is that it's become the Walmart (WMT) of online shopping, offering "always low prices" to the Internet shopping masses -- prices often superior to what its bricks-and-mortar rivals can offer.

But key to Amazon's ability to beat the competition on price is the fact that current law permits Amazon to avoid charging sales tax on most of its sales, only collecting tax on sales to states where it maintains a "physical presence."

But maybe not for long.

States Are Sick of the Tax Dodge

Across the nation, dozens of states are struggling with budget deficits, and looking to Amazon's sales success as a partial solution to their problems. A movement's afoot to require the e-tailer to begin collecting taxes for the states, removing one of its biggest advantages over the competition.

So how does Amazon prepare for its date with "tax doomsday"?
  • It steadily expands the list of goods it will ship to you, starting with books and now going all the way through nonperishable groceries, all sold at cut-rate prices.
  • It offers $79 "all you can eat" shipping on these goods through Amazon Prime (with analysts postulating it loses $11 annually per membership).
  • It gives away free streaming of movies and television shows, a la Netflix (NFLX) as part of that service.
  • It offers 15% discounts for "subscribe and save" shopping.
  • And finally, it invents a line of Kindle devices that it sells to customers at an estimated loss of $10 to $15 apiece on just hardware costs alone.
Indeed, it sometimes seems like every new idea Amazon has dreamed up in recent years has been calculated to more efficiently and consistently lose money for the company. And now the company warns that it may lose as much as $200 million in the current quarter as a result. It's enough to make an investor shout: "This is crazy! Is this any way to run a business?"

Crazy Like a Fox

Actually, yes. In fact, it's precisely what Amazon must do if it's to survive tax doomsday.

You see, the day's not far off when Amazon won't be able to offer the lowest prices anymore. Just last month, the company struck a deal with the state of Indiana. The Hoosier State would not ask Amazon to collect sales taxes on goods delivered to in-state shoppers for two years ... but on Jan. 1, 2014, Amazon will begin collecting sales tax.

This deal was significant because historically, Indiana has traded tax favors for warehouse jobs. (Last summer, the company announced its latest, 900,000-square-foot distribution center would be built near Indianapolis.) If Amazon is coming to an agreement with Indiana, though, the writing's on the wall. The sales tax exemption is going away.

Assuming other states follow Indiana's example (as California already has), Amazon has perhaps two years left to "train" shoppers to shop its site. Ideally, Amazon wants customers to do this automatically through subscribe and save features, or as part of the company's Kindle ecosystem. If that doesn't work, Amazon will at least want to make switching to another retailer inconvenient, entailing worse product selection and the loss of Prime privileges such as free shipping and free streaming movies.

In short, Amazon has good reason to lose money today. It has to -- or else it will lose customers tomorrow.

Motley Fool contributor Rich Smith does not own shares of any company mentioned above. The Motley Fool owns shares of Walmart Stores and Amazon.com. Motley Fool newsletter services have recommended buying shares of Netflix, Amazon.com, and Walmart Stores. Motley Fool newsletter services have recommended creating a diagonal call position in Walmart Stores.



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51 Comments

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djparker

The Governments we have here, State and Fed plus the rest of them, drive the cost of living UP for all of us without stifling their costs. This is more of the same. Time for a REAL Teaparty!

February 07 2012 at 6:39 PM Report abuse +2 rate up rate down Reply
Craig

Its your government, as in "We the People" and it needs support. If you dont like how it is run, find out who follows your thinking and vote for that Representative. If you dont like to pay for what we jointly recieve, then find a place which suits you better. Mexico has very low taxes, Somalia has even lower. Ill bet there ae corners in teh Amazon and Africa where tehy don't even know what Tax means. If you don't like the way your taxes are spent, then again find a representative who agrees with you. But how about this. Since wages have been stagnant since Reagans '80s Why not demand price controls rolled back to that time? If its fair to limit wages why is it not fair to limit prices?

February 07 2012 at 5:13 PM Report abuse -1 rate up rate down Reply
monza866

All govt thinks its their right to take your money even when they don't do anything to deserve it.

February 07 2012 at 11:35 AM Report abuse +3 rate up rate down Reply
1 reply to monza866's comment
stevenurke

Really. So how does the UPS or FedEx truck get to your home to deliver the goods you purchased. You will not meet a person more distrustful of our government and the waste of dollars, but how exactly fair is it if you tax the local business that actually employs residents of your area while exempting the business that has no local presence? You reallty think it is fair?

February 07 2012 at 11:51 AM Report abuse -2 rate up rate down Reply
2 replies to stevenurke's comment
knarf714

yes

February 07 2012 at 12:34 PM Report abuse rate up rate down
Sonny

Hey, Al Gore invented the internet.............don't blame it on the Republicans! Local businesses should blame Al Gore and the Dems!

February 07 2012 at 1:36 PM Report abuse +1 rate up rate down
oohsah

I did all my Christmas shopping on Amazon and let me tell you I think it is cool.I despise shopping in crowded ass malls and hillbilly Wal -mart. Guess i'm just getting old.....

February 07 2012 at 10:28 AM Report abuse +3 rate up rate down Reply
1 reply to oohsah's comment
jabster62

Age has nothing to do with it. Even if you go to the malls or Wal-Mart during the Christmas season, everything is pretty much picked-over and there is seemingly nothing nice left. Also, more time is spent looking for a parking space than actual shopping and gas is expensive. Traffic is usually impossible.

On-line there's always something nice, and it's delivered to anywhere you want it.

It's not "older", it's smarter.

February 07 2012 at 10:53 AM Report abuse +1 rate up rate down Reply
1 reply to jabster62's comment
stevenurke

Great and I concur. But how is it fair to the local businesses? We the people pass the local and state sales tax laws yet we do not want to pay the local sales taxes. Amazon has a cost advantage that is unfair to the local business. You might know them, they live in the area, employ people in the area and contribute to the tax base in the area you live.

I love people who complain about corporations moving jobs overseas and then they buy from a company that could care less about the local area you live in.

February 07 2012 at 11:53 AM Report abuse rate up rate down
mhcontain

Not so fast. If you have employees or a presence in the State (even a sales office), then you have to pay tax there. This is called nexus. If you have no presence in that State then no tax. Plain and simple. Because they are building a warehouse in IN, IN can legally tax them. I'm sure they got enough other tax breaks to make it worth their while. States that have no Amazon employee will not be able to tax them and will lose in court.

February 07 2012 at 9:37 AM Report abuse rate up rate down Reply
Jay

Maybe these tax and spend politicians need to understand that we would rather have better prices than what they offer which is nothing.

February 07 2012 at 9:21 AM Report abuse +1 rate up rate down Reply
Lisa CapuletCo

So what happens when Amazon decides to vacate their warehouses and set up distribution in Mexico or Canada?
'cutting off your nose to spite your face' Greed makes for very stupid decisions.

February 07 2012 at 8:59 AM Report abuse +2 rate up rate down Reply
1 reply to Lisa CapuletCo's comment
pitciarn

drive the business out of the USA into Mexico

February 07 2012 at 1:47 PM Report abuse rate up rate down Reply
wbaxter249

I'm a freelance writer and because my state expects Amazon to collect sales tax, Amazon just doesn't allow affiliates from this state. I lose $$ every year because of this stupid rule.

February 07 2012 at 12:35 AM Report abuse +1 rate up rate down Reply
smoknjoe

This all may be a non issue. Looks like there is already a push to keep this from happening.

http://www.atr.org/committee-approves-bill-prevent-states-taxing-a6316

States should keep there jurisdiction with their own borders.

February 06 2012 at 5:28 AM Report abuse +1 rate up rate down Reply
lifehub

Where does AOL get this junk from?? They need to quit ptetending they're smart and stick to Hollywood stories and weight loss techniques.

February 06 2012 at 4:46 AM Report abuse +1 rate up rate down Reply