[jessriedel]

Um, doesn't thin margins mean generally mean the industry is mature and most things have been tried? I guess if you hold constant the "degree of difficult" for innovation, then large revenue make an industry "ripe for innovation". But this applies just as well to Apple, right? A 1% increase in efficiency in a $100 billion industry nets the same profits, regardless of the existing margins. Or am I misunderstanding?

[kevinpet]

A thin margin is a little like being highly leveraged.

Spacely Sprockets buys sprockets at about $9.50 and sells them at $10.

Cogswell Cogs makes cogs from scratch for $5 and sells them at $10.

If these companies are "the same size" meaning they generate roughly the same profit, then SS is selling 10x the volume of CC. If they can both cut costs by 10%, then SS's profit almost triples, while CC's only increases by 20%.

This cuts the other way too -- if you are operating at thin margins, a small change can push you into unprofitable. If you have fat margins, your profits just decline.

[jessriedel]

Thanks, this was the only reply I got that gave me a decent explanation. I guess it all boils down to defining business size by the amount of profits rather than by revenue or assets. The article's claim, then, is contingent on the cost of a single unit of innovation being set by this size metric and not the others. I'd say this is a very non-obvious assumption, but at least I now understand the claim.

Can anyone give an argument for why the cost to reduce costs by 1% should be a function of profits rather than of revenue or assets?

[jw_]

Hadn't thought of it this way - thanks.

[dllthomas]

A very useful perspective, thanks!

[pg]

No. Amazon is famous for seeking out low-margin businesses; that's what attracted them about AWS as a business. Walmart is another example.

[lquist]

Do they seek low-margin businesses? My take was that they looked for industries where they could comfortably price lower than anybody else. Case in point: tablets. Traditionally a fairly high margin business (on a unit basis), and Amazon comes in at a price that is only feasible because of the Prime play.

[VandyILL]

I think it's that they go after low margin industries in situations where they know that they can use their scale to undercut the existing businesses. Since the margins are so low the existing businesses do not have many options to compete or different ways to add value. Combine this with the fact that Amazon operates on a long horizon and is willing to take losses on certain investments as they scale over time and eventually dominate that market by pushing the margins even lower.

Then there's other things like Prime play which may justify them going after low margins in the tablet industry, but there's other good android tablets in that price range.

I think what you're thinking about w/ prime and tablets is their general approach with complimentary products.

For example they're developing original content. This isn't just to profit off content, it's also from the realization that physical books and movies are becoming less imporant and that digital copies are becoming more and more prevalent. This lowers the cost of the goods & reduces the amount Amazon earns by charging a % of the sales. So it makes sense for Amazon to just outright own and distrubute the content too.

But this also compliments other Amazon businesses. If people are watching TV through Amazon then Amazon has more opportunities to advertise their products to individuals. I doubt Amazon plans on loosing money on original content, so it's not a loss leader, but the fact that it boosts the value of their tablets, prime service (which significantly increases the amount people spend at Amazon per year), advertising etc. means that they are willing to accept much lower margins on content production than traditional studios and perhaps even Netflix.

[kalininalex]

Some businesses are fundamentally high-margin, and some are low-margin. It mostly depends on the amount of raw materials involved.

For example, Microsoft (software) is a high-margin business. Their cost of raw materials is low, so 77% of revenues goes to pay for R&D, other expenses, and then profit.

Apple is a lower, but still a high-margin business with healthy 37% of revenues remaining after paying for the cost of materials and assembly. Apple can charge significantly more for their devices than they pay in raw material costs. But it may change, so Apple investors are generally watching its gross margins. For example, last year Apple's margin was 47%, i.e. it declined quite a bit since then.

Amazon (as any retailer) is a low-margin business. They move a lot of products, but 89% of the revenue goes to pay for those product. So only 11% of the total revenue is available for R&D costs and profit.

[corry]

"Most things have been tried" <-- but the idea is that 'new things to try' are popping up all the time. My read on the article is that low margins show things have been optimized already, so new things that further optimize it will be welcome (to some players).

[notahacker]

Problem with "new things to try" in construction is that many of them require significant investment in physical infrastructure or research and development to meet (often justified) regulatory requirements. That doesn't fit well with low margins and high vulnerability to economic cycles.

[VLM]

Also many hands on productions aspects of construction (use laser cutters instead of circular saws to cut wood) are human life critical, and little money is spent on non-hands on aspects. Like the admittedly cool blueprint system being plugged. Or something like "replacing the HR and OSHA (dis)orientation class with something like coursera".

A pity the blueprint system being plugged is ipad / idevice centric. "Google Glass, show me blueprint 84Q..."

[InclinedPlane]

A low margin business means that your competition will have extreme difficulty lowering their prices.

However, it's very rare for there to be fundamental, physical limits to the internal cost of doing business. Which means that if you can do that better (through manufacturing improvements, supply-chain improvements, what-have-you) then you can undercut your competition only slightly while reaping significant profits.

And, because your competition is running on such low margins they can't easily compete with you. So, from a pure price perspective, you either get to retain your higher profit margin while being price competitive or you simply eat the majority of the market before it has a chance to settle to a lower price-point, which is win-win.

It does, however, mean that you need to put in a lot of hard work.

[lquist]

Um, doesn't thin margins mean generally mean the industry is mature and most things have been tried?

No, it usually means it's a commodity business. Innovation can be a defensible competitive advantage. As mentioned in the article, because of operating leverage, a fairly small innovation can yield significant profit growth.