Second, Amazon is looking to outsource inventory management in new product areas when that makes sense. Consider the arrangement the company signed last year with Toys R Us. While Amazon fulfills all toy orders placed through its Internet site, Toys R Us is responsible for the inventory. Amazon plans to take the same approach with its newly announced foray into personal computers. “Fulfillment is where we add value,” notes Jenson, though the company has also been trying to make its warehouse system more efficient.
Naturally enough, outsourcing inventory increases Amazon’s turnover, since it is expressed as a ratio of cost of goods sold to inventory held. So far at least, the results of Amazon’s inventory efforts are encouraging, as overall turnover increased from an average of 9 times annually at the end of the first quarter of 2000 to 13 at the end of this year’s, according to Epoch’s Levy. And while the fact that third parties are responsible for the inventory entitles Amazon to book only a small portion of the revenue derived from it, profit these days is a much higher priority.
Still, much depends on Amazon’s continued ability to get credit from its suppliers. And while the company’s stated objective is to reach profitability by the end of the current fiscal year, or December 31, a truer test of its business model’s viability won’t come until the end of the first quarter of the next year. That’s when Amazon will have to pay off suppliers for goods it sells during the coming Christmas season, when roughly a third of the company’s revenues are likely to be generated.
As a result, observes Andrew Ebersole, a bond analyst at KDP Investment Advisors, suppliers are likely to keep close tabs on the amount by which the company’s cash balances exceed its payables during that period. “Come January and February, Amazon will have to pay [for] those goods at the same time that its revenues will be declining,” says Ebersole. At that point, he says, Amazon will need “a lot of liquidity.”
That helps explain why negative working capital, while perhaps a current fact of life for Amazon, is not a goal, except “over time,” as Jenson puts it. It also suggests that other companies may have to be sufficiently profitable to win the confidence of their suppliers before they can manage working capital aggressively enough to become more profitable still.
For a look at companies best able to squeeze cash flow out of working capital, see the tables that begin below.
Ronald Fink is a deputy editor at CFO.
When Push Comes to Shove
The temptation to delay payments to suppliers may be especially hard to resist during an economic downturn, says Stephen Payne, president of REL Consultancy Group. “The short-term, knee-jerk reaction is to take as long as you can to pay,” he points out.