Why Amazon and Google are spending up big: Bartholomeusz

Yesterday the world’s leading internet retailer, Amazon announced a 38% increase in first quarter revenue and its shares fell. A few weeks ago another internet colossus, Google, announced first quarter revenue growth of 29%. Its shares fell.

The common denominator for two of the giants of the internet age was that the increase in revenues significantly out-stripped the increase in earnings – in fact, Amazon’s first quarter earnings were actually down 33% while Google’s rose an otherwise very respectable 18%.

What appears to have concerned the market is the surge in costs at both companies, with Amazon’s costs up 42% and Google’s 54%. What’s more, both groups are promising/warning that the increased spending is going to continue, with Amazon saying second quarter earnings could be as much as 65% lower even as it said it expected revenues to rise between 35% and 47%.

The heavyweights aren’t the only internet companies to have recently reported rapidly rising revenues but even faster-growing costs. In fact, it appears to be the theme of the first quarter reporting season in the US.

In almost all cases the companies say they are investing heavily in future revenue and profit growth and that the surge in spending reflects the scale of the opportunities they see. Amazon, for instance, is investing heavily in expanding its distribution centres to support its online retailing core and in cloud computing data centres as part of its expansion into data storage, and plans to continue to do so.

Markets don’t like it when the growth in costs out-strips the growth in revenues but are more tolerant of it when it occurs within immature businesses and, despite their size, Google and Amazon’s continuing impressive levels of revenue growth would suggest that they are yet to mature.

There’s an interesting and important question as to whether, given the competitiveness and the levels of innovation in eCommerce generally, that moment of maturity, when the revenues can be harvested for maximum profit, will ever eventuate or whether the companies are destined to spending increasingly heavily just to protect their leadership positions as the technology giants move increasingly into each other’s core spaces.

Google, Amazon, Microsoft and Apple in particular are engaged in an intensifying struggle for audiences and customers. But there are others, like Facebook or the ”deal of the day” model for online shopping, that are creating new models and aggregating new audiences that represent prospective threats and competitive disciplines.

The financial markets may not like it when expense growth is rising faster than revenue but they have been prepared to accept it because the potential of the online markets and the models that have been built around them has yet to be defined.

There is an element of that in the resources sector, where the potential for the commodity boom to be prolonged has kept opposition to the massive levels of capital expenditure being committed to quite subdued – although BHP Billiton and Rio Tinto shareholders are just starting to become agitated about the extent to which they are getting their direct share of the cash gushing through the major miners.

It is improbable that a traditional big and established publicly listed industrial company, no matter how blue-chip, would be allowed to sacrifice margin and continually and materially increase its spending each year in order to maximise its revenue base in the long-term.

That is, of course, the beauty of the internet and, for the moment at least, the resources sector. At this moment there is an unknowable element to them that means there is no ceiling on their potential value and profitability.

That gives them a reasonably open licence to invest against that potential – as long as the rate of revenue growth and the prospect of an eventual leveraged surge in earnings as those revenues are eventually harvested remain strong enough to retain the market’s support.

This article first appeared on Business Spectator.