Amazon, drones and low returns: James Saft

December 3, 2013

Dec 3 (Reuters) – Jeff Bezos’ plan to deliver
packages by drone isn’t just an idea which skirts the line
between satire and reality.

It is also a neat little illustration of how technological
innovation may be lowering overall investment returns.

The online retailer is testing delivery by unmanned flying
vehicle, Bezos, founder and CEO, told CBS TV
show 60 Minutes on Sunday. Drones, heretofore best known for
their military uses, could be useful for packages up to 5 lbs in
weight, a segment which comprises 86 percent of
deliveries, he said. ()

The goal, according to Amazon, is to have a system in place
by 2015 which can make residential deliveries in under a half an
hour by drone.

Putting aside the fact that drone use is currently strictly
controlled, not to mention issues of cost, it seems that in
coming years when you see a drone in the sky you’ll think “my
house” and “extra virgin olive oil” rather than “high
explosives” and “Taliban”.

That in itself could be accounted progress in human terms,
but this project raises some investment issues, ones which are
not new to shareholders.

Using drones is best seen as a logical extension of Bezos’
business philosophy, which keeps prices low and customer
friction at a minimum, almost without reference to expense. His
fanatical dedication to building customer loyalty, and scale,
comes at a price. Profits at the company, famously, have failed
to materialize, even as revenue soars. In the last quarter revenue was $17 billion, up 24 percent, but resulting
in a loss of 9 cents per share. That’s because
invests, plowing revenues into new warehouse fulfillment centers
with ever-better technology.

Both the low prices and the imperative to invest in what may
be low-yielding technological improvements may well be a
hallmark of the modern economy. You cannot put the genie of
Internet price transparency back into the bottle, nor can you
afford to skimp on technology, as the Obama administration has
found in the healthcare arena.

So far, investors have done marvelously in
capital appreciation terms, with the stock soaring despite the
lack of profits. Investors may well be reading this correctly;
the new economy is a winner-take-most economy, with
disproportionate rewards to those who lead. Better to be Amazon
than your local (now likely vanished) bookstore, but profits in
retail overall are now harder to find.


Even if Amazon profits do come through, the question
becomes, in an age of huge technological turnover, how
sustainable are they? And, almost more importantly, how much
ongoing profit, in investment terms, will this new world

William Bernstein, of investment advisory firm Efficient
Frontier Advisors, wrote a piece recently describing what he
called the “Paradox of Wealth,” a tendency for economic growth
to give rise to low returns.

Bernstein argues that this happens for a combination of
factors: because richer people defer consumption more willingly,
leading to a surfeit of capital; because these low returns
themselves tend to encourage speculation (hello,
investors?); and because technological innovation speeds up.

This last point is the one which Amazon so well illustrates.

New technology, be it drones or automated warehouses, don’t
just denote improvements in service or productivity. They also
represent the obsolescence of all sorts of technologies and
investments in which companies have sunk costs. Companies must
invest or die, and to invest they issue shares, diluting their
existing investors. One study found share dilution of 30 percent
per year in fast-growing Asian nations.

“As technology makes the world ever more wealthy, the
returns on both riskless and risky assets will of necessity
fall. Pray that the naysayers are wrong, and that both processes
continue,” Bernstein writes. ()

So Amazon, and drones, may represent a more prosperous
world, and perhaps one in which human wishes, at least material
ones, are more easily fulfilled. But at the cost of lower

Bezos’ strategy makes good sense, given that reality. If you
are going to live in a world where you must invest or perish,
and must accept lower returns, far better to be the company
which invests first and gets the most out of the adoption of new
technologies as they arise.

Unfortunately, we can’t all get rich off of
shares. The big issue in all of this is what happens to any
number of plans, from when you will retire to how you will pay
for healthcare, when your portfolio fails to deliver that 7 or 8
percent you are banking on.

That whirring noise you hear may not be a drone delivering
olive oil but your investment profits being cut down to size.
(At the time of publication, Reuters columnist James Saft did
not own any direct investments in securities mentioned in this
article. He may be an owner indirectly as an investor in a fund.

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