We thought this day would never come. Amazon.com (Nasdaq:AMZN), the largest of the dot-coms, has turned its streak of losses around, and posted a net profit for the fourth quarter of 2001.xml:namespace prefix = o ns = "urn:schemas-microsoft-com:office:office" />

            This comes after five years of nonstop quarterly losses that amounted to an astounding $3 billion. Investors, particularly venture capitalists, know that businesses often have to persevere through some losses, sometimes even gut-wrenching losses, before gaining traction and beginning to make money, but five years and $3 billion is more than even many of the most daring venture capitalists will endure.

            Unbelievably, many investors were saying two years ago that if Amazon turns a profit in the next few years, they would sell their shares in the e-tailer. In the late-1990s dot-com buildup, it was a widely accepted, and even encouraged, practice to eschew short-term profitability in favor of long-term growth.

            On principle, this isn't financial foolishness; companies do it all the time to some degree. Whenever a company buys advertising space in a magazine, for example, it's sacrificing some portion of its profits from the current fiscal quarter in an attempt to attract more revenue in the ensuing ones. This is just good business sense.

            Amazon.com, however, like far too many other Internet firms in the dot-com heyday, tested the limits of this principle. It suffered quarter after quarter of huge losses with nary a questioning eye, firmly believing that once it had established a customer base of sufficient size, it could easily shift its core business model from growth to profitability.

            The idea behind this belief was that these companies could offer below-cost pricing and include complimentary services such as free shipping. It brought in masses of customers, but resulted in considerable expenses.

            As it turned out, these e-tailers had to shift from growth to profit-driven business models not because they had reached the critical mass of customers that they had preset as the point at which to start making money, but because their working capital had fallen far too low. Simply put, if they had not raised their prices and abandoned other loss-leading services, they wouldn't have enough money to stay in business. Their private investors became unwilling to accept any more months of losses.

The Differences between Amazon and Beyond.com

Amazon.com was able to avoid the fate of e-tailers like Beyond.com because it's the largest e-tailer on the Web. There have been three benefits of its size that have allowed Amazon to survive its staggering losses.

            First, it has enjoyed greater and more diversified investment, making it much less susceptible to the whims of investors, which has kept its coffers filled with more than enough working capital.

            Second, Amazon has had a sufficient advertising budget to make more of a name brand for itself than virtually any other dot-com could ever claim. Buying from a big name like Amazon is worth something to consumers, and they will often pay more for the security of purchasing from Amazon over a lesser-known company. While other e-tailers were forced to sell items below cost or lose their customers, Amazon enjoys some amount of brand recognition allowing it to maintain a large customer base without having to compete strictly on price.

            In addition to Amazon's ability to compete through its brand name—a true luxury in the dot-com world—it has more power to compete on price. Because it places larger orders with its suppliers, Amazon.com has always been able to negotiate lower supply costs than its competitors.

            Because of these three advantages that result from Amazon's size, it has been able to survive long enough to outlast most of its competition. And, as each of those competitors has closed shop, Amazon and the other remaining e-tailers have been able to relax their low-price strategy slightly.

A Profit Is a Profit

Now, with so many dot-coms out of business, Amazon.com has been able to raise its prices to the point at which they're actually higher than its products' supply costs plus associated operating expenses. The company is profitable.

            Although Amazon's profit was a very modest $5 million in relation to its total revenues of over $1 billion in the fourth quarter, this is the latest in an upward progression for the company's profits. This quarter was especially noteworthy only because it happened to be the one in which the company crossed the line from red to black.

            Therefore, while a one-cent per share profit on a stock valued at about $10 per share may not sound terribly impressive, bear in mind that Amazon lost $1.53 per share for the quarter one year ago, for a total loss of nearly $1 billion.

            But, how did Amazon manage to turn its finances around over the course of the year? First, sales were up for the holiday shopping season, reaching $1.12 billion compared to the $972 million worth of merchandise it sold a year earlier. The reduced number of e-tailers remaining in the market has allowed Amazon to garner more customers, even as its prices have risen. While 1998 was a much better time if you were looking for investment money to start a dot-com, it seems this is a much better time to actually operate one.

            In addition to its increased sales, Amazon is reaping the benefits of its efforts to streamline its operations. No longer focused on sales growth at any cost, the company has over the past year been focusing on profitability, while investors have been selling their shares in the company as Amazon's losses continued mounting.

            To make its way into the black after operating so deeply in the red for so long, Amazon needed to take on the capacity for increased sales while at the same time cutting back its operations. Although benefiting from increased Q4 revenues, it was primarily by controlling its operating costs that Amazon was able to enjoy revenues that exceeded its costs.

The Long-Term Outlook

While Wall Street was very impressed with Amazon's fourth-quarter earnings, there's no guarantee that the company will be able to maintain that profitability throughout the year. After all, Q4 brings all the holiday sales, which brings with it the highest revenues for retailers.

            With no Christmas shoppers during Q1 through Q3, it's possible that Amazon will drop back into the red for the first, second, and/or the third quarter. While Amazon's earnings fell from $972 million in the fourth quarter of 2000 to $700 million in the first quarter of 2001 to $668 million in the second quarter, it simultaneously reduced its losses from Q4 2000's $545 million to Q1 2001's $234 million to Q2 2001's $168 million.

            If Amazon's Q4 to Q1 earnings drop by the same amount that they did a year earlier, and if Amazon can reduce its costs by the same amount it did a year ago, the company will still be able to stay in the black in each quarter. Even if Amazon is unable to remain in the black for each quarter of 2002, however, a strong Q4 will provide a fighting chance of pulling Amazon into the black for the year.

Is This Good News for Other E-Tailers?

Now that Amazon.com has at the very least proved that a large-scale e-tailer can turn a profit, does this mean that 1998's promise of the Web as a great place to make money is true? Yes and no.

            Yes, because Amazon.com has now demonstrated that it can, at the very least, be done. No, because the company has yet to prove that it can continue to turn a profit consistently. And, at the rate of making $5 million per quarter, Amazon would need 150 years to recoup the $3 billion in losses it has racked up since it went public in 1997.

            The great potential of the Internet for e-tailers has been the ability to set up a company without having to pay for physical locations and the employees, taxes, utilities, and other expenses that went along with them.

            Unfortunately, what no one figured into the equation was the need for e-tailers to be able to compete against a World Wide Web full of competitors. Brick-and-mortar stores have to compete only against their local rivals. A physical store has more ways of differentiating itself from its competitors (by way of parking, location, service, etc.) that can make a customer prefer one over another notwithstanding price.

            Yet, there are profits to be had for e-tailers now that they no longer have to give products away in order to retain customers.