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Back when the Japanese carmakers were eating their American rivals alive, the classic joke about General Motors was that its marketing strategy was: “We lose money on every sale, but we make it up on volume.”
Investors have been tolerating a similar approach from some of the US’s most prominent technology companies for quite some time. Twitter and Uber are lossmaking, and Tesla just reported only the second quarterly profit in its history.
Smaller tech companies, whether in the US or elsewhere, also tend to bridle whenever an analyst or investor starts asking too many questions about the path to profitability. Revenue and user growth are the key measures. Profits will follow eventually.
Many point to Amazon as their role model. The 21-year-old company has revolutionised retailing and entertainment and shaken up cloud services. But the $380bn company still cannot be counted on to generate reliable profits.
On Thursday the company forecast that it could make nothing for the crucial fourth quarter, compared with $1.1bn for the same period last year. Amazon is spending so much on new distribution warehouses, video content with big name stars and its snazzy new digital assistant Alexa that projected year-on-year sales growth of 17 to 27 per cent (to as much as $45.5bn) might not be enough to cover its costs. “We’re in a period of ramping up investment in the second half of 2016,” said Brian Olsavsky, chief financial officer.
Nor is Amazon the only technology group spending up a storm. Google owner Alphabet said on Thursday that its “other cost of revenues” line had jumped 29 per cent in the latest quarter to $4.2bn because of higher data centre and content expenses, and its chief financial officer suggested that profit margins were unlikely to improve significantly over the short term. And Tesla is about to double down on capital spending as it develops its first mass market vehicle.
Innovation is expensive, no question, and the big tech companies have revolutionised our lives in the past two decades. But many of them are pouring money into the same things and not all of them will come out winners. Sony’s Betamax videotape, which lost out to the VHS format, is just one example of how a company can have the right idea but still lose money on its investment.
Twitter provides a more recent cautionary tale about the woes of being in a crowded field. The messaging site went public amid high hopes that it could follow Facebook’s path to profitability but has thus far failed to do so. It also invested heavily in video, both on its own site and by snapping up Vine in 2012 and building it up as a home for short clips. But rival platforms also went hard for video, and Instagram and Snapchat have pushed past Twitter when it comes to daily users. This week, Twitter said it would close down the Vine mobile app and lay off 9 per cent of its workforce, as it struggles to survive.
Amazon’s big push with Alexa will probably encounter stiff resistance from Google, Microsoft and Apple, which have digital assistants of their own. And Tesla’s mass market electric cars will have to compete with offerings from traditional carmakers.
Ambitious plans to woo users and boost sales are both very good things. But there is a reason why profit is the bottom line. As Snapchat’s lossmaking owner prepares for a float that could value it at more than $20bn, investors would do well to keep that fact in mind.
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