From the University of Chicago's ProMarket, Feb. 15:
Is Amazon Violating the Sherman Act?
In January of this year, Amazon briefly became the world’s most valuable public company (It has since lost that title to Apple). Achieving this milestone marked a high-water point in the firm’s meteoric rise. But perhaps even more noteworthy is the fact that Amazon attained this venerated position without turning in any significant profit.
In fact, if a careful observer overlooks the GAAP loopholes that allow Amazon to dress up its numbers, during 2017 the firm experienced a negative cash flow of $1.461 billion, with its lease repayments alone totaling $200 million. Moreover, as of 2018, those lease obligations were only part of an enormous amount of debt—upwards of $50 billion—that Amazon owed its creditors. Far from a temporary dip, 2017 represents the norm for the company: Amazon has operated with a negative cash flow for the majority of its existence.
Amazon has justified not turning a profit to its investors by stating that such profit sharing would diminish its ability to leverage raised capital to enable rapid expansion and substantial internal investment. The strategy reflected in these statements is that Amazon is increasing its present fixed costs to facilitate the future expansion of its overall productivity and overall revenue. In other words, the long-term goal of Amazon appears to be to facilitate a time in the future in which the company would become hugely profitable.
In the past year, Amazon’s corporate conduct came under scrutiny from multiple sources across the political spectrum. Additionally, new voices within the legal academic world, most notably Lina Khan, suggested that antitrust laws should be revised in order to better check Amazon’s increasingly recognized power. Most recently, an uproar broke out following the revelation that Amazon has begun raising prices at Whole Foods, after initially slashing them following its acquisition of the chain. Such activities, albeit legal, further exacerbated the outcry of Amazon’s critics, who already chastised the firm’s long-term growth strategy.
In a forthcoming paper, “Prime Predator: Amazon and the Rational of Below Average Variable Cost Pricing Strategies Among Negative-Cash Flow Firms,” I suggest that Amazon’s negative cash flow rapid expansion story may in fact conceal a more nefarious growth strategy that violates existing antitrust laws. The paper presents a theoretical explanation of how Amazon’s past and current conduct might be in violation of existing antitrust laws, namely Section 2 of the Sherman Antitrust Act. Simply put, I argue that instead of making legitimate investments which increase its fixed costs, Amazon might be engaging in a long-term predatory pricing strategy.
What Constitutes a Predatory Pricing Strategy
In 1975, Phillip Areeda and Donald Turner published their groundbreaking work on anticompetitive pricing strategies, “Predatory Pricing and Related Practices under Section 2 of the Sherman Act.” That article, published in the Harvard Law Review, set forth a straightforward test to determine whether a given firm’s pricing strategy was in violation of the law.
According to Areeda and Turner, a firm that engages in predatory pricing is a firm whose pricing strategy seeks to drive out or exclude rivals by selling its products at an unprofitable or unremunerative price. Under the test proposed by the two, a plaintiff must first demonstrate that the market in which the alleged predator operates is favorable for predation and that such a pricing strategy is rational. He must then proceed to establish that the alleged predator’s prices are either below the firm’s average variable costs (AVC) or its marginal costs (in certain scenarios).
According to the two, such an act of predation was rational if the firm which had lowered its prices in Time 1 (during predation) was able to recoup its loses in Time 2 “through higher profits earned in the absence of competition.”
In 1978, Robert Bork published The Antitrust Paradox, his seminal work in the field of antitrust. As a proponent of the Chicago School, Bork naturally drew rather extensively upon the contributions of Areeda and Turner and incorporated their theory of predatory pricing into his work. However, in Bork’s account, the definition of recoupment was subtly—yet nonetheless crucially—revised. Instead of simply defining recoupment as earning higher profits in the absence of competition, Bork held that recoupment can only occur through a rise in prices.
As mentioned, this change might seem trivial or minor, but its ramifications were significant. In subsequent decades, the Supreme Court came to adopt the price predation test as it was formulated by Bork, and Circuit Judge Frank H. Easterbrook came to view this pricing strategy as irrational and unlikely. In short, by the turn of the century, Areeda and Turner’s groundbreaking theory was rendered moot by the courts.
I argue that the original definition of term recoupment, as it was first suggested by Areeda and Turner, should be significantly broadened. I seek to demonstrate that recoupment could be achieved without a rise in prices in the post-predation period and that higher profits could be attained in the absence of competition by other means. In particular, I seek to show that higher profits could be the result of capturing a greater market share and/or the development of technological efficiencies....MUCH MORE
Related:
March 2018
Amazon, the Zenith of Tax Avoidance (AMZN)
Keeping in mind that in addition to the electrical engineering/computer science degrees Mr. Bezos was schooled in the ways of Wall Street at D.E. Shaw.
From Angry Bear:
How Amazon’s Accounting Makes Rich People’s Income Invisible
Increasingly, businesses don’t generate profits. They generate capital gains. It’s fiendishly clever.
Image [sic] you’re Jeff Bezos, circa 1998. You’re building a company (Amazon) that stands to make you and your compatriots vastly rich.
But looking forward, you see a problem: if your company makes profits, it will have to pay taxes on them. (At least nominally, in theory, 35%!) Then you and your investors will have to pay taxes on them again when they’re distributed to you as dividends. (Though yes, at a far lower 20% rate than what high earners pay on earned income.) Add those two up over many years, and you’re talking tens, hundreds of billions of dollars in taxes.
You’re a very smart guy. How are you going to avoid that?
Simple: don’t show any profits (or, hence, distribute them as dividends). Consistently set prices so you constantly break even. This has at least three effects:
1. You undercut all your competitors’ prices, driving them out of business. Nobody who’s trying to make a profit can possibly compete.
2. You control more and more market share.
3. You build a bigger and bigger business.
Number 3 is how you monetize this, personally. The value of the company (its share price/market cap) rises steadily. Obviously, a business with $136 billion in revenues (2016) is going to be worth more than one with $10 or $50 billion in revenues — even if it never shows a “profit.” You take your profits in capital gains.
Because stock-market investors are always going to be thinking: “They could always turn the dial from market share to profits. Just raise prices a skootch, and reap the harvest. In spades.”But: they never do. It’s like a perpetual-motion machine, or holding yourself up by your own bootstraps. All that rising valuation is eternally based on the fact that they could raise prices and deliver profit (and yes: they could). In the meantime the business both generates and has massive value. It employs 270,ooo people, delivers zillions in employee compensation, pays zillions more to suppliers, receives hundreds of billions in revenues, and dominates whole segments of multiple industries. Are there really no “profits”? Nobody’s being irrational here....MORE
