The period between the current long macroeconomic wave’s first and second halves has radically changed retail, and Amazon.com (NSDQ: AMZN) has leveraged the rise of the Internet very similarly to the way Dell did during the first half of the wave to dominate the retail space. When the major PC companies were selling their desktop computers in brick and mortar stores, Dell could not. They were not considered big enough to deserve shelf space next to the large PC makers such as Microsoft and Apple.

Instead, Dell sold its PCs via catalog initially, and then the Internet arrived at which time Dell exclusively sold its products online. It gained a tremendous price advantage by completely taking out the middle distribution and computer stores. Seemingly overnight, Dell exploded in growth as a result, even though its move to an online sales model was born of necessity and not brilliant foresight.

In a similar vein, Jeff Bezos – Amazon’s founder and CEO – felt he was late to the Internet party when he drew up his initial business plan to sell books, CDs, DVDs and computer hardware and software in 1994. This was a result of reading an analyst’s report which projected enormous growth for the then fledgling Internet.

I read the exact same report at about the same time but was unwilling to move to Silicon Valley and therefore was unable to obtain venture capital funding for my idea of automated maintenance and sales of computer software via the Internet. Alas, Lion Technology would never join the Internet race! Ironically, five years later I was asked to meet with the CEO and CTO of a company which offered this same concept I had five years earlier. However, they did not take my advice and broaden their concept as technology shifts continued and have therefore struggled to grow (the CEO and CTO have since been replaced by the Board of that company)

If Amazon had simply sold books in the way brick and mortar stores sell them, you can bet they would have been successful by leveraging the economies of scale of a national chain – but with no inventory to carry. However, they would not have become a tech company; Jeff Bezos has gone well beyond the concept of a book discount super store. At Amazon they saw the changes which these new digital devices would bring and anticipated them.

Bezos pursued digital books by developing the Amazon Kindle. The Kindle is constantly connected to the Internet which enables Kindle owners to buy digital books, magazines and songs, and play them almost instantly on their Kindle readers. The shift from printed books to digital books has been as profound to the publishing business as Gutenberg’s invention of the first printing press.

The cost for books has dropped dramatically, and has completely remade the publishing industry. If authors want to go through the effort to self-publish a book, now they can at very low cost. The publishing industry traditionally would have started with a limited run of printing a first edition of the book. If it sold well they would do 2^nd and 3^rd printings for that title. But the books had to sit somewhere and wait to be sold. In the new publishing model the only thing which waits is a single digital file where copies of it are repeatedly downloaded as they are sold.

The power in book publishing has swung from the publishing companies to the creators of the content themselves – the authors. Today, publishing companies try to win authors into their stable by laying out marketing campaigns for them to demonstrate the value that they can bring to market for an author. International publishing used to pay next to nothing due to high cost of complying with the various national laws. This has also changed for authors going through Amazon’s self publishing process as Amazon collects the fees for the books and distributes the money to the authors. Amazon has in effect eliminated the primary issue for an author with an international best seller.

As a result of Amazon’s success in publishing it has gone further in an effort to digitize every book in order to erase the gap which used to exist when books went out of print. Once digitized, a book never has to go out of print ever again. The digital age has been a democratizing process far beyond its utilization in the Arab Spring via social media. As Thomas Jefferson once said, “The field of knowledge is the common prosperity of all mankind.”

Beyond supporting Jefferson’s far-reaching thinking, Amazon.com has gotten into trouble by digitizing out-of-print books where the owners are no longer living or known. They have also had legal dust-ups over their pursuit of the publishing industry with the authors themselves. As few out-of-print books possess the staying power of current popular tomes, this has had no effect whatsoever on Amazon’s revenues.

Amazon has done the same thing with DVDs and music CDs. It is selling digital copies of them as Apple has been doing since 2003. Amazon did not pioneer MP3 music sales but they did change the industry by selling the music copies without requiring digital rights management (DRM). This has forced Apple to drop DRM from all of its online sales as well.

Amazon is being called the world’s greatest disruptor for its seismic impact on retail as a result of how they change the retail concept of everything they sell. Walmart was the most successful retailer in the first half of this tech wave, but Amazon has clearly moved out ahead of Walmart during the past five years.

The difference of course is that Walmart has booked much more profit than has Amazon. Walmart is working to e-tail its sales as well but is trailing at this point. Amazon continues to plow its profits back into the business, and has software development centers on five continents in over 20 cities to do just that.

Amazon has also continued to defy investors gravity as it makes no dividend payments to its shareholders; however, its stock continues to trade in sky high multiples while Apple (NSDQ: AAPL) is trading at only 10 times forward earnings. Apple is viewed by STI as a better investment vehicle not only for their dividends but also for its extremely low stock valuation for a consistently profitable tech company.

Until very recently Amazon’s stock has continued to rise, and one might ask – why? Amazon’s stock not only continues to climb as it moves into segment after segment while gutting the competition, but also because it is moving squarely into the future of computing in the Cloud.

Amazon took the enormous software and hardware resources they posses to run their fast growing business and are reselling it as a Cloud service. Called Amazon’s Web Services (AWS), Amazon’s S3 offering provides end users with Cloud-based storage services. Their EC2 services provide scalable virtual servers for businesses.

The revenue for Amazon’s AWS has climbed every year since 2006 and has now reached the billions of dollars. Since 2012 Amazon runs the entire company on its AWS services, which has become the current leader in Cloud based services. Traditional computer companies like Oracle (NSDQ: ORCL), Apple and Microsoft (NSDQ: MSFT) are trailing and therefore the competitive threat is very real for the entire tech industry from Amazon.

At the moment, the Cloud is primarily in the hybrid stage. Hybrid refers to companies that have their own internal computer servers supplemented by partially outsourcing Cloud-type services from other vendors. This is why companies such as Oracle are currently doing so well. If the entire industry were to flip a switch to abandoning hybrid and totally using the Cloud then this would be very bad news for the Oracle’s of the world

However, the industry won’t flip the proverbial switch. It is an ongoing evolutionary process that will reach a tipping point in the future, but companies having their own computers will likely never totally disappear, primarily for security reasons. But, in the future, more and more will outsource and out-task Cloud services as companies such as Oracle and SAP will be able to provide economies of scale to justify the jump to the Cloud.

We suspect critical intellectual property will not make the move to external Clouds. Companies will likely keep that in-house until there are regulations prohibiting and tracking the use of a company’s intellectual property by Cloud providers.

We don’t recommend buying Amazon.com (in fact, it is a short sell recommendation in our Equity Trades Portfolio) but do suggest buying Oracle, Microsoft and Apple. One has to wonder how much higher Amazon can continue to appreciate while generating very little profit and paying no dividend. 

Last month’s quick 10% drop after announcing disappointing earnings may have been an early warning sign that future missteps will be punished more harshly, but even after that haircut the stock is still trading at almost 600 times TTM earnings.  At what point will Amazon be evaluated by the stock market no differently than any other retailer, ignoring the means by which it acquires customers and focusing instead on the extent to which it can profitably serve them?

As we learned from the prior long wave, attempting to predict winners 5 – 10 years in the future is a futile task; by its very nature technology constantly seeks out the most cost efficient means of getting something done, and companies that wait too long to convert market share into profitability are often swept away by a more agile competitor.

McDonalds wasn’t the first fast food restaurant chain in the United States; A&W and White Castle were started in the 1920s just as the National Highway System was coming into existence.  But they eventually were surpassed by McDonalds, KFC, and several other chains that did a better job of recognizing consumer demand and delivering product in a profitable manner.

Until Amazon demonstrates that it can do that, someone else just might come along and eat their lunch

STI Portfolio Stocks mentioned in this article:

Amazon.com (NSDQ: AMZN) is a ‘short sell’ in our Equity Trades Portfolio

Oracle (NSDQ: ORCL) is a ‘buy’ in our Investments Portfolio

Microsoft (NSDQ: MSFT) is a ‘buy’ in our Investments Portfolio

Apple (NSDQ: AAPL) is a ‘buy’ in our Investments Portfolio