Amazon's drones a sign of returns losing altitude

Technology forces companies to invest or die, and that means shrinking portfolio values for us

PUBLISHED : Thursday, 05 December, 2013, 6:00am
UPDATED : Thursday, 05 December, 2013, 6:00am

Jeff Bezos' plan to deliver packages by drone is not 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 was testing delivery by unmanned flying vehicle, Bezos, the founder and chief executive, told the CBS network. Drones, heretofore best known for their military uses, could be useful for packages up to 5 pounds (2.2 kilograms), a segment which comprised 86 per cent of Amazon deliveries, he said.

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

Putting aside the fact that drone use is strictly controlled, not to mention issues of cost, it seems that in coming years when you see a drone in the sky you will 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 Amazon 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 materialise, even as revenue soars. In the last quarter Amazon revenue was US$17 billion, up 24 per cent, but resulting in a loss of nine US cents per share. That's because Amazon invests, ploughing revenues into new warehouse fulfilment centres 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 in the United States has found in the health care arena.

So far, Amazon investors have done marvellously 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.

William Bernstein, of investment advisory 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, Amazon 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, does not just denote improvements in service or productivity. It also represents 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.

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 returns.

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 health care, when your portfolio fails to deliver that 7 or 8 per cent 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.