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- Don D., California
Amazon Bites the Tax Bullet
It wasn’t too long ago that Big Tobacco was fighting regulation tooth and nail. The companies simply didn’t want the government dictating what it sold and how. Altria (MO), which owns Phillip Morris, was one of the most outspoken. The reason was fairly obvious, it seemed that the company, one of the world’s largest tobacco companies (it has since separated out its international operations as a stand-alone company) had the most to lose.
However, as time passed it became increasingly obvious that the public crusade against smoking cigarettes was going to eventually lead to more regulation. Altria abruptly changed its tune and supported regulation. At first the switch seemed odd, but taking a step back and looking at the competitive landscape from a distance helps to clarify what Altria was doing.
When one of the largest competitors submits to oversight, other industry participants are virtually forced to accept the same review. So, Altria’s actions basically resulted in the entire industry succumbing. The oversight plan, meanwhile, was strict enough that it made it virtually impossible for new entrants to come to the market. In effect, simplifying a very complex situation, Altria was protecting its market share for years to come. Moreover, weaker players would likely find it harder to compete under the new rules, potentially allowing Altria to expand its market share in a competitive market.
The decision has proven to be a good one, as Altria continues to thrive in the U.S. tobacco market despite declining use of tobacco, continued public backlash, and rising taxation of the product. A similar set of events is unfolding in the Internet sales taxation debate, with industry heavyweight Amazon.com (AMZN) seemingly set to take a page from Altria’s playbook.
There are some material differences between the tobacco issue and the internet sales tax issue. First, consenting to pay state sales taxes won’t grant Amazon.com a lock on its market share. It will, however, create a material barrier to entry for anyone looking to get into the market. Moreover, it could open up a new business line for Amazon, if it offers its technology for tracking state taxes to competitors large and small. It also burdens competitors with an additional cost of doing business, which has been a particular benefit for smaller retailers.
In the early years of the Internet, it seemed prudent to allow retailers to avoid state level taxation to help a new market develop. Now, however, it is pretty obvious that the Internet is here to stay and that some very successful companies are benefiting in a way that brick and mortar merchants can justifiably claim is unfair. As states grapple with tight budgets, or worse, support for the current tax policy has waned. Amazon, meanwhile, might wind up looking like the “good guy” by changing sides in a fight it has long championed.
The biggest losers will be small online retailers and those that are only marginally profitable. That said, any company that has online operations will be effected if Internet sales are taxed at the state level. A few percent taken off the bottom line will likely be obvious to investors—and the added cost of buying online will be very obvious to consumers seeking out the best deals.
The biggest beneficiaries, outside of Amazon.com, could be brick and mortar retailers, since the price advantage between their offerings and the same items found on the Internet will be narrowed. This will be particularly true for big ticket items where state sales taxes begin to be material. In fact, the instant gratification of driving home with a new television might begin to outweigh the reduced price available from a company without storefronts.
Such a taxation change will also put pressure on the ability of online retailers to charge for shipping—an already tense issue. Such costs are analogous to, though perhaps not equal to, the costs associated with owning and operating a storefront. Having to offer more free or supplemented shipping options to keep customers coming back could also hurt online retailers’ bottom lines. Of course, a reduction in online sales would have a secondary impact on the companies that handle the shipping, such as FedEx (FDX) and United Parcel Service (UPS). These companies have benefited from the increase in Internet sales and any drop off could materially hamper their top and bottom lines.
Amazon’s decision on the state tax issue will have wide ranging implications. It won’t be the “master stroke” that Altria’s choice on tobacco regulation appears to have been, but accepting state level taxation seems likely to be more of a benefit and less of a detriment to Amazon’s business than to the businesses of its competitors.
For more information on the companies mentioned, along with the investment merits of the corresponding stocks, subscribers are encouraged to check out our full reports in The Value Line Investment Survey.
At the time of this article’s writing, the author did not have positions in any of the companies mentioned.