cash-conversion-cycle-amazon

What Is Cash Conversion Cycle? Amazon Cash Machine Business Strategy In A Nutshell

The cash conversion cycle (CCC) is a metric that shows how long it takes for an organization to convert its resources into cash. In short, this metric shows how many days it takes to sell an item, get paid, and pay suppliers. When the CCC is negative, it means a company is generating short-term liquidity.

How does the cash conversion cycle work?

There are three aspects to take into account the cash conversion cycle:

  • Days inventory outstanding
  • Days sales outstanding
  • Days payable outstanding

In other words, how long it takes for an item from when it sits in your inventory to when it is sold. How long it takes for you to cash the sale. And how much time you have to pay back suppliers.

Case study

Imagine you buy from an online store (just like Amazon). You ordered an item and spent $50. You’ll get the item in 7 days. The online store has already collected the $50 and will ask the supplier to send it over to you within a week. But the store will pay the supplier only after 30 days. This means that now the store has $50 that can spend the next three weeks before the amount is due to the supplier. Those three extra weeks are crucial as the money could be spent to order other items and sell them with the same cash conversion cycle. 

Therefore when an organization learns how to use its cash conversion cycle appropriately, its financial model drives its business strategy to fuel the growth of the business.

I want to show you how Amazon uses a negative cash conversion cycle to generate extra liquidity to power up its business growth.

Related: How Amazon Makes Money: Amazon Business Model in a Nutshell

A better look at Amazon profitability

is-amazon-profitable
Amazon is a profitable company. Its operating income and net income passed $12.4 billion and $10 billion respectively in 2018. The operating income was driven primarily by Amazon AWS, contributing $7.29 billion. Amazon has been consistently profitable since 2015 when it posted 596 million in profits.

If you look at Amazon’s income statement, you’ll see that its operating income when it comes to the e-commerce side it’s tight.

The part of the business that has high margins is related to Amazon AWS:

amazon-q1-2020-operating-income-holds-thanks-to-aws

Instead, Amazon‘s e-commerce platform, while it does have much better margins compared to the past, is still low compared to other parts of the business. 

Yet, the company generates substantial cash from the operations.

Amazon‘s continuous blitzscaling

amazon-cash-pandemic
Throughout the COVID pandemic, Amazon recorded a substantial increase in revenues that also resulted in more cash from operating activities (Amazon has positive cash conversion cycles). However, cash was spent from operations to expand shipping and fulfillment. And from investing activities in increasing the capability of the Amazon tech platform (AWS).
 

So how does Amazon generate so much cash from operating activities? 

The answer is in the cash conversion cycle, or the ability of Amazon to keep its operating margins low and yet generate short-term liquidity to keep expanding the business.

In fact, on the one side, Amazon has to make sure to keep its prices low, as this is part of its mission, and on the other side through the cash conversion cycle, the company can still generate cash, unlocked to grow the operations. 

This is a sort of business strategy driven by a financial model that drives the whole business. Thus, Amazon can keep its aggressive pricing strategy and yet still manage to continuously expand its operations. 

The Amazon business model, combined with its financial model made it take over several industries along the way. And it enabled Amazon to be in a continuous “blitzscaler-mode” nonetheless its size. 

what-is-blitzscaling
Blitzscaling is a business concept and a book written by Reid Hoffman (LinkedIn Co-founder) and Chris Yeh. At its core, the concept of Blitzscaling is about growing at a rate that is so much faster than your competitors, that make you feel uncomfortable. In short, Blitzscaling is prioritizing speed over efficiency in the face of uncertainty.

Understanding Amazon‘s financial model 

A financial model, driven by cash conversion cycles, can be used for generating additional cash by efficiently managing three aspects:

  • Days inventory outstanding (how long it takes before we sell that item we have sitting in the store?)
  • Days sales outstanding (how long it takes to get paid by our customers?)
  • Days payable outstanding (how much time we have before we are due to our suppliers?)

Amazon is quite successful in managing its cash conversion cycle.

In fact, as of 2017, gurufocus.com reported that Amazon had a cash conversion cycle of -26.92! 

  • Amazon.com Inc’s Days Sales Outstanding for the three months ended in Dec. 2017 was 19.87.
  • Amazon.com Inc’s Days Inventory for the three months ended in Dec. 2017 was 35.27.
  • Amazon.com Inc’s Days Payable for the three months ended in Dec. 2017 was 82.06
    Therefore, Amazon.com Inc’s Cash Conversion Cycle (CCC) for the three months ended in Dec. 2017 was -26.92.

It practically means that Amazon has almost thirty days before payments are due to its suppliers, while it has already generated available cash for the business by selling items in its online store!

But how and when does it make sense to operate a cash-generating business model? I believe there are four main aspects to take into account:

  • Trust from customers
  • Digitalization
  • Negotiating strength
  • Inventory

First, you need to be Trusted by customers

Before Amazon could become so efficient in managing its cash conversion cycle business strategy, it took years to become trusted by its customers. Today Amazon.com is one of the most popular websites on earth, where each day billions of people purchased anything:

similar-web-amazon

Data: Similar Web

Digitalization makes it easier

With digitalization, it has become easier for online stores to manage their cash conversion cycle. For instance, think of the case in which you open up a store with a simple landing page. You don’t have anything down yet, but you start getting sales in.

Once an item gets pre-ordered, you can get it from a supplier and send it over to a final customer. In short, digitalization helps companies keep a more efficient inventory based on what customers order online even before they have it sitting in the inventories.

That is not an Amazon case. Amazon played the opposite business strategy: build giants super-organized inventories called Fulfillment Centers.

Fulfillment centers are the key to Amazon successful cash conversion cycle strategy

Amazon has been investing billions of dollars in automating and making more efficient its “fulfillment centers.” That, of course, helped the company to strengthen its cash conversion cycle:

Advantageous credits terms with suppliers

Another aspect is the company’s ability to negotiate convenient payment terms with its suppliers. If you’re able to stretch the payment agreement terms in a way that allows you to run your business on credit, it becomes easier to have excess cash to invest in the business operations growth. Just like Amazon has been doing in the last years.

Affiliate networks and programs

affiliate-marketing
Affiliate marketing describes the process whereby an affiliate earns a commission for selling the products of another person or company. Here, the affiliate is simply an individual who is motivated to promote a particular product through incentivization. The business whose product is being promoted will gain in terms of sales and marketing from affiliates.

Another critical element of Amazon‘s successful cash business strategy was built upon a network of publishers around the web, that in exchange for a referral to Amazon products could get a fee. This is the premise of affiliate marketing, on which Amazon has also built its fortune.

Key takeaways

  • The cash conversion cycle is a crucial aspect of any business in which success is based on short-term liquidity. When current assets minus current liabilities is positive, it means the company can generate extra cash from its operations.
  • If well managed the cash conversion cycle can become a sort of cash-making machine that generates additional liquidity for an organization.
  • This is a sort of financial model that combined with a viable business model can unlock substantial growth for the business!

Below a summary of how it all works:

cash-conversion-cycle-amazon

Breaking down Amazon‘s Flywheel

amazon-flywheel
The Amazon Flywheel or Amazon Virtuous Cycle is a strategy that leverages customer experience to drive traffic to the platform and third-party sellers. That improves the selections of goods, and Amazon further improves its cost structure so it can decrease prices which spins the flywheel.

Read: Amazon Flywheel

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Published by

Gennaro Cuofano

Gennaro is the creator of FourWeekMBA which target is to reach over two million business students, executives, and aspiring entrepreneurs in 2020 alone | He is also Head of Business Development for a high-tech startup, which he helped grow at double-digit rate | Gennaro earned an International MBA with emphasis on Corporate Finance and Business Strategy | Visit The FourWeekMBA BizSchool | Or Get in touch with Gennaro here

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