MONEY LOSING GIANTS: Being profitable is virtually useless
for modern companies. Founder’s don’t care about profit, shareholders don’t care about profit,
and even employees don’t care about profit. This has resulted in an era of money losing giants. In
the last 12 months, Zillow lost $101 million. WeWork lost $2.7 billion. Snapchat lost $1.43
billion. And Uber lost, wait for it, $9.1 billion. Traditionally, such losses would be a nightmare
for owners. If they don’t turn around the company soon, bankruptcy would be a high probability. But,
modern companies don’t really care. What they all care about instead is growth and lots of it. As
long as the company is growing, any loss is deemed acceptable. It’s not just these new startups that
have been going down this path either. Tech giants have been using this strategy for decades. Amazon,
for example, has always teetered on the edge of profitability, and their retail business is
still unprofitable to this day. A similar story can be said about Google. Google is a cash cow,
but that’s only due to one business, their ad business. Virtually everything else is
a loss. Their cloud business, for example, lost $480 million last quarter. And as for Facebook,
I mean, do I even have to say anything about the Metaverse?
Some more legacy company have also turned to this strategy in recent times like Disney. While Disney
is still profitable as a company, they’re definitely using the modern approach when it
comes to new services like Disney+. Despite having hundreds of millions of subscribers,
Disney streaming lost $1.5 billion in the last quarter alone. And it’s not like these companies
are forced into losses. Most of them could raise prices, cut marketing, lower reinvestments
and become profitable basically overnight. But, they actively choose not to because 1,
they can afford it, and 2, they actually think that’s it’s the better play long term. It wasn’t
always like this though. Back in the day, profit was king. Owners needed profits to pay themselves.
They needed profits to pay shareholders and they needed profits to give employees bonuses
and additional perks. So, whether you were running an oil business or a steel business,
the goal was to achieve profitability as quickly as possible. But, over time, the
urgency to reach profitability slowly withered away. Instead of having 3, 6, or 12 month
timelines to reach profitability, owners started having 2, 5, 10 year long timeframes. And now,
it seems like this timeframe has expanded to encompass infinity. So, here’s the story of how
everyone involved in a company from shareholders to employees slowly accepted indefinite losses.
FOUNDERS SUCCUMB:
While this acceptance of losses may seem like a new trend, it’s actually been developing for
a 100 years and dates back to WW1. Such large scale wars are naturally full nation efforts,
so it’s not surprising that the government expected everyone to step up and offer their
knowledge and expertise to the government. This of course included companies and their executives who
were especially important in scaling production, managing logistics, and negotiating deals with
contractors. But, there was just one problem. Laws prevented the government from accepting
services from unpaid volunteers. But, with that being said, the government also wasn’t willing
to pay these executives a substantial salary because one, they were already rich, and two,
this was more of a service than a job. So, they would eventually settle on paying these executives
$1 dollar salaries. Some of the earliest examples of this were Bernard Baruch, Robert S Brookings,
and Herbert Bayard Swope who all served on a WW1 advisory commission. This practice just became
even more common during WW2 with even more notable people participating in the 1 dollar
a year service. Likely the best example of this was William Knudsen who was the CEO of GM. But,
after the war came to a close and the US entered one of the most prosperous periods of its history,
the $1 salary was more or less forgotten about. And it wasn't until the 1970s that we would see
another resurgence of this trend. The automobile industry would be hit hard by the 1970s. Not only
was there ludicrous amounts of inflation, but the Middle East would join forces and impose
a devastating oil embargo on the US and most western countries. To make things worse, Japanese
cars were also starting to gain popularity. The automotive company that was likely hurt the most
was Chrysler. By the late 1970s, the company was on the brink of bankruptcy and was in dire need
of a bailout. So, Chrysler’s CEO, Lee Iaccoca, would begin lobbying Congress for a bailout. And
to show that he was serious about turning around the company and not just pocketing the bailout,
he would offer to take a $1 salary. Chrysler would end up receiving the bailout and Iaccoca
would stage one of the biggest turnarounds the automotive industry has ever seen. But,
the biggest sticking factor for many of his peers was not his business excellence but his $1 salary.
You see, back in the 70s and early 80s, taxes were really bad. In fact, if you made more than
$215,000 per year, you had to pay income tax of 70%. But, long term capital gains tax was
much more reasonable at 28%. So, for obvious reasons, founders trended towards decreasing
their cash compensation and increasing their stock compensation. They didn’t take this to
the extreme of taking $1 salaries, but this is eventually were it led to with Steve Jobs. When
Steve Jobs returned to Apple in the late 1990s, he would accept a $1 salary. He didn’t do this to
decrease taxes or earn more stock compensation or really any financial reason. Rather, he was
trying to make a statement that he was there to save Apple, not to make money. But, it didn’t
take long for other CEOs to make this a trend. From their perspective, this was a win win win
win scenario. They could reduce public criticism about their salaries. Boards could approve stock
compensation plans at a magnitude that was simply impossible with cash. Stock had extraordinary
growth potential. And founders and CEOs could get away with paying far less in taxes. Now of course,
these leaders still had to make sure the company was profitable because that’s what kept that stock
price high, but this was quickly changing as well because the next domino to fall were shareholders.
SHAREHOLDERS SUCCUMB: Traditionally, one of the most
attractive features of stock was their dividend. This makes sense as this is what really makes you
feel like an owner of the company. Every quarter, you get a share of the company’s profits. This is
why many traditional companies like Exxon and Coca Cola swear by their dividend payments. Exxon has
paid dividends for 112 years and they haven’t even missed a single payment. This isn’t to say
that Exxon was always performing well. In fact, in many years like 2020, they were doing quite bad,
but they paid a dividend anyway because like I said, they swear by it. Historically,
dividends are what attracted investors like Warren Buffett to a stock.
So, maintaining a pristine dividend reputation was vital for such companies. We should also mention
that for many stocks, this was their primary return. I mean steel companies and insurance
companies weren’t gonna double every year. More realistically, they were gonna grow 5 to 10% for
a few decades and then top out. So, the dividend is what made stocks like AT&T which hasn’t moved
in nearly 30 years worth owning. But, all of this would change with the internet. Suddenly,
companies were able to grow 100% every year for 10 years straight and then grow 50% every year
for the next 10 years. And the company that really solidified this notion was none other than Amazon.
While Amazon’s retail business was never that profitable, they did find a goldmine called
Amazon Web Services. If Jeff Bezos really wanted to, he could’ve leaned in on AWS,
raised the prices of Prime a bit, and started paying out solid dividends.
But, this made no sense for our man Jeff. You see, Jeff had already subscribed to the idea of no cash
compensation for himself. He took a very modest salary of $81,840 throughout his entire career
at Amazon. For Jeff, the money was in the stock, not the bottom line, and he wanted investors to
get on the same page. Fortunately for Jeff, there was a new but rapidly growing subset of investors
called growth investors who were getting on the same page. Most of these investors weren’t fans
of dividends and they saw dividends as a complete waste of capital due to taxes. If you didn’t know,
dividends are taxed twice, once at the corporate level, and once at the investor level. This means
that if Amazon was gonna pay $1 in dividends, they would first have to pay about 25% in corporate tax
meaning that only 75 cents would make it to the investor. From there, the investor would have
to pay personal income tax on that 75 cents. And given that most investors with a sizable stake are
already pretty well off, they usually have to pay 40% of this dividend to taxes. And yes,
I know that some companies are able to pay tax exempt dividends, but that’s not always the case,
so bear with me here. With 40% income tax, the investor is only left with a mere 45 cents. The
worst part is that many of these investors are just looking to reinvest the dividends anyway. So,
it makes no sense for Amazon to payout a dividend only for the government to take 55% and then have
45% come back to Amazon. Instead, Amazon can just reinvest 100% of the profits themselves and that’s
exactly what Amazon has done. For the longest time, value investors would ridicule Amazon
and these so called “growth investors”. But, over the past 10 years, growth stocks have taken over
the market. Most of the big tech companies pay little to no dividends and all of the returns for
investors are from growth. And since then, even Warren Buffett has opted to invest in Amazon,
so there was only one more group to convert to the dark side: employees.
EMPLOYEES SUCCUMB:
Like shareholders, employees have historically trended towards profitable companies. After all,
for employees, joining a company isn’t just an investment, it’s their livelihoods. Also,
traditionally, employees used to stick around at the same company for their entire careers,
so choosing a stable company with large profit margins was essential. But, over time,
employees have become more and more risk tolerant. For one, employees no longer feel
that they’re tied down to one company. In fact, they’ve realized that their peers who constantly
switch companies tend to earn a lot more money. So, employees today are a lot more likely to
join a startup or a company that’s trying to stage a turnaround. Sure, it might not work,
but in that case, they can just find another job. If it does work though, they suddenly become a
key member at this new company, maybe even an executive. But, nowadays, you don’t even have
to become an executive to cash in on many of the same perks like stock compensation. Historically,
employees may have refused to take stock compensation because it’s inherently riskier. But,
as we said, employees are willing to take a lot more risk nowadays. Not to mention,
they’re a lot more aware of how the wealthy make their money. They see the Fortune 500
list, they see billionaires, and they see YouTube videos like this. And they realize,
if they want to become truly wealthy, they have to own assets like real estate and stock. So,
more and more employees started looking and asking for stock compensation. For companies,
this was a godsend. As we discussed, it’s way easier for companies to pay stock compensation
than pay cash compensation. This is the main reason that compensation at big tech companies
is so high. Unless, you’re at an entry level, 50% or more of the compensation is stock. The
best part for companies was that they didn’t even have to convince employees to take stock
compensation. Employees were literally asking for it. And with that, the last domino had fallen.
MODERN COMPANIES: None of this is to say that companies
want to lose money, but they are more tolerant of losses than ever before. And as long there’s
more growth to achieve, companies are willing to stay at breakeven operations indefinitely. A great
example of this is Salesforce. Every single year, their revenue has gone up, but their
net income is virtually nothing in comparison to their revenue. A similar story can be seen with
Shopify and Amazon and Uber and AirBnB and Zillow and basically every modern tech company that you
can think of. As long as the company is growing, neither the employees nor the founders nor the
shareholders care about profit. For all three of these groups, having the company make no money
is counterintuitively the most lucrative option as no money is being siphoned by taxes and everything
can be reinvested into further growth. Now, we should also mention that many of these companies
are starting to realize that there’s no such thing as infinite growth, but that’s a wholenother
story. If you ran a company, would you go after profit or growth? Comment that down below. Also,
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