The Amazon Risk Premium

It is no secret that Amazon has taken over the retail game and changed the way we buy virtually everything.  My front porch cannot go two consecutive days without an Amazon package sitting on it, and I know that some front porches see even more action than mine.  What has been more under the radar, at least for some, is Amazon’s propensity to disrupt other industries.  Amazon has ventured into cloud computing, music streaming, entertainment content, healthcare, and a multitude of others.

I recently listened to a podcast that included an interview with Scott Galloway, a professor at NYU’s Stern School of Business.  Mr. Galloway has written extensively on the largest tech companies on the planet, including Facebook, Apple, Google, and of course, Amazon.   He said something during the interview that resonated with me.  He claimed that Amazon, although generally classified as a retail/e-commerce company, is actually in the business of disruption.  Amazon’s competitive strategy involves examining industries that are ripe for disruption, and figuring out a way to flip these industries on their heads and revolutionize the way they operate.

Amazon drone

From a valuation perspective, I thought not about how being in the business of disruption impacts Amazon’s value, although it certainly does, but about how every other company’s value is now effected by Amazon’s business model.  In a typical risk rate build-up model that is used in a large number of business valuation analyses, the riskiness of the subject company’s industry must be taken into account.  Here is the formula that is generally used by valuators to determine the appropriate risk rate:

Ke = Rf + ERP + IRPi + SP + SCR

In this formula, the IRPi factor is what is known as the industry risk premium.  The valuator must consider the inherent risks in the industry in which subject company operates.  I argue that the most significant risk factor for most industries in the Amazon Age is the risk that the industry is disrupted by technology, perhaps (or maybe likely) from Amazon, or another company that may not currently be an industry player.  It almost seems appropriate to re-name the industry risk premium the “Amazon Risk Premium.”

Although it can be difficult to predict how Amazon or another disruptor may impact an industry in the future, it is imperative to consider these risks in almost all valuation analyses.  In most cases, the existence of Amazon and its focus on technological disruption across a wide range of industries has driven valuations down for other companies.  The more likely an industry is to get disrupted, the higher the risk rate used for the subject company, which results in a lower valuation.

In what seems like Amazon’s quest to take over the world, almost any industry could be impacted.  While this has the potential to make lives better for consumers (not sure how I would turn the heat down in my house without Alexa – would I actually have to get up off the couch?), it may make life more difficult for companies attempting to compete with Amazon.  Even if your company never dreamed of taking on the behemoth, how is the Amazon Risk Premium impacting the value of your business?  Are you considering the susceptibility of your industry or business to disruption?