Amazon asked some of its retail partners to give them warrants (a type of stock option) as part of their merchandising deals, the Wall Street Journal reported. “… Amazon uses its market heft to increase its wealth and clout” was the tone of the article. But it’s also possible that Amazon crafts deals for win-win relationships.
Why would Amazon (or any other company) use its market size to seek warrants rather than a better profit margin? Higher margins seem simpler and surer. If Amazon could ask for warrants, it presumably could get better terms without the warrants. After all, there is certainly a limit to what even Amazon can ask for. Otherwise, Amazon would ask for everything all the way to first-born sons.
Understanding the counterparty’s advantage from the deal begins a good bargaining strategy. For many companies, gains from a deal are non-linear. That is, the gain starts out small when a small volume of goods are sold, but becomes disproportionately large when a large volume is sold. This gets tricky when neither side of the deal know for sure what sales will be.
The retail partner may very well be looking at high fixed costs, and marketing costs that show economies of scale, and think, “If our sales are small, we need every bit of profit margin per unit that we can get. But if we can get a large volume of sales, we’ll have plenty of profit, both per unit and in total.” And Amazon may be a good way to get that large volume.
The retail partner cannot afford to give Amazon a large cut of the profit unless sales are very large; a large cut for Amazon could doom the partner if sales don’t grow. But Amazon can see the retail partner earning huge profits if sales are indeed high, so it wants a share of this profit potential.
Different deal structures could accommodate the difference in company interests. Amazon might ask for a larger cut if sales grow rapidly. That, however, would not be a great strategy if the company’s success enabled them to sell goods through other channels, such as the partner’s own website.
The warrant deal may be a good way to cope with non-linear profits under uncertainty about sales. The owner of the retail partner may look at possibilities this way: “If I succeed with Amazon having warrants, my share of the company will be worth $10 billion. If I succeed without Amazon, my company will be worth $11 billion, which is better. But the odds of success are much higher if I work with Amazon. If it all works, the difference between $10 billion and $11 billion is pretty small, So I will maximize the odds of success, even if it means giving up a billion dollars at a time when I already have $10 billion.”
The warrant deal makes sense under these assumptions, which may or may not be correct. Matt Levine looked at the same article and noted that Amazon’s announcement of the deal would push the retail partner’s stock price up, making the warrants a self-fulfilling option.
The lesson for other businesses is to look at how a counterparty benefits from a deal as well as one’s own profits. The right deal structure may increase chances of success for both parties.
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July 01, 2021 at 06:12PM
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Amazon Asking For Warrants From Retail Partners May Be A Good Deal For Them - Forbes
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