I don't know anything about running businesses but I just heard that Amazon ran at a loss for almost a decade. Uber for 14 years. Open AI apparently lost $15.6 billion last year. Why is this okay? If I decided to run my own business and it wasn't profitable for several years, would that also be fine? Please explain like I'm five.
Why is it acceptable for some companies to run at a loss and still exist?
byu/EOFFJM inAskEconomics
Posted by EOFFJM
6 Comments
So long as the funders of the company (1) have the money, and (2) like the direction of the management, a company can run at a loss indefinitely.
Amazon is a great case in point. Amazon spent all those years taking their profits and re-investing them in the company so that it could grow into the current logistics powerhouse it is in 10 years, rather then the 40-50 years it would have taken if ownership had taken more profits. In fact a company like Walmart could have beaten them “to the punch” if they hadn’t invested so aggressively in growth.
The value of a business is the net presence value of expected future cash flows. As such, cash flows can be negative indefinitely as long as investors believe they will eventually be positive enough that the return on capital will be attractive on a risk-adjusted basis.
In more five-year-old-terms, a company like Uber may decide that even though it could be profitable short-term by charging higher prices and hiring fewer people, they can mail more money long-term by keeping prices low and expanding as rapidly as possible, reinvesting revenue in growth as opposed to taking profits.
As long as investors also believe this strategy makes sense, the company can continue to raise money from investors and put that into the business.
Once these businesses go public, it’s not even necessary for the company to turn a profit for investors to realize their gains, because they can sell stock to other investors who also believe future profits will cause their investment to grow.
I would add, it’s actively misleading to say businesses “lose money.” This implies they are doing something irresponsible or irrational. It’s more helpful to frame this as investing instead.
So your question becomes, why is it acceptable for companies that aren’t profitable to raise money to invest in their future growth rather than optimizing the business to be profitable today, and the answer to that is that investors want the highest return on their capital, which often come from deferring profitability.
If you owned the company and had the money to lose, it is typically fine to lose money while running your business. There is no particular law that makes it an obligation to run a company profitably. (other than for fraudulent or other criminal reasons)
Major company decisions are made by the owners and investors of the company that put in their money. The representatives of the owners are the Board of Directors (BoD).
In the case of Amazon, the investors and Jeff Bezos planned to expand their operations quickly based on their model of online sales (initially books). This required multi-year operational losses because they expanded ahead of their business. (In a sense, Amazon is somewhat lucky that AWS or basically cloud based web services started to become highly profitable)
In the case of OpenAI, their major shareholders (owners) were big companies like Microsoft who possibly saw great future potential and were willing to invest in a money losing business initially.
There is a lot going on here.
“Accepable ” is not the best word here. Acceptable by whom?
One thing to note loss doesn’t have to mean what is known as negative cash flow. As a CPA I could bore you with wonky accounting jargon but I won’t. But not all expenses mean cash is being spent in that year. That means a company could show a loss and the amount of cash in their “bank accounts ” is going up.
But for the examples you gave what was or is going on is investors are willing to keep putting more money into the business to fund the losses. They did this because they saw something that convinced them the future profits would be large enough to justify the constant investment.
In the case of Amazon and Uber it turned out to be true. People who kept buying stock every time those companies issued more has made a huge profit on the increased price of the stock now they are profitable.
In short those investors thought keeping the company going by putting cash into them would be worth it in the long run when they finally sold their stock.
Companies don’t go bankrupt because they lose money, but because they run out of money. As long as someone (both shareholders and creditors) is willing to cover for the money lost in the business operations, the company can continue to operate.
Obviously, that only happens if the said financiers expect to recover their money and some more. Which means that the business must grow and follow a reasonable path to profitability. To seed so that one can sow.
That is typical of new ventures and growth markets.
Because the expectation is they will make profit in the future.
The more technical answer is that firms operate at losses but still operate over shutting down because of fixed costs. So shutting down may end up being more of a loss than staying open and operating at a smaller loss. For example, a beach resort pizza shop may lose money every month from September though May, but then make a lot of profit in the summer. It’s still worth staying open in the winter (in cases) if their revenues exceed the labor and material costs (variable costs) even if it doesn’t cover the fixed costs like the lease (rent). This is because typical leases run over years, not months. So shutting down in the winter will still mean paying the lease. So operating at a loss, but a loss less than just the cost of rent is preferable to shutting down and paying that rent.
Companies that are starting out are willing to operate at a loss because of future expected revenues and profits.