In our extended analysis of eBay, we explored some of the unique characteristics of the auction business. Our discussion highlighted qualitative factors that make auctions particularly profitable. But one could also do a more quantitative assessment of eBay’s profitability by looking more closely at its margins.
For example, using Morningstar’s data, we see that from 2003-2007 eBay averaged nearly 80% gross margin on sales and a 25% operating margin. eBay’s cost of goods sold is consistent and low, which makes sense, because the crucial component of the sales transaction that they provide—the website—is, most simply, computer code. They don’t need to worry much about raw goods prices, energy prices, or the cost of new production processes. Contrast the relative simplicity (and profitability) of eBay with General Motors. From 2003-2007 GM’s gross margins averaged about 15%, and their operating margins were a piddling 1%. With margins so low, a lot of things have to go smoothly for GM to turn a meager profit. And if business were quickly to turn, the company becomes vulnerable to bankruptcy.
On the other hand, a business with high margins has the flexibility to deepen and widen its moat. In fact, one might be so bold as to say that margins are the crucial determinant of a business’ moat. Even if a competitor were to challenge the business, high margins mean that a company could cut prices to compete, or redirect cash flows to better develop and market their product. For eBay, even if the cost of computer hardware, networks, or programmers escalates, there is substantial margin to absorb these added costs.
All told, we find eBay’s moat is wide and deep, and there may even be a crocodile or two in there. Qualitatively, the auction business is uniquely profitable; eBay leads in market share, and its brand is well known. And one can see these qualities expressed more tangibly in eBay’s consistent, high margins.
Disclosure: I, or persons whose accounts I manage, own shares of eBay at the time of this writing.
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