Watch Your Back, Amazon: Sears Could’ve Eaten Your Lunch

Even in the best of times, the retail cycle is cruel. Margins are tight, discounts can tempt even the most loyal shoppers and chain after chain has destroyed itself grabbing more market share than it could profitably handle.

In other words, defeat emerges from the jaws of victory with shocking regularity. The situation makes the impending death of Sears (NASDAQ:SHLD) the perfect time to gauge the prospects for Amazon (NASDAQ:AMZN) to grow into its market capitalization before the cycle spawns the next generation of retail competitors.

After all, Sears should’ve been Amazon. And for over a century, it was Amazon. Strip away the dot-com-era origins and Amazon was always a catalog retailer, mailing a wider range of merchandise to consumers than any local market could support on its own. That was the original Sears Roebuck business model.

At its peak, Sears accounted for what was then a gigantic 2 percent of a much more fragmented U.S. retail landscape that was made up of independent outlets and the occasional regional chain. The ability to serve scattered demand from a central inventory was the key to its success — even if a town supported a general store, the catalog model let the company sell more specialized merchandise across the country.

In short, the catalog provided pre-Internet Americans access to something like the “long tail” of niche inventory that helped Amazon overwhelm brick-and-mortar bookstores that just weren’t big enough to stock every title the local market wanted to see.

But adding up niches just wasn’t enough to keep Sears ahead of the core categories that every American consumes: fresh food, personal care products and housewares. This is the kind of stuff people tend to buy locally. It’s why supermarkets and drugstore chains remain such a vibrant part of the economy even as Amazon carves up the mall, store by specialty store.

Not coincidentally, it’s how Walmart (NYSE:WMT) led Sears to forsake its catalog model and ultimately choke on its own sprawling brick-and-mortar presence. If Sears brought the biggest department store in the country to everyone’s mailbox, Walmart built that store on the outskirts of every population center it could capture.

The inventory wasn’t initially as extensive as the complete Sears catalog, but it was enough to provide instant gratification. In contrast, the catalog orders could take 4-6 weeks to deliver. Even better, Walmart was cheap. Sam Walton’s vision was to build enough scale to crush all of his competitors’ margins. In that fragmented landscape, there were a lot of fragile competitors to crush.

Walton’s vision even forced Sears into the strategic error that would eventually kill it — and which Jeff Bezos should be watching now. To fight the big box, Sears moved as much of its catalog as possible into brick-and-mortar stores of its own. By the time Eddie Lampert got involved, Sears was already as much a real estate play as a retail chain. Now, the real estate is practically the only thing left.

Amazon’s margins are razor-thin as it is. Three years ago, Jeff Bezos managed to squeeze a 12 percent profit out of product sales. Since then, his slice of the retail universe has roughly doubled. However, chasing new categories has cut that profit margin in half. Amazon actually earned $300 million less on retail in the recent quarter than it booked in 2015, despite generating $17 billion more in gross sales.

That might be a full-spectrum competitor killer someday but in the here and now, I’m not convinced that this strategy can allow Amazon to grow fast enough to conquer the world. On its current growth ramp, the retail end of the business might reach a lofty $1 trillion by 2022, at which point it might generate $50 billion a year in profit, leaving behind many massacred retail rivals in its wake.

But getting there means assuming Bezos will capture a huge slice of what’s now a $6 trillion U.S. consumer marketplace. While it’s not a ridiculous proposition — I’ve made my Turbo Trader subscribers a lot of money buying the extremes of enthusiasm — it makes a lot of assumptions about competitors leaving the goal undefended for years to come as Bezos keeps racking up the strategic score.

What’s a whole lot more likely is that Bezos will get bogged down building local Amazon stores, especially grocery stores, where margins are notoriously even thinner than in general merchandise. Even his acquisition of Whole Foods Market, one of the most profitable grocers around, was still a drag on the overall Amazon bottom line, and that’s saying something.

After all, if Amazon manages to keep 5 percent out of its retail activities, hyper growth on that side of the company might justify a $1.5 trillion market capitalization four years from now. A more realistic scenario has that growth curve level off as consumer tastes change. In that event, I’m more than half convinced Jeff Bezos’ behemoth is roughly fairly valued here at 100 times earnings today, and possibly a 20-times earnings multiple if you’re looking out beyond 2022. There just isn’t enough blue sky for the company to capture.

And in the meantime, Sears will go down in history still running on a 16 percent margin even in bankruptcy: a one-time catalog retail operation that was once three times as profitable as Amazon is today but ended up being doomed by the weight of old-fashioned brick and mortar.