The Other Box - The Diff

In this issue:

  • The Other Box
  • Revenue and Recognition
  • Evergrande Continues
  • Pensions Get Saner
  • NFTs: Fundable
  • The "Forever CEO"

The Other Box

Marc Levinson's The Box is a wonderful book about the global impact of the shipping container, whose invention and deployment basically led to a unilateral global tariff cut. This enabled much more complicated supply chains (the tariff cut had a disproportionate effect on multi-step processes where each step is most economical in a different location), and basically created the modern global trade system. At the other end of the supply chain, there's another kind of box, and it's going through its own boom right now.

If container ships are a tax cut for business-to-business shipping, the cardboard box is a tax on e-commerce over in-store purchases. If a product is on a shelf, it may or may not be in a box, but if it's being delivered to the customer, it's almost always in another box. So growth in e-commerce has meant growth in box shipments. Both International Paper and Westrock, two of the largest publicly-traded box makers, are still reporting mid-single digit year-over-year increases in boxes sold per day, even though the comparable period last year includes the beginning of the great Covid-induced e-commerce boom.1

Via this WSJ article, which has more on the shortage from earlier this year.


In one sense, e-commerce is a successful way to dematerialize shopping—replacing a physical store with a website, and thus replacing one store trip per purchase with one delivery truck trip that will deliver many purchases—the actual delivery is being rematerialized, with packaging.

Packaging sets up an interesting tradeoff for companies that are weighing curbside and delivery. In one sense, they can be fairly agnostic, since the marginal profit from selling more products probably swamps the margin-improving effects of pricing things differently based on how they're shipped. In one sense, it gives stores a way to choose between labor inflation and materials inflation: having employees pick up goods in the store and walk them to the customers' cars increases the worker-hours required to generate a given amount of revenue, but delivering those goods directly means that the cost of boxes (and gas) hit the seller. Secular trends in commodity prices are hard to bet on, but a labor price reset is plausible—ironically, some of this is driven by Amazon's voracious demand for fulfillment workers, which has pushed up starting wages in other industries, meaning that one effect of Amazon is to make brick-and-mortar companies focus more on e-commerce than on physical stores, at exactly the same time that Amazon is moving in the opposite direction.

One interesting feature of boxes from an ESG perspective is that, while making them involves cutting down trees, long-term demand trends actually lead to trees planted today. So a one-time increase in box consumption will lead to net emissions, since it raises the value of harvesting timber relative to keeping the trees, but expectations for higher long-term demand increase the returns from planting more today. This is especially attractive to companies that consider ESG a temporary trend; they get credit in 2021 for sequestering carbon, even if their plan is to release it by selling more boxes to Amazon in 2031.

And the big box companies do seem to be thinking this way: Westrock recently told investors that the Covid bump was turning into a secular trend towards higher cardboard box consumption, and International Paper is spinning off its office paper business to focus more on selling boxes.

Packaging comes at an interesting point in the customer interaction, especially for Amazon. Up to the moment of delivery, Amazon is the primary owner of the customer interaction: the product search happened on their site, Amazon accepts the payment, the buyer is probably a Prime customer, and the product itself generally sits in an Amazon-owned warehouse until Amazon logistics delivers it—in an Amazon-branded box—to the customer's door. But from the point that they open the box, that customer is seeing the seller's logo, not Amazon's, which means that the box is Amazon's chance to make a last impression.

Amazon thinks about this in two ways:

  1. The company increasingly uses the boxes as ad inventory, for Amazon in general or to promote new Prime Video releases, special offers, etc. Amazon delivers four billion packages per year, or about 4% of the total US volume of junk mail each year; since direct mail is a roughly $10bn business, this implies that their ad inventory from boxes alone is worth something on the order of $400m per year. But, unlike regular direct mail, Amazon's boxes will at least be looked at before they're thrown out.
  2. Because Amazon's boxes are a cost center, they spend a fair amount of effort making them cheaper. This sometimes includes working with retailers to come up with more efficient packaging, and sometimes just means using less material. In fact, one of the in-house ads Amazon runs points to, a section of their site devoted to showcasing how much material they've saved through more efficient packaging.

The cardboard box is a microcosm of several economic trends: the incremental margin pressures that face companies expanding into a lower fixed-cost business model; the ripple effects of tech on more smokestack-oriented parts of the supply chain; the nonlinear effects of measuring the environmental impact in one year of decisions that have a long-term effect; and, of course, Amazon's allergy to a) paying more than it needs to for anything whatsoever, and b) doing any business activity that cannot, in some way, be converted into a revenue generator.

Disclosure: I own shares of AMZN.


Revenue and Recognition

Stripe has launched its revenue recognition product, allowing companies to see their business on an accrual rather than cash basis. I try to think about my business on an accrual basis, but run my life on more of a cash basis (rent is paid out of this month's cash flow, not this month's recognition of last month's annual subscription), and I suspect many other business owners are in the same boat. Actually doing accrual accounting is challenging. What's especially interesting about this product from Stripe is that it's priced at 0.25% of payment volume, with a discount for higher spending. Doing accounting right makes a business more fundable, with both debt and equity, so Stripe Revenue Recognition users should have higher dollar retention for Stripe than other customers. This pattern—pricing a product so it benefits from customer growth, and building products that accelerate customer growth—shows up a lot in the highest-growth companies (I mentioned it in Tuesday's Gitlab writeup, too). And it's increasingly common because it works.

Disclosure: I have many friends at Stripe, and Stripe is publishing a book I'm working on. Also, Stripe processes payments for The Diff.

Evergrande Continues

Michael Pettis has some thoughts on what comes next for Evergrande, with an emphasis on how urgent the problem is and where the contagion could spread:

Potential homebuyers, for example, frightened about what they read in the news, are becoming reluctant to close on homes, resulting in an already sharp decline in home sales. What is more, they are likely to refuse to prepurchase unfinished apartments or put down deposits, except at large discounts, thereby squeezing liquidity and raising financing costs for the developers... At the same time, sales agents and other employees are likely to be highly distracted during working hours, worrying about their employment prospects and in some cases the loss of their savings in wealth management products. Such circumstances can cause a sharp decline in labor productivity. What’s more, contractors have been suspending construction work until their payment prospects have been assured, while suppliers, similarly, are less willing to accept commercial paper as payment for their deliveries. The result, as Evergrande has already announced, is that construction projects are rapidly falling behind schedule.

Part of what made property development in China such a high-growth business was that it had a favorable cash cycle: companies got paid in advance for apartments they'd deliver when complete. But this kind of cash cycle becomes pathological when the business is challenged: their only opportunities are to either give up or grow their way out of the problem, and given the unpredictable consequences of business failure in China, a small shot at recovery often looks like a reasonable risk to executives.

It's possible that Evergrande realized it was insolvent well before the current problems, and that its late-stage growth was a desperate effort to keep cash coming in. The opaque economics of the business will make that hard to determine both now and after the fact (unlike in US collapses, there probably won't be legal cases that painstakingly document what went wrong and, as a side effect, provide abundant primary source material for anyone who wants to write a good book). But the facts fit that narrative: there were Evergrande skeptics for years, but the company's problems only started getting serious when regulators started requiring property developers to dramatically curtail leverage and growth.

An interesting further consideration on Evergrande's incentives: given how weak China's banking system is and how dependent on real estate the country's economy is, Evergrande is a problem that the state would strongly prefer goes away on its own rather than being painfully shut down. So in a sense Evergrande has done what many savvy companies do: achieved lock-in from other parts of its supply chain, so it's hard to displace.

Pensions Get Saner

More public pensions are lowering their expected return calculations in light of outperformance in the last year. This reveals something important about asset allocation. In theory, a pension's expected rate of return is an output: start with a portfolio that's safe enough to deliver on the pension's promises, estimate the return from its various assets based on the current risk-free rate and historical outperformance thereof, pad the number a little bit to be safe, and you have an expected return. In practice, it's an output of a different calculation: figure out what expected rate of return avoids the need for a tax increase, figure out what the likely range of returns is based on whatever collection of risk assets would lead to this rate of return on average, estimate how long everyone involved in the rate-of-return decision is expected to stay in their job, and, as long as the worst-case financial outcome is probably further in the future than the median job switch, keep assumed rates of return high so the pension doesn't need additional outside funding.

The truth is somewhere in the middle; total cynicism isn't action-guiding in a world where pension managers could make more money in the private sector, but idealism is incompatible with election cycles. Since assets have outperformed and property taxes have gone up, states are at a point where they have far fewer worries about raising taxes to fund their pensions, which lets them be more realistic about what kinds of returns they can expect when real rates are close to zero and equities have had a nice run.

NFTs: Fundable

Two companies involved in the non-fungible token space announced funding rounds yesterday: Dapper raised $250m and Sorare raised $680m. Both companies have exclusive relationships with athletic leagues, and together they imply that the fairly new market for digital equivalents to baseball cards is worth far more than the century-old market for actual baseball cards, at least to the companies that sell them. The high value for NFT companies echoes some of Coinbase's earlier funding rounds, when investors weren't entirely sure they understood crypto but were definitely willing to invest in it once they could do so through a business that had a more conventional P&L and recognizable metrics.

The "Forever CEO"

The FT highlights the trend of longer tenures for CEOs of big investment banks ($). For the ones who lasted the longest, one way to look at it is that there isn't much that's more dangerous for a bank CEO's track record than a financial crisis, so if they weren't getting fired from 2007-2009, they're probably sticking around until retirement. But the article has another clue:

[Former Citi CEO Sandy] Weill has said the reason Dimon left Citi in acrimonious circumstances was that he was impatient to be elevated to the top role. “The problem was in 1999 he wanted to be CEO and I didn’t want to retire,”

Perhaps in the post-crisis environment, when banking rules got stricter and leverage went down, more of the ambitious employees decided to leave for the buy-side and for other industries. And while losing high-variance people can be a problem, it means that many of the senior executives who would have been angling for the CEO's job have already left.

This is "per day" because their results move around a bit based on the number of shipping days in the quarter. Those overall shifts aren't material, but a one day increase or decrease affects the growth rate by more than a percentage point, so they typically adjust to give a cleaner look at business trends.

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