How Big Tech’s Earnings Are Inflated by Other Tech Companies - WSJ

Big Tech companies report inflated earnings because other tech firms' purchases of cloud services, chips, and software boost their revenue and profit. This circular ecosystem distorts earnings ratios analysts use to evaluate management performance.

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Teaching notes are auto-generated. Worth a fact-check before class.

Why this matters

The Big Tech ecosystem—Meta, Google, Apple, Amazon, Microsoft, and Nvidia—are deeply interconnected. These companies buy each other's products: Amazon uses Google and Microsoft cloud services; Meta buys Nvidia chips and AWS infrastructure; Apple buys from multiple suppliers in the circle. When Company A sells to Company B, Company A records revenue and profit. But if Company B then sells to Company C, and Company C sells back to Company A, the same dollar gets counted as "earnings" multiple times as it bounces around the ecosystem. This inflates the profit figures that appear on financial statements and distorts the ratios (like net profit margin or return on assets) that investors and analysts use to judge whether management is running the company well. A student reading earnings reports might think a company is thriving, when in fact much of its profit comes from selling to other tech giants rather than to genuine external customers.

Key points

Big Tech companies buy from each other heavily; when one sells to another, it records revenue and profit, inflating reported earnings.
Earnings ratios (net profit margin, return on assets) used to evaluate management look better when they include these internal-ecosystem sales.
An analyst comparing Big Tech's true customer demand must adjust for circular revenue to see which company is genuinely profitable.
Management's effectiveness is harder to assess when earnings include inflated revenue from other tech firms rather than organic customer growth.

Key terms

earnings: The profit a company reports on its income statement after subtracting all expenses from revenue.
net profit margin: A ratio calculated by dividing net income (profit) by total revenue; it shows what percentage of every dollar of sales becomes profit.
return on assets (ROA): A ratio calculated by dividing net income by total assets; it measures how efficiently a company uses its property, equipment, and other resources to generate profit.
revenue: Money a company brings in by selling products or services to customers.
financial ratio: A mathematical comparison of two numbers from the income statement or balance sheet, used to evaluate a company's financial health and management performance.
ecosystem: A network of interdependent companies that buy from and sell to each other, often in the same industry.

Discussion prompts

01
If 30% of Google's reported revenue comes from Amazon and Meta buying cloud services, does that mean Google's management is 30% less effective than it appears?
Answer: Not necessarily—but it does mean the earnings ratio overstates real external demand. Students should recognize that a high profit margin could reflect captive sales rather than genuine market strength. The key is separating organic customer growth from circular revenue to judge whether management is truly winning in the marketplace.
02
How would you restate Big Tech's earnings ratios if you excluded all sales to other Big Tech companies?
Answer: Students should subtract each company's sales to other Big Tech firms from reported revenue, recalculate net profit (which also falls because cost of goods sold drops), then recompute net profit margin and ROA. The adjusted ratios will be lower, revealing that management's true operating performance is weaker than reported figures suggest.
03
Why might investors or lenders care about adjusted earnings that strip out internal tech-sector sales?
Answer: Adjusted earnings show real earning power independent of the closed loop. Investors and lenders want to know if a company can survive and grow without relying on other tech firms' spending. A company with low adjusted earnings but high reported earnings is riskier and less impressive from a management-performance standpoint.

Bringing it to class

Start by drawing a simple circle on the board with five or six company names. Draw arrows showing purchases: Google → Amazon (cloud), Amazon → Nvidia (chips), Nvidia → Meta (hardware). Now ask: 'If these same dollars bounce around the circle, are they being counted multiple times in "earnings"?' Then show a hypothetical: Company A reports $100M revenue and $30M profit (30% margin). But $40M of that revenue came from Company B, and Company B only buys because Company A is its customer too. Erase that $40M and the $12M profit it generated—suddenly the margin is only 30% of $60M, or 18% true margin. This gap between reported and adjusted ratios is the teaching moment: earnings ratios can deceive if you don't ask 'where did this money actually come from?'