Why Amazon is suddenly swimming in profit

August 8, 2016 04:45 PM

In the fourth quarter of 2015, Inc. posted a profit of $482 million, more than double its previous highest-earning quarter. In the two quarters since, profits continued to rise, to $513 million in the first quarter and $857 million in the second quarter. In the first six months of 2016, the company’s combined profit was $1.37 billion—no other half in Amazon’s history is in the same universe.

So after years of reporting little to no profit, Amazon is now posting record gains quarter upon quarter. At the same time, its expenses are growing faster—26.4% in the first half of 2016 versus 17.5% in the first half of 2015.

So what’s propelling Amazon into profitability? Let’s look at the numbers.

First, there’s revenue. Amazon’s compound annual growth rate from 2012 to 2015 was 20.5%.

That revenue is coming from several business lines, with the most coming from its North American e-retail business (60%), followed by its international retailing business (33%) and then Amazon Web Services (7%), its rapidly growing and highly profitable cloud computing business.

Digging into the North America retail business specifically, Amazon’s figures include revenue it generates on the sale of goods it sells directly to consumers, and the commissions it collects when merchants sell products through the Amazon marketplace. Commission rates vary by product type from 8% to 25%, with most product categories at 15%. In other words, for a $100 sale by a marketplace seller, Amazon collects $15.

The percentage of units sold by marketplace sellers on Amazon has been steadily rising. 49% of units sold worldwide on Amazon were by marketplace sellers in the second quarter, up from 45% a year earlier, Amazon says. Amazon does not break out percentage of marketplace sales by North America.

With an established selling platform, Amazon’s take on each sale is money it makes at small expense; Amazon made a margin of 4.3% on its North American retail business last year, up from 2.5% in 2014. For the first six months of 2016, Amazon’s margin was 3.7%.

Merchants are quickly adding SKUs to Amazon, the sales of which will pad Amazon’s margin. Marketplace merchants offered 372 million products for sale in the second quarter, up 22% from 304 million a year earlier, according to an assortment analysis from R.W. Baird & Co. senior analyst Colin Sebastian. In the second quarter marketplace merchants accounted for 92% of SKUs listed for sale on Amazon in North America, and 91% a year earlier.

Marketplace sellers are also adding supplemental services sold by Amazon along with those SKUs. The primary service is Fulfillment By Amazon, whereby merchants selling on the Amazon marketplace pay Amazon to store and ship their goods for them, and get their SKUs tagged as eligible for Prime shipping on Amazon. Amazon does not say how many merchants use FBA or break out its contribution to revenue, but Amazon chief financial officer Brian Olsavsky said earlier this year that 50% of marketplace goods sold in 2015’s fourth quarter were fulfilled via FBA.

Further, according to Baird figures, the number of Prime-eligible SKUS in the second quarter grew at a higher rate—23.4%—than the number of SKUs Amazon added during the quarter for direct sale from Amazon—13.7%—implying continued adoption and use of FBA by merchants.

Second, Amazon’s deepening entrenchment with U.S. online shoppers cannot be overstated. During the 30 days ended Aug. 7, received 110.9 million unique visitors—effectively one in three people in the United States—viewing 768.9 million pages. The next-nearest e-commerce competitor, eBay Inc., with 63.5 million, had about half as many unique visitors and 293.4 million page views. This data, coincidentally, is from web analytics firm Alexa Inc., a subsidiary holding of Inc.

Such visitors add up in dollars and cents, as Amazon is involved in a progressively greater proportion of U.S. e-retail sales. The total value of all goods transacted on Amazon sites in the United States, including its own goods and goods sold on its marketplace, was $112.8 billion last year, equal to 33.0% of all retail goods sold online in the United States. In 2014, it accounted for 29.2%. In one year’s time Amazon’s market share grew 3.8 percentage points with each customer, sale and commission contributing to its bottom line. This is on top of a 2.6 percentage point gain between 2013 and 2014.

Macquarie Research estimates say Amazon’s gross sales—sales made by Amazon and by other merchants selling on Amazon—in 2015 accounted for 24 cents of every $1 of retail sales growth. Within e-retail, it calculates that Amazon commanded 51 cents of every $1 in sales growth.

The accelerant fueling Amazon’s market gains is Prime, the $99 annual fee program that gets members fast shipping and access to a growing list of perks, such as video and music streaming, e-books, online storage and Prime-only products. When consumers join Prime, they tend to consolidate their online shopping with Amazon. Securities research firm Consumer Intelligence Research Partners LLC (CIRP) estimates Amazon has 63 million Prime members in the United States at the end of June, up 43% from 44 million a year earlier and a 16% gain from the 54 million CIRP estimated at the end of 2015. CIRP estimates Amazon Prime members spend an average of $1,200 annually with the e-retailer.

Speaking earlier this year, Amazon founder and CEO Jeff Bezos described Prime as a physical-digital hybrid program “unlike anything else.”

“Prime members, once they pay the annual fee, [think] how can I get more value out of the program,” Bezos said. “So they look across more categories, they shop more. A lot of their behaviors change in a way that is very attractive to us as a business.”

“With Amazon Prime in so many American households, when you have a choice of buying online from Amazon or from someone else, when with Amazon you can get it shipped in two days, you are going to go that route,” says Marshal Cohen, retail industry analyst with NPD Group Inc.

Amazon’s pervasiveness and its outsized role in U.S. shoppers’ online shopping habits is evident from the results of the Internet Retailer 2016 Online Shopping Survey, which 535 U.S. adult online shoppers took online in late April. 94.5% of consumers who are frequent online shoppers (placing at least two orders online a month) say they are Amazon customers, and 71.0% report access to a Prime membership. Further, 54.8% of frequent shoppers say they made 51% or more of their online purchases over the past 12 months on Amazon. Factor in Prime membership, and 63.6% of frequent shoppers say they made 51% or more of their online purchases over the last year on Amazon.

Wall Street appears pleased with the way Amazon’s is developing its profit formula. After reporting an $857 million profit in the second quarter—its highest ever— Inc.’s market capitalization surged to $365.2 billion, making Amazon the fourth-largest public company in the United States. It trails Apple Inc., Alphabet Inc. (Google) and Microsoft Corp.

Amazon is the No. 1 e-retailer in Internet Retailer’s just-released Global 1000, which includes data and analysis about online retailing’s power players.




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