Amazon is not a retail business – at least more
Amazon (NASDAQ: AMZN) is practically synonymous with online retail. A growing majority of Americans are starting their online shopping searches on Amazon.com. He recently made a big expansion into the brick and mortar world with the purchase of Whole Foods Market.
But comparing Amazon’s activity to Wal-Mart Stores (NYSE: WMT) or other big retailers don’t do it justice. In fact, the brand of the type of business Amazon is completely missing.
Understanding Amazon’s business is important for investors to assess its decisions like its purchase of Whole Foods or its reported delivery service.
Amazon is not a retail business. It is a service company. And the key to Amazon services is that Amazon is its biggest customer.
A summary of Amazon services
- Amazon Web Services: AWS is the cloud computing division of Amazon. While trying to build its own infrastructure, Amazon realized that it could also offer Infrastructure as a Service (IaaS) to other businesses and that it is now the most profitable business. from Amazon.
- Fulfilled by Amazon: Fulfillment by Amazon allows small merchants to utilize Amazon’s warehouse capacity, order fulfillment operations, and its customer service team. Fulfillment by Amazon was born out of the growth of Amazon Marketplace, the fixed-price online marketplace that allowed third-party merchants to sell items on Amazon. Amazon’s takeover of operations enabled it to provide a better customer experience for buyers as well as address issues faced by merchants.
- Amazon Prime: Prime is Amazon’s loyalty membership program, which started off with a plan for a two-day expedition. Amazon has gradually added more and more benefits to the program, such as video and music streaming, free eBook rental, exclusive products, etc. With the acquisition of Whole Foods, Prime will also become the grocery chain’s loyalty program.
- Amazon Prime Video: A video-only Prime offer available in markets without Prime shipping benefits as well as in the United States.
- AmazonFresh: AmazonFresh is Amazon’s online grocery ordering and delivery service. Deployment of the service has been very slow, reaching only a few cities in the decade since its initial launch.
- Amazon Advertising: Amazon’s digital advertising platform to sell more products, increase online traffic, and / or increase app downloads. The platform quietly morphed into one of the largest online advertising companies in the world.
- Amazon Pay: A system that allows other online merchants to authenticate customers and use the shipping and payment information saved on Amazon to quickly pay.
- Amazon Kindle Store: Amazon’s e-book store integrated into all of its Kindle devices.
- Amazon Music and Amazon Video: Amazon digital media stores to download movies or music for devices like Fire TV or Echo speakers.
- Amazon Unlimited Music: Amazon’s subscription music service. There is an Echo-only option at a low price.
- Amazon Prime Air: Amazon’s experimental delivery service, in which it is developing a network of piloted and unmanned freight carriers.
Amazon becomes its biggest customer
Amazon uses the same cloud computing infrastructure as its AWS customers. It uses the same warehouses, shipping and fulfillment capabilities as FBA users. Most of Amazon’s advertising offering comes from Amazon itself. Amazon uses the payment processing software behind Amazon Pay for every transaction on its websites.
It’s more than just vertical integration, however. Apple (NASDAQ: AAPL) did a great job using the vertical integration of design (chip design and internal software), production (having its own labs), retail and customer service (the Apple Store). But Apple’s efforts are aimed at supporting its own products.
Amazon, on the other hand, is developing services for itself and then expanding them to the rest of the market, even its competitors. These markets are also generally massive. In this way, Amazon has an integrated demand for its products (itself), which allows it to instantly reach scale and offer competitive prices.
Put in context
If we look at Amazon as a customer, the acquisition of Whole Foods was not an expansion into brick-and-mortar retail. It was an extension of AmazonFresh.
Whole Foods will become AmazonFresh’s biggest customer.
AmazonFresh could potentially provide food delivery to many small grocers across the country, helping them compete with big national brands like Wal-Mart. It would also give Amazon the scale it needs to be economical to deliver groceries right to people’s doors.
Likewise, Amazon’s efforts to develop its own delivery service aren’t just a way for Amazon to lower its fulfillment costs. Amazon will become a full competitor for UPS (NYSE: UPS) and FedEx (NYSE: FDX). Amazon is already one of their biggest customers, so it instantly grows. It can sell any excess freight capacity to other retailers at competitive prices.
Amazon Prime Video – a video streaming service available worldwide – arises from unused global rights for many video content on Amazon Prime (Amazon Prime Video’s biggest customer). This has been wasted in markets where Amazon lacks the infrastructure to support core Prime benefits, such as fast shipping. The opening of the video service globally has allowed Amazon to price the service below Netflix while producing marginal profit.
Why investors need to see Amazon through a service lens
There are a few major implications of viewing Amazon through a service lens.
First, the profit margin on services is generally higher than on retail. Wal-Mart’s operating margin last year was only 2.8%. Even UPS and FedEx – services with relatively high operating expenses – posted operating margins of 9% and 8.4%, respectively. Netflix’s contribution margin in the mature US market was 36.2%.
Amazon’s AWS generated an operating margin of 30.3%. The company’s retail operations in North America and abroad generated operating margins of 5.1% and -1.1%, respectively. If other services can reach their potential scale like AWS, the profit potential is clear.
Second, as a service company, Amazon’s addressable market is much larger than global retail. Amazon is also present in the cloud computing market, the digital advertising market, the parcel delivery and fulfillment market, and the digital media market. These markets are all huge.
Viewed from a services perspective, Amazon’s market capitalization of around $ 470 billion – one of the largest companies in the world – makes sense. This is one of the reasons it is worth more than virtually all of the other major retailers combined. Amazon is not just their competitor; they could possibly be Amazon customers.
This article represents the opinion of the author, who may disagree with the “official” recommendation position of a premium Motley Fool consulting service. We are heterogeneous! Challenging an investment thesis – even one of our own – helps us all to think critically about investing and make decisions that help us become smarter, happier, and richer.