What is it about Amazon’s retail profitability that we just don’t get?

Discussion
Photo: Getty Images/MikeMareen
Feb 11, 2022

Through a special arrangement, presented here for discussion, is a summary of  Steve Dennis’ recent Forbes article. Steve is President & Founder of SageBerry Consulting and a senior Forbes Contributor. He is the author of  Remarkable Retail: How to Win and Keep Customers in the Age of Disruption.

If my Twitter and LinkedIn feeds are even a small indication, there remains a wide-spread belief that Amazon.com makes little or no money in “retail”, and that its wildly profitable Amazon Web Services (AWS) division continues to subsidize the company’s phenomenal e-commerce growth.

While true for many years, it certainly isn’t the case any longer. But it also speaks to the broader issue of comparing Amazon’s retail business on the basis of traditional retailer metrics. It’s time for a radical rethink.

Unfortunately, the way Amazon reports its earnings makes it difficult to glean the relative profit contribution of its various business segments. While AWS is clearly a huge and growing cash cow, even on a relatively simplistic segment analysis basis, it’s pretty likely that North American Retail is generating plenty of cash.

As Benedict EvansJason Goldberg and others have been pointing out, the largest, fastest growing and most profitable part of Amazon’s retail operations is its marketplace. Here, Amazon owns no inventory and receives a fat fee on the nearly $400 billion in GMV (gross merchandise value) it helps sell. Since third-party sales largely leverage the same fulfillment network as its first-party sales — where Amazon does in fact operate like a more traditional retailer — there is no way for outsiders to precisely determine relative profit margins. Given the escalating commissions and inventory-holding savings, it’s hard to imagine that Amazon would allow this part of its business to grow if it weren’t profitable.

But the big reveal in last week’s earning report was Amazon’s confirmation of the size of its advertising business. At over $31 billion, it’s now likely Amazon’s most profitable line of business. Critically, this business simply does not exist without retail. The size and growth of retail enables the massive profitability of advertising.

The idea of using one product line to help sell another is far from new. Polaroid sold cameras to make money on the film. Gillette sells razors to make money on blades. Costco still derives the vast majority of its earnings from membership fees, not selling products. And on and on.

Analyzing a typical retail business is pretty straightforward. With Amazon, not so much.

DISCUSSION QUESTIONS: What areas of Amazon’s business do you think are most lucrative and how is retail tied to its overall strategy? Can traditional retailer metrics be used to measure Amazon’s retail performance, and is there a point in trying?

Please practice The RetailWire Golden Rule when submitting your comments.
Braintrust
"I still have trouble viewing Amazon as a 'profitable retailer.' More like an e-commerce retailer with a wildly profitable side gig — advertising. "
"Even if you believe as some — I believe incorrectly — do, that “retail is a loser” for Amazon, retailing is at the core of all of Amazon’s profit engine."
"A company’s businesses units, especially one as large as Amazon, are measured by each unit’s contribution."

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23 Comments on "What is it about Amazon’s retail profitability that we just don’t get?"


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Neil Saunders
BrainTrust

From everything I have seen, I believe Amazon is profitable in retail. Maybe not wildly profitable, but profitable nonetheless. Of course, Amazon uses its retail business and its customer base to make profits in other areas – such as advertising. That is not unique; many other retailers like Kroger and Walmart have always made – and are now increasingly making – money from marketing opportunities which they sell to third parties. However at the end of the day, Amazon has always been willing to sacrifice some short-term profitability in favor of long-term innovation. Wall Street accepts that from Amazon much more than it does from many other retailers.

Rick Watson
BrainTrust

Doubling fulfillment capacity and doubling employee count in two years + generational COVID-19 expenses equals much larger than expected expenses. Many of them one-time.

In 2022, this will be reduced and too much is being made of this. The “retail” business just gets saddled with these expenses that are not really “operating the retail business.”

Lee Peterson
BrainTrust

I don’t think AWS “subsidizes” the rest of the company by any means, but any good merchant will tell you, diversify your assortment and you’ll survive a lot longer than if you don’t. So by even having that option, Amazon is proving they will be around for a long, long time. And if you don’t think having a broad range of services is important vs putting all your eggs in one basket, just check on Peloton — see how they’re doing.

Gene Detroyer
BrainTrust

Perfectly said. I don’t know any company with a better strategic plan for the future than Amazon.

Brandon Rael
BrainTrust

The Amazon Marketplace and their AWS offerings are a significant part of Amazon’s revenue and profitability metrics. However Amazon has recently revealed how sizable its advertising business model has become. Amazon said its advertising business is growing 32 percent and booked over $31 billion last year.

Amazon’s winning strategies include not being tied to the traditional retail metrics. Their rate of revenue increases, relentless diversification strategies, AWS, and now their advertising operating model is a winning combination. It is key to consider that advertising is still tiny by Amazon standards, according to the company’s earnings statement, representing 7 percent of total revenue in the fourth quarter. Advertising gives Amazon twice the revenue that physical stores do, and it’s more sizable than the company’s subscription services, including Prime memberships.

Doug Garnett
BrainTrust

I continue to doubt Amazon profit in retail-like sales. What’s not mentioned here is that North America includes digital content as well as Amazon devices – commonly sold in traditional retail and likely in huge volume.

But, suppose Marketplace makes up for vast losses in retail-like sales and is a huge portion of their ever growing billions dumped into shipping costs, it has taken them 26 years underwritten by investors and delayed payments to vendors. It remains an abuse of power to have done that to create AWS – a monopoly abuse of power. Amazon needs to face government action as a result.

Melissa Minkow
BrainTrust

Amazon competes with fast fashion retailers in its apparel business. Clothes are inexpensive, arrive quickly, and are on trend. I’m not surprised by the possibility that it does well – I’m hearing more and more people say they’ve bought apparel, at least, from Amazon recently.

Jeff Sward
BrainTrust

I still have trouble viewing Amazon as a “profitable retailer.” More like an e-commerce retailer with a wildly profitable side gig — advertising. And never mind AWS. The advertising creates enormous opportunities for Amazon. I once thought Google was in the “information” or “search” business. Until I heard Eric Schmidt say that they were flat out in the advertising business. I don’t view Google as a retailer, but they do a pretty great of leveraging the internet to make money in advertising.

Gene Detroyer
BrainTrust

Back in my day, the money retailers extorted for cooperation from vendors far surpassed the straight profit from the retail business itself.

Paula Rosenblum
BrainTrust
Well, we have to split retail into two parts: the marketplace (free money!) and its own goods. Then there are Amazon’s logistics services, but also the two sides of its fulfillment strategy — FBA (you sell it through the marketplace, Amazon fulfills it) or third-party Prime. FBA helps cover logistics costs, third-party Prime avoids them entirely. I suppose we have to think about Amazon Electronics as well, but they are a separate business unit to me. So — no, I don’t think Amazon makes much money on its OWN end-to-end retail operations. Will it ever? It seems the company has finally started adding more box sizes to its mix. For me, it’s quite simple. Ship less air and you’ll make more money. Whether it be your plane or someone else’s. Don’t forget, the price of gas is insane now. Will Amazon’s own retail operations ever be a big profit stream? I don’t think so. If Mr. Bezos owned less of the company, some enterprising investor would insist on breaking it up. But he owns enough… Read more »
Lisa Goller
BrainTrust

While we know Amazon as a B2C leader, it’s also a B2B powerhouse.

Selling digital ads, logistics services and its own tech (like Just Walk Out) to other businesses is lucrative. These B2B offerings elevate the retail game by connecting retailers and brands with omnichannel shoppers. Retail strategically helps Amazon reach the masses, shape consumer habits and modernize industry standards.

Traditional retailer metrics could be misleading, as we aren’t comparing apples to apples. Unlike its retail rivals, Amazon is a digital mastermind that happens to sell merchandise.

Nicola Kinsella
BrainTrust

A marketplace is always going to be more profitable than selling your own inventory.

In traditional retail, for every order, you have the cost of inventory, and the cost of fulfillment. And you don’t make money until you sell the inventory. In short, you make money once. Amazon’s marketplace model is far more lucrative. Why?

Because on orders “fulfilled by Amazon” they can make money four ways.

  • Advertising to promote items before they are sold;
  • Inventory storage fees before items are sold;
  • Referral fees when items are sold;
  • Delivery fees when items are sold.

And they make money even before an item is sold.

So is Amazon making money from their “retail business”? Absolutely.

Gene Detroyer
BrainTrust

I have always bristled at the use of the word “subsidize” explaining a company’s profitability. A company’s businesses units, especially one as large as Amazon, are measured by each unit’s contribution. If there is none now or projected in the future, that unit is spun off or closed.

Just because traditional retailers apply the same thought process and measures to Amazon doesn’t mean that Amazon is doing it wrong. They must understand the Amazon structure to determine Amazon’s profitably, if not they can not compete.

It is likely that AWS is hugely profitable. Every megabit of new business goes right to the bottom line. The advertising business is likely the same. What is happening at Amazon with adverting is no different than the fees retailers charge for price reductions, shelf position, promotional features and advertising itself.

Shep Hyken
BrainTrust

For Amazon, AWS is a BIG winner. Amazon’s retail business is more than selling merchandise. It’s about “partners” (resellers), warehousing, fulfillment, logistics, advertising and more. So, measurement compared to other retailers must be different. It’s not just sales of what’s “on the shelf” or the webpage.

Ryan Mathews
BrainTrust

I think we are judging computer chips as though they were potato chips. Amazon has a holistic, organic strategy where each individual business unit reinforces and expands the potential of the others. Even if you believe as some — I believe incorrectly — do, that “retail is a loser” for Amazon, retailing is at the core of all of Amazon’s profit engine. While it is perhaps not the most elegant metaphor Amazon is like a corporate slime mold. When an independent single mold cell has problems obtaining food, it sends out a chemical “signal” that attracts other slime molds which bond together forming a larger mass. So a single unit that can’t support itself suddenly is a much larger entity more likely to survive. And no, while traditional retail metrics can be used to measure Amazon’s retail strategy, they shouldn’t be. It’s a much different life form.

Gene Detroyer
BrainTrust

Your description is perfect. When I teach strategy, I teach dominoes. You might want to repeat it for retailers so they understand what real corporate strategy is.

Camille P. Schuster, PhD.
BrainTrust

Great points. There is a reason it is difficult to tease pit retail numbers. If you have an organic strategy you look at the business differently. I doubt if Amazon is losing money on retail, but their organic diversified strategy is definitely making money.

David Mascitto
BrainTrust

If we look at a basic transactional view of retail — buy inventory, market it, sell it, ship it, replenish, repeat — it seems that Amazon retail is a loss leader for its other businesses such as advertising and marketplaces. The retail side with low prices and free shipping is designed to drive traffic, and the traffic is what they sell to third-parties and make profit from. So, in the traditional sense of transactional retail, Amazon might not be profitable. But that’s by design. Is there any point in trying to measure their performance? From a retailer’s point of view, they have to come to the realization that they will not beat Amazon on price or shipping cost. They will need to find their unique value proposition to win and keep customers that goes beyond free shipping.

Craig Sundstrom
Guest

Much like with Facebook yesterday, my first thought here is “why should the retail community care? Is it really the business of anyone other than Amazon’s shareholders?”

One possible justification for concern would be if the retail component really isn’t profitable, it could be evidence of antitrust violations … predatory pricing (and indeed there is a whole school of thought that this is really Amazon’s raison d’etre: to put other retailers out of business and become a monopolist). But this is, needless to say, a complex question far beyond the scope of RW to answer even — and here I’ll have to disagree with Steve — for a “typical retail business” … let alone Amazon.

Rachelle King
BrainTrust

The interesting part is the connective tissue between retail and advertising. One may be more valuable because the other is more profitable. Tack on all their other business operations and it’s evident that Amazon is not a traditional retailer. There is little value in trying to categorize them as one.

Karen Wong
BrainTrust

Traditional retailer metrics aren’t really relevant in an omnichannel world to begin with. Attribution was a lot easier in a predominantly single channel world. In the case of Amazon, their digital businesses are so large, it’s less omnichannel, more omni-division.

The profitability of retail itself isn’t really a relevant metric by itself. As others have pointed out, using retail as a loss leader isn’t really new. Retail is core to Amazon because its success and profitability of business as a whole is built upon the growth of retail. All of its more profitable areas — AWS, ads and FBA — require retail to thrive.

Oliver Guy
BrainTrust

Amazon’s business model is very different from a traditional retailer. Many of the new retail models that Amazon pioneered (online, subscription, etc.) do not lend themselves to traditional measurement approaches.

When existing retailers attempt to replicate these models sometimes the measures do not change appropriately. A classic example of this is where online sales are measured and compared to store sales – this can drive the wrong behavior. Appropriate and balanced measures are key to ensuring the success of all ventures.

Robin Gaster
Guest

Amazon’s recent financials illuminate the reality that it’s not a standard retail business, where revenues from customers covers costs and profits.

Instead, it’s a complex web that built on four distinct revenue streams — customer revenues, Marketplace fees, Prime subscriptions, and Advertising. Those multiple streams let Amazon sell in retail often at below nominal cost, while still making a profit. Together, they cover the enormous lake of red ink generated by Amazon’s s own retail operations.

Other big retailers cannot match this — they don’t have Prime, they don’t have a working Marketplace at scale, and they don’t have a monster advertising business.

This new model is laid out in my article below, and in more detail in my book “Behemoth, Amazon Rising.

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Braintrust
"I still have trouble viewing Amazon as a 'profitable retailer.' More like an e-commerce retailer with a wildly profitable side gig — advertising. "
"Even if you believe as some — I believe incorrectly — do, that “retail is a loser” for Amazon, retailing is at the core of all of Amazon’s profit engine."
"A company’s businesses units, especially one as large as Amazon, are measured by each unit’s contribution."

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