Some companies have a small clientele and a huge capacity for making money. Others have an enormous customer base coupled with a long-term plan that goes beyond making as much money as possible as quickly as possible. Amazon.com Inc. (AMZN) is unusual among the largest companies in the United States ranked by market capitalization, in that its profit margins are tiny, but its stock is phenomenally expensive. For years and years, Amazon lost money without apology.

Predating even its contemporaries eBay Inc. (EBAY) (founded 1995) and Google Inc. (GOOG) (1998), Amazon opened for business in 1994 in a small West Coast office with a skeletal staff and a tight budget. Since then the company has focused on growth almost exclusively, showing just enough profit to keep shareholders happy. The existing ones should be ecstatic: the stock trades at more than 500 times earnings. Large short-term payables are a necessary part of Amazon’s business model, meaning that the company’s book value is somewhere south of $10 billion, barely one-twentieth that of America’s biggest banks and petrochemical corporations. (For related reading, see What's At Stake As Google Takes On Amazon.)

It’s hardly worth mentioning that Amazon founder Jeff Bezos, the only chief executive officer the company has ever had, loves and lives to defy convention. If he didn’t, Amazon would be an unremarkable bricks-and-mortar bookstore in downtown Seattle, rather than the one company most responsible for the demise of that type of business.

Revolutionizing Retail

Amazon seems to be the one company most beholden to the idea of trying something novel and worrying about its impact on finances later. In Bezos’s own words, “nothing gives us more pleasure at Amazon than ‘reinventing normal.’” The company breaks even on Kindles, instead making money on the content delivered to each unit. Amazon does this while simultaneously revolutionizing the way books are read, no less – turning them from fragile physical objects into easily transportable digital files.

Take Amazon’s unmanned drone experiment, which is still in the research-and-development stages. If it succeeds, not only will Amazon make the idea of two-day delivery sound glacial, the company will do the impossible – attach a positive connotation to the word “drone.” Amazon recently introduced grocery delivery (in the San Francisco, Los Angeles and Seattle areas) for $300 annually, apparently undaunted by the profound failure of that venture when attempted by others in the late 1990s. Will it be sustainable this time around? If any company is qualified to answer that question, it’s the one that popularized annual flat-fee delivery for non-perishable items in the form of its Amazon Prime membership program. “I already paid, I might as well order some more stuff” is the rallying cry of Amazon’s best customers.

Primed For Profit?

For a literal answer to the question “How does Amazon make money,” it’s not that simple. Revenue is one thing, profits (on famously low margins) something else. Last year’s $274 million in net income came from incalculable little sources: a pillow sham here, a pair of pumps there (in 2009, Amazon purchased Zappos.com). But perhaps Amazon’s most profitable endeavor to date is something blessedly low-tech – the one-price shipping (and related benefits) of Amazon Prime. (For more on this topic, see Is Amazon Prime Still The Best Deal In Tech?)

For the unfamiliar, buying a Prime subscription includes access to digital content unavailable elsewhere – TV shows watchable on certain versions of the Kindle, for instance. In a world in which certain services couldn’t subsidize others, Amazon would be losing money on such an offer. According to a Time magazine report, the average Prime subscriber gets $55 worth of shipping and $35 worth of digital content for the $79 price. The math doesn’t appear to work out.

Why 244M Customers Just Isn't Enough

To quote David Letterman, “We lose money on every sale, but we make it up in volume.” Well, Amazon actually does. That average Prime customer is costing the company $11 a year, but in return is buying an extra $719 in merchandise when compared to the average non-Prime customer. It’s $1,224 annually for the former, $505 for the latter, and even with Amazon’s slim profit margins that’s still money in the bank. At least one analyst believes that the correlation between Prime price and money subsequently spent is perfectly inverse, and that if Prime were free, Amazon’s creative devastation of the physical retail realm would accelerate. The company claims at least 20 million of those high-volume Prime customers, an ever-growing proportion of the whole. Which, by the way, is 244 million customers. That total likely makes Bezos cringe – after all, it means 97% of the planet isn’t buying from Amazon.

The Bottom Line

Apple has the celebratory product releases and slavish devotion. Google has the ubiquity, its tentacles all over our online lives. But only Amazon is the company that – more than any other – redefined commerce for a world no longer content to shop in person when there’s no compelling reason to do so. Leveraging itself into a position of market dominance, Amazon has done so to the extent that it’s now practically synonymous with online retail. With unparalleled convenience and famously receptive customer service, Amazon seems bound to continue its prosperous growth in its third decade of existence and beyond.

Related Articles
  1. Investing News

    How Merck Found Its Way Into Millions Of Medicine Cabinets

    With over $40 billion in revenue from pharmaceutical sales, there's a good chance that you'll be very grateful for one of Merck & Co.'s drugs some day.
  2. Investing News

    This Company Is No Mickey Mouse Operation

    With its famous history that's become part of popular culture, and the instantly recognizable silhouette in its logo, The Walt Disney Co. is only an animation studio in the same way that Johnson ...
  3. Investing News

    What's At Stake As Google Takes On Amazon?

    Google's decision to go head-to-head with Amazon with a new same-day shopping service isn't just about cheap Cheerios, coffeemakers, and clothing.
  4. Investing News

    This Company's Dividend History Is The Real Thing

    Take water. Add some sugar, a little carbon dioxide and some flavoring. Sell at a gigantic markup. It sounds almost too simple to work, and yet Atlanta-based Coca-Cola Co. has remained a staple ...
  5. Investing News

    Is Amazon Prime Still The Best Deal In Tech?

    If you asked that question a week ago, when Seattle-based Amazon.com, Inc. (Nasdaq:AMZN) raised its annual fee for Amazon Prime to $99 from $79, you might have heard a far different answer.
  6. Investing

    What’s Holding Back the U.S. Consumer

    Even as job growth has surged and gasoline prices have plunged, U.S. consumers are proving slow to respond and repair their overextended balance sheets.
  7. Economics

    The Problem With Today’s Headline Economic Data

    Headwinds have kept the U.S. growth more moderate than in the past–including leverage levels and an aging population—and the latest GDP revisions prove it.
  8. Economics

    Explaining Market Penetration

    Market penetration is the measure of how much a good or service is being used within a total potential market.
  9. Economics

    Calculating the Marginal Rate of Substitution

    The marginal rate of substitution determines how much of one good a consumer will give up to obtain extra units of another good.
  10. Personal Finance

    A Day in the Life of an Equity Research Analyst

    What does an equity research analyst do on an everyday basis?
RELATED TERMS
  1. Substitute

    A product or service that a consumer sees as comparable. If prices ...
  2. Equity

    The value of an asset less the value of all liabilities on that ...
  3. Fast Fashion

    Definition of "fast fashion."
  4. Securities-Based Lending

    The practice of making loans using securities as collateral. ...
  5. Duty Free

    Goods that international travelers can purchase without paying ...
  6. Negative Option Deals

    A dubious business practice that involves supplying a typically ...
RELATED FAQS
  1. Are Social Security payments included in the US GDP calculation?

    Social Security payments are not included in the U.S. definition of the gross domestic product (GDP). Transfer Payments For ... Read Full Answer >>
  2. What is the difference between called-up share capital and paid-up share capital?

    The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
  3. Why would a corporation issue convertible bonds?

    A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>
  4. How does additional paid in capital affect retained earnings?

    Both additional paid-in capital and retained earnings are entries under the shareholders' equity section of a company's balance ... Read Full Answer >>
  5. What types of capital are not considered share capital?

    The money a business uses to fund operations or growth is called capital, and there are a number of capital sources available. ... Read Full Answer >>
  6. What does marginal utility tell us about consumer choice?

    In microeconomics, utility represents a way to relate the amount of goods consumed to the amount of happiness or satisfaction ... Read Full Answer >>

You May Also Like

COMPANIES IN THIS ARTICLE
Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!