Amazon.com Inc. (AMZN), the world’s largest online retailer, is rapidly growing in a broad range of businesses under founder and CEO Jeff Bezos, including its core e-commerce operations, cloud services, digital advertising, groceries, and prescription drugs. It also sells Amazon products such as the Alexa personal assistant and ecosystem, and movies through its Amazon Prime Video platform.

Amazon ranks as one of the world's top companies by market value. Though the company was briefly valued at nearly $1 trillion in 2018. At the start of 2019, when Amazon released its 10-K and Annual Report, it had a market capitalization of $755.7 billion.

The company's net income more than tripled last year from $3 billion in 2017 to $10.1 billion in 2018. This income growth was powered by a 31% gain in revenue, from $177.9 billion in 2017 to $232.9 billion in 2018. Amazon has a current ratio of 110%, and an after-tax return on equity (ROE) of 23%.

Key Takeaways

  • Amazon makes money through its retail, cloud service, and digital ad service businesses.
  • In 2018, Amazon made $7.2 billion in domestic sales, while losing $2.1 billion in international sales.
  • Amazon Web Services (AWS), Amazon's cloud service, generated nearly $7.3 billion in operating income in 2018, more than half of Amazon's total.
  • Amazon Advertising Services, one of company's fastest growing businesses, sold $10.1 billion in 2018.

The Business Model

So, Amazon is making money – a lot of it. How? The short answer is sales. Amazon sells a lot of things – and services – to consumers and vendors. It's known for using its low expense structure to beat competitor prices, build market share, and dominate a business.

Amazon’s E-Commerce Business

Amazon is dominant in retail e-commerce, accounting for nearly 50% of all online sales in the U.S. in 2018, per eMarketer, generating $207 billion from retail operations in the U.S. and abroad.

But Amazon's e-commerce unit doesn't just make money from selling directly to consumers. It also makes money selling services and access to its platform to vendors and content creators.

Amazon is building out its branded product businesses, including Kindle e-readers, Fire tablets, Fire TVs and Alexa suite, the personal assistant driven by artificial intelligence. The company also produces and sells original media content. And the company sells subscriptions to Amazon Prime, a program that offers unlimited free shipping, unlimited streaming of thousands of movies and TV shows, and free restaurant delivery.

Amazon also sells to vendors. Amazon's 2018 annual report says the company offers programs "that enable sellers to grow their businesses, sell their products in [Amazon] stores, and fulfill orders through [Amazon]." Amazon is selling those programs in exchange for fixed fees, a percentage of sales, interest, or some combination of these payments.

Amazon offers a similar deal to content creators – authors, independent publishers, musicians, filmmakers, skill and app developers.

The company has inked sales arrangements with major retail brands such as Nike Inc. (NKE), Best Buy (BBY), Kohl's (KSS) and Investopedia's sister brand The Spruce.

Amazon’s ever-increasing size has allowed it to gain market share in part by slashing prices below competitors'.

Not Always a Cash Cow

Amazon was the U.S. e-commerce leader in 2018, with $239 billion in gross merchandise volume (GMV). Alibaba led globally with roughly $768 billion in GMV. But Amazon retail isn’t a cash cow, and in some cases loses money.

For instance, Amazon has lost money in each of the last 3 years in its international sales. In 2018, it lost $2.1 billion on $65.8 billion in international sales, while making $7.2 billion in operating income on $141.3 billion in sales in North America.

Amazon's Cloud Business

By contrast, Amazon Web Services (AWS), launched in 2006, has accelerated income and posted high margins over the past three years. AWS provides services to businesses, government agencies and academic institutions to store information and deliver content - Amazon refers to them as a "broad set of global compute, storage database, and other service offerings."

  • AWS has grown an average of 48% over the three years ending December, 2018, booking nearly $26 billion in sales that year.

Amazon controlled more than a third of the cloud market in 2018, more than twice its next closest competitor, per Synergy Group. AWS competes with Microsoft Corp.’s (MSFT) Azure, and Alphabet Inc.’s (GOOGL) Google Cloud. Amazon's annual report said AWS booked almost $26 billion in 2018 sales, a 47% increase from the year prior, and generated nearly $7.3 billion in operating income - more than half the company's operating income.

Digital Advertising

Amazon has been aggressively investing in its digital advertising service. eMarketer forecasts that revenue will grow 50% per year through 2020, expanding its share of the U.S. market from 4.1% in 2018 to 7%. That's not a huge percentage. But Amazon is the only player that has even made a dent in the Google and Facebook duopoly, which controls 37.1% and 20.6% respectively, totaling 57% of the market.

Amazon's digital ad business is projected to grow 50% a year through 2020, expanding its U.S. market share from 4.1% in 2018 to 7%. That makes Amazon the only significant competitor to Google and Facebook, which together control 57.7% of the U.S. digital ad market.

In the Net Sales category 'Other' section of its annual report, Amazon said it made $10.1 billion in ad sales in 2018, a 114% increase from $4.7 billion in 2017. This includes ad revenue made by Amazon's gaming platform and social network, Twitch.

Future Plans

In its annual report, Amazon says the company and its strategic planning are guided by four principles:

  • Customer obsession rather than competitor focus
  • Passion for invention
  • Commitment to operational excellence
  • Long-term thinking

Amazon said it will continue investing in improving products, services, consumer experiences, and operations. Going forward, expect Amazon to invest heavily in experimenting with, improving upon, and expanding its core competencies in retail, services, and ads. Whole Foods offers a good example of that effort.

Whole Foods

Amazon’s enormous revenue and market reach have given it unique power to invest heavily in new products and markets and to wage pricing wars that have defeated rivals. In 2017, Amazon paid $13.7 billion to acquire the organic grocer Whole Foods Market Inc., giving it a new beachhead to expand in several areas.

For starters, owning Whole Foods has given Amazon access to high-end consumers, retail locations and a fast-growing leader in the grocery business. The move also is viewed as providing Amazon an opportunity to grow in pharmacy, apparel, and other businesses. In June 2018, Amazon entered the prescription drug space with the buyout of online pharmacy platform PillPack for $753 million.

To further bolster its competitive position, Amazon has been ramping up its delivery capability to get products more quickly to consumers. It plans to boost its fleet of cargo jets by 25% over two years to 50 planes while adding air hubs. Meanwhile, the firm added more than 8 million square feet of fulfillment center space across the U.S. last year.

As Amazon sees its online grocery business grow, it's testing out urban register-free convenience stores with Amazon Go. The company has been experimenting with other pop-up stores and store formats around the world.

Of course, let's not forget that as one of the biggest e-commerce retailers in the world, Amazon has massive amounts of data to leverage in reaching consumers, and understanding what they want.

Other Plans

Customer obsession rather than competitor focus, passion for invention, commitment to operational excellence and long-term thinking don't just mean a continued and intensified commitment to one's core competencies. Amazon has ambitions beyond being the world's number one retailer and cloud-computing services provider.

128

The number of companies purchased by Amazon.

Amazon is diversifying, noting in its 2018 annual report that it was holding $942 million in equity and equity warrants of public and private companies.

Though it is notoriously private, according to CB Insights via Inc., Amazon has bought at least 128 companies since it was founded. Those companies cover a slew of industries: Artificial Intelligence, Business and Cloud Services, Clothing and Accessories, Financial Services, Food, Beverage and Consumer Products, Hardware, Home Services, Media Production and Entertainment, Publishing, Social Commerce and Networks, Transportation and Logistics. The rationale is clear for some of these purchases, but not obvious in other cases.

Though it appears that Amazon plans to continue disrupting consumer product, brick and mortar retail, pharmacy, small business lending, and digital payment businesses, CB Insights suggests we might have to look for less obvious answers to predict Amazon's future. If Jeff Bezos' interests are any indication, it might be useful to take a look at his conference MARS, an acronym standing for Machine Learning, Automation, Robotics, and Space.

Key Challenges

Despite Amazon’s nearly uninterrupted growth, it faces numerous challenges. The expectations of Amazon investors frequently are higher than the company's already lofty growth rate, leading to stock pullbacks even when it delivers stellar results. A much bigger overlooked risk may be more intense government scrutiny, changing global regulations, and anticipated increases in expenses. These could curb Amazon's growth. Additionally, Amazon's growth and expansion places a significant strain on the company's management, operational and financial resources, and exposes the company to legal, financial and competitive risks.

Despite its size, Amazon also faces powerful and well-financed rivals such as Walmart Inc. (WMT), which is mapping out its own plan to take market share from Amazon and Alibaba. (BABA).