Amazon's (AMZN) Prime Day Rules Change for Suppliers Sends Message to Investors
Amazon (AMZN) is acting all grown up. The company for years was so focused on revenue growth that the whole idea of running a massive business focused entirely on that metric and without an eye to profit was named for it, the so-called “Amazon model.”
Recently though, several things have indicated that the e-commerce giant is shifting more permanently towards the goal of a mature company: profit.
The latest among them is a change to the way they charge companies for being included in Prime Day promotions, at least when it comes to some grocery items. Until now, suppliers paid a flat fee for inclusion in deals offered during the now two-day “day” of deeply discounted deals offered to Prime members, but this year will be different. They will instead be charging what they referred to as “additional funding” to make up for any losses incurred on discounted products.
This isn’t “pass-through” transactions either. These are products that Amazon buys wholesale, then retails to consumers. They are the ones choosing to sell them as loss leaders, but they are charging their suppliers to cover that loss. What is amazing however is not that they are doing that, it is not uncommon for suppliers to at least share in the cost of promotions, it is that they feel that they have the power to demand it of all sale participants in one division, and that they are right.
Their dominance of retail has reached the point where those suppliers will put up with this rather than risk being dropped from Amazon’s platform.
That kind of power was always the end goal of the aggressive growth. In retail, as Walmart showed a long time ago, growth increases buying power, and buying power equates to margins. Delaying profitability was designed to increase margins once the tap was turned on, although many doubted that they would be able to do that effectively when the time came. They were wrong.
Amazon has reported record profit in each of the last four quarters, and for Q! 2019 they made $7.09 per share, an increase of well over one hundred percent from the same quarter in 2018. A large part of that, however, has been attributable to the growth of Amazon Web Services (AWS), the company’s cloud computing division. That business operates at much higher margins than the core retail business and, as I have pointed out many times (most recently in February of this year) that has until now been the driver of profit growth.
What this news shows, however, is that Amazon is increasingly serious about increasing overall margins from their retail operations, and even tiny increases there will make a massive difference to overall profitability. In 2018. Amazon’s total retail sales were $200 billion. At that number even a 0.1% increase in margins equates to close to an extra quarter of a billion dollars in profit. Those are mind-boggling numbers, but the message for investors is clear.
Put simply, you should own AMZN. Over the last few years, all the arguments against doing so have been shown to be bogus: “Growth like that can’t be sustained,” “After years of breaking even they will be unable to transition to profitability,” “They will soon become too big and unwieldy,” etc, etc.
The only one with a ring of truth was that triple digit multiples couldn’t be sustained forever. There are, however, two ways of reducing P/Es, a fall in price or an increase in earnings, and AMZN has gone the second route.
And if you are worried that a company with around half of all total U.S. e-commerce has no more room to grow, consider this. As impressive as that is, it still only represents around 5% of total retail. There will inevitably be a limit to what percentage of sales will be online, but does anybody really believe that limit is 5%?
It is tempting to look at a company like Amazon and ask where the growth is coming from, but over the last year or so they have provided an answer to that question. Earnings growth is being facilitated by margin improvement. That has until recently been based on expansion of higher margin divisions of the company, but now that they seem focused on improving margins in their massive e-commerce business, the potential is so huge that further spectacular gains in the stock look likely.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
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