Amazon’s growth over the past several years has been nothing less than amazing. The e-commerce giant continues to grow its customer base and revenue every year apart from adding more and more sellers to its marketplace. The company’s competitive position in the retail and technology industry has also continued to strengthen and that is reflecting clearly in the growing market cap of the brand. Despite the spread of Covid-19, Amazon is among the richest companies in the United States and the world with a market cap that is above $1.3 trillion. Founder Jeff Bezos himself is the richest man on the planet with a net worth of around $117 billion. The superior growth of Amazon is also a result of its focus on technological innovation and customer experience. Apart from being the most loved e-commerce brand, Amazon is also a leading cloud player. Amazon has a strong competitive edge even against its nearest competitor and its mobile customer base was almost double that of Walmart in 2019. The growth and success story of Amazon from being an online bookseller to the largest online retailer is one of the biggest success stories of the twenty-first century. However, its business model and its distribution network have played a key role in driving rapid growth for the company.
In this post, we will discuss the business model of Amazon, how it makes money and the factors that make Amazon so successful.
Amazon’s Business Segments:
Amazon has divided its business into three main segments that include North America, International, and AWS. North America is the largest reportable operating segment of Amazon followed by International and AWS. All three segments experienced impressive growth in 2019.
The North America segment of Amazon mainly includes the money earned from the retail sales of consumer products and subscription services in North America through focused online and physical stores. This segment includes export sales from North America online stores.
North American operations of Amazon are its largest reportable segment. It has consistently accounted for the largest portion of Amazon’s annual net revenue. During both 2018 and 2019, Amazon North America accounted for 61% of the net sales of the company. Amazon generated around $170.8 billion in net sales from the North America segment (21% y-o-y growth). Compared to the last fiscal, Amazon’s North America segment experienced a growth of 21%. During fiscal 2018, Amazon’s net sales in North America equaled $141.4 billion. The growth in net sales of the North America segment was mainly a result of the growth in unit sales of products on Amazon’s online marketplace. Growth in sales was driven mainly by Amazon’s continued efforts to optimize its pricing mix as well as attractive shipping offers, availability of a larger variety of products as well as growth in the availability of in-stock inventory.
The net sales of Amazon International segment mainly include the money Amazon earns from the sales of consumer products as well as subscription-based services through the internationally-focused online stores. Amazon includes the export sales from these internationally-focused online stores in this segment (including sales to the customers based in the US, Canada, and Mexico) but excludes the sales from its North America focused online stores.
The second-largest reportable segment of Amazon is the international segment that accounted for around 27% of net sales of the company during 2019. This segment experienced 21% year on year growth in 2019. Net sales on Amazon’s international segment during 2019 grew to $74.7 billion compared to $65.9 billion during fiscal 2018.
The growth in net sales is mainly a result of the growth in unit sales on Amazon’s international platform. Apart from Amazon’s pricing strategy, shipping offers, as well as an increased variety of products available on Amazon marketplace and higher in-stock inventory availability, also played a leading role in the growth of Amazon International’s net sales.
AWS (Amazon Web Services):
The net sales of AWS include the money Amazon generates from global sales of compute, storage, database, and other service offerings for startups, enterprises, government agencies, and academic institutions.
Amazon web services (AWS) is the cloud segment of Amazon’s business. This segment has also achieved impressive growth during recent years. In 2019, this segment achieved a growth of 22% compared to the previous fiscal year and represented 12% of the company’s net sales. The net sales of AWS grew to $35 billion in 2019 compared to $25.7 billion in 2018. Increased usage of Amazon Web Services products by customers worldwide mainly led to the growth in AWS net sales during 2019. The growth in AWS net sales was partially offset by the pricing changes across the AWS platform during 2019 as Amazon continued to make efforts to reduce prices for its customers worldwide. The users of AWS products include both large and small enterprises as well as individual users. According to a 2017 case study by Amazon,
“Netflix uses AWS for nearly all its computing and storage needs, including databases, analytics, recommendation engines, video transcoding, and more—hundreds of functions that in total use more than 100,000 server instances on AWS.”
Amazon’s net sales, operating expenses, and operating income/loss by business segment in 2019. (in billions of US dollars)
|Segment||Net Sales||Operating Expenses||Operating Income|
Amazon’s Geographical segments:
Geographically, Amazon has divided its business into five geographical segments, four of which are Amazon’s leading markets and the fifth includes all the other remaining markets of Amazon. The United States is the leading market of the company followed by Germany, the United Kingdom, and Japan. These are the four leading geographical segments of Amazon and the rest geographical markets count as one segment – the rest of the world. During fiscal 2019, the United States generated around 69% of the net sales of Amazon. Amazon’s net sales in the United States reached $193.64 billion in 2019 compared to $160.15 billion in 2018 (y-o-y growth of around 21%). Germany, which is the second-largest geographical market of Amazon, accounted for $22.23 in net sales in 2019 compared to $19.9 in net sales in 2018. The United Kingdom is the third-largest geographical market of Amazon based on net sales and accounted for $17.53 billion net sales in 2019 compared to $14.5 billion in 2018. Japan generated $16 billion in net sales in 2019 compared to $13.8 billion in 2018. The rest of the world, which is one geographical segment of Amazon, generated $31.1 billion in net sales in 2019 compared to $24.5 billion in 2018. (data from Amazon form 10K 2019– ir.aboutamazon.com)
How Amazon makes money (main revenue generating activities)?
While retail sales are the main source of revenue for Amazon there are other sources of revenue for the company as well. Here is a description of the main channels from which Amazon makes money.
Amazon offers consumer products through its online and physical stores. It recognizes revenue when the ownership of the product has been transferred to the customer. The ownership of the product is considered transferred to the customer when the product is delivered to a third party carrier or if Amazon is the main delivery agent, the product has been handed to the customer. During 2019, Amazon generated $158.4 billion in net sales from retail sales. Of the total retail sales, the company generated $141.25 billion from online stores and $17.2 billion from physical stores.
Third party sellers:
Third-party sellers sell their products and fulfill orders to customers through Amazon’s online and physical stores. In this case, Amazon is not the seller on record. Amazon receives commissions and related fulfillment or shipping fees. These commissions and fees are recognized when the services have been rendered through Amazon’s platform. This occurs when the product has been handed over to a third-party carrier or in the case of Amazon to the customer. Third-party seller services are also a major source of revenue for the company from which it generated $53.8 billion during 2019 compared to $42.75 billion in 2018.
Amazon also makes money from subscription services. The subscription sales of Amazon include fees associated with Amazon Prime memberships as well as the fees it charges for access to content like audiobooks, digital audio, and video, e-books as well as other non-AWS subscription services. With Prime memberships, the customers can have access to a large and evolving suite of benefits Customers pay the subscription fees in advance or at the time the services are delivered. Amazon recognizes the revenue from such subscriptions over the subscription period. During 2019, Amazon generated $19.2 billion in revenue from subscription services compared to $14.2 billion in 2018.
AWS (Amazon Web Services):
Amazon Web Services also generates a significant portion of Amazon’s revenue. AWS portfolio includes compute, storage, database, and other services. Amazon uses standalone pricing to allocate revenues to services. Revenue is recognized mainly when the customers use these services on the basis of the volume of services utilized like compute or storage services delivered on-demand. Amazon also offers certain services like compute or database for a fixed quantity for a specified term. Revenue for such services is recognized ratably. Sales commissions paid by Amazon related to the contract exceeding one year are capitalized and amortized over the contract term. The contribution of AWS to Amazon’s net sales has grown substantially in recent years. During 2019, AWS generated $35 billion in net sales compared to $25.7 billion in 2018.
Other sources from which Amazon makes money:
The other sources from which Amazon makes money mainly include advertising services. The revenue from advertising on Amazon’s platforms is recognized when ads are delivered and on the basis of clicks and impressions. In 2019, Amazon’s earnings from other sources grew to $14.1 billion from $10.1 billion during the previous fiscal year.
Financial performance over the past two years
Amazon has experienced impressive financial growth over the past three years. From $177.9 billion in 2017, the net sales of Amazon have grown to $280.5 billion in 2019. Its market cap is also higher than $1.3 trillion despite the coronavirus pandemic. While Amazon’s North America segment experienced more than 50% growth from 2017 to 2019, the AWS segment saw its revenue double during the same period. The international segment also experienced around 40% growth in net sales. However, due to high operating expenses, the international segment of Amazon has been generating negative operating income (operating loss) over the last three fiscal years.
The consolidated net income of Amazon Inc grew to $280.5 billion in 2019 which was 20% higher than the previous fiscal when the company generated $232.9 billion in revenue. The operating income of the company grew to $14.5 billion in 2019 compared to $12.4 billion in 2018. Amazon uses operating income as a measure of profitability since the company believes that considering its vast selection of products operating income is a more meaningful measure as compared to gross profit or gross margin. However, Amazon’s operating income during 2019 mainly grew across the AWS segment. While the North America segment experienced a decline in operating income, the International segment again generated an operating loss. Net operating income from the North America segment fell by around $230 million in 2019 compared to 2018 mainly due to increased shipping costs and marketing expenses. There was also a negative impact of foreign exchange rates on the operating income of the Amazon North America segment of around $23 million.
Operating loss from the international segment decreased in 2019 compared to the previous fiscal year. This mainly happened due to the increased unit sales as well as growth in sales by third-party sellers as well as higher sales of advertising on Amazon’s international platforms. Apart from that certain operating expenses of the Amazon international segment also grew slower compared to the last year while marketing expenses grew.
Free cash flow of Amazon grew to $25.8 billion in 2019 compared to $19.4 billion in 2018.
During the first quarter of 2020, the net sales of Amazon grew to $75.5 billion compared to $59.7 billion during the same period last year (YoY growth of 26%). On the other hand, the operating income and net income of Amazon Inc decreased during the first quarter compared to the same period last year. The operating income of the company declined to $4 billion in Q1 2019 from $4.4 billion during the same period last year. Compared to $3.6 billion in Q1 2019, the net income of Amazon Inc came down to $2.5 billion during the same period last year. The company expects an operating profit of $4 billion during Q2 2020.
Amazon’s business model depends on several pillars and its core strength lies in its reliance on technological innovation, large product range, pricing, and international presence. While the US is the main market of the company, its international sales have also grown fast during recent years. Moreover, the contribution of Amazon AWS to the net sales of the company has grown fast in the last three years. Covid-19 has put the business models of all large and small businesses to test. However, Amazon has proved to be a tough brand and it has not just survived the challenge but the company also saw its market cap grow fast during the pandemic.
Instead of relying solely on retail sales, Amazon has diversified its business model to add more sources of income. Cloud computing as well as subscription services also contributed significantly to the net sales of the company during 2019. While this has reduced the company’s dependence on retail sales, it has also helped it find faster growth and establish itself as the leading e-commerce and cloud brand.