(This is not an actionable idea.)
From researching dollar stores, one of the things that struck me was that you can purchase a pregnancy test for a dollar. Amazon’s #1 best seller pregnancy test costs $12.33– a magnitude more expensive than dollar stores. Amazon is clearly not competing on price!!
By comparison, a more discounting-oriented online retailer like Newegg has razor-thin gross margins of between 8 to 11% (before overhead). Newegg sells computer parts online. Its financials are available via the S-1 filing on EDGAR due to Newegg’s aborted IPO.
Whereas Newegg’s value proposition is in offering the lowest prices online, Amazon is more like an online convenience store. It is a marketplace with an incredible selection and fast shipping. Researching purchasing decisions on Amazon is a pleasant experience relative to other online options, since the reviews on the Amazon website are quite helpful. For example, the reviews section contains lots of 1-star reviews from consumers who are unhappy with the false positives from this pregnancy test. (Yes, most medical tests have an error rate.)
Amazon is also pushing into other high-margin areas of online retailing. Currently, its front page features expensive dresses… some of which are several hundred dollars. In bricks and mortar retailing, apparel needs to be sold at very high margins because these items turn over slowly (eating up capital and store space). A size 9 dress hanging on the rack is waiting for a size 9 woman to walk through the door. Many retailers do not carry inventory for unusually tall women because the low numbers of unusually tall women cannot drive inventory turns.
How profitable is Amazon’s online retailing?
In my view, Jeff Bezos wants Wall Street to leave him alone (despite working at a hedge fund… or because of it). That makes it difficult to figure out how much money Amazon’s online retailing segment really makes. If you skim through the 10-K, you will see that it doesn’t try to provide transparency on the different parts of Amazon. For example, the 2015 10-K finally disclosed segment information for Amazon Web Services. Apparently AWS contributed a third of Amazon’s operating income in 2013 ($673M out of $1993M or 33.8%), yet Amazon did not disclose segment data for AWS back in 2013.
Amazon likely lost money on its Paypal-esque ACH payments system given that it currently pushes customers into signing up for a Visa credit card rather than linking their bank account to Amazon’s ACH payments system. While I think pursuing such ventures is worthwhile, a lot of Amazon’s early stage ventures will bleed cash for years before they generate positive cash flow. This may obscure how profitable the online retailing aspect of Amazon is.
On the other hand, Amazon does have some high-margin business lines that may inflate overall margins. There is an Ebay-like aspect to Amazon where third parties can list new and used goods for sale such as books. Fulfillment is handled by the third party. This is very similar to eBay. While listing fees are higher on Amazon than other options (e.g. running your own online store and using Google Adwords to find customers), many vendors will list items on Amazon simply because Amazon drives traffic. This is potentially a wonderful business since Amazon’s ability to drive sales allows it to charge higher prices than its peers for performing the same service (connecting buyers with sellers).
Ultimately, I haven’t figured out how profitable Amazon’s online retailing actually is. However, I think that it is a mistake for investors to assume that all online retailers compete on price and that therefore online retailers are not very profitable. The reality is that Amazon often does not compete on price.