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What Are the Key Factors Driving Amazon’s Gross Margins?

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Jun. 8 2016, Updated 8:08 a.m. ET

Amazon considers AWS and third party sellers to be major drivers of its gross margins

Amazon’s (AMZN) gross margins improved from 32% in 1Q15 to 35% in 1Q16, as the chart below shows. The company mentioned that there are two major factors driving growth in its gross margins: its cloud division Amazon Web Services (or AWS) and third party sellers. AWS managed fast revenue growth of 64% on a year-over-year basis in the last quarter, which provided leverage for strong growth in gross margins.

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Third party sellers are the small-scale sellers that depend on big e-commerce players such as Amazon to sell their products. Amazon mentioned that these sellers now account for 48% of paid units on Amazon, up from 44% in the same period last year. Third-party sellers benefit Amazon in a big way. The company doesn’t have any product costs associated with these sales, yet it gets a commission from them. Thus, this is a great source of profit for Amazon.

Amazon will increase warehouse storage fees this holiday season

Early this month, Amazon announced that it will raise the warehouse storage fees for third party sellers for November and December this year. The reason for the increase is that during last year’s holiday season, the company’s warehouses reached capacity. By raising prices during the holiday season, Amazon wants to encourage third party sellers to only stock items in its warehouses that are more likely to sell. Higher storage fees will likely help Amazon grow its gross margins even more.

On the other hand, brick-and-mortar players such as Walmart (WMT), Best Buy (BBY), and Target (TGT) can’t reap such benefits from third party sellers because they must first buy merchandise before selling it to customers. Amazon has also been helping third party sellers to qualify to sell products under the Prime program without needing to store their goods in Amazon’s warehouses. 

For diversified exposure to Amazon, you can invest in the PowerShares QQQ Trust, Series 1 ETF (QQQ), which invests about 6.2% of its holdings in Amazon.

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