9 Nov

Amazon: The Secret to Bezos’s Success

WRITTEN BY Shankar Iyer

Did you know that Amazon (AMZN) is the second publicly traded company in the US to cross the $1 trillion market cap? Amazon briefly crossed this threshold in August 2018 when the stock price peaked at the record high of $2,050.50. Apple (AAPL) was the first US tech company to achieve this milestone on August 2, 2018. And guess what? Microsoft (MSFT) is the third company to reach the trillion-dollar market cap. Till now, only tech companies that have gone this far with respect to market valuation.

Trillion-dollar trivia

Here is something fascinating about companies with the trillion-dollar market cap. The Chinese oil company PetroChina is the first company globally to set the one trillion dollar valuation benchmark. PetroChina was valued at around $1.1 trillion during its IPO listing on Shanghai Exchange back in 2007. It was an epic milestone, but it was very short-lived. The Chinese company’s valuation spiraled downwards soon after that. The financial crisis of 2008 pulled down the company valuation to less than $260 billion by the end of the year.

On November 6, before the exchanges opened for trading in the US, Apple and Microsoft were still valued above a trillion dollars. However, Amazon’s valuation took a beating in the past few days and dropped to about $890 billion. The company’s earnings miss for the quarter ending in September 2019 also removed Amazon’s CEO Jeff Bezos from getting the title of the world’s richest man.

This raises a question: how does Bezos’s company earn money? Are the revenue streams stable enough to cross the trillion-dollar valuation again and remain on the other side?

Amazon September 2019 quarterly results

Amazon: The Secret to Bezos’s Success
Complete SEC Filing available here.

Amazon’s quarterly results for September 2019 missed analyst expectations, and the stock price took a beating. In the third-quarter earnings, the e-commerce segment contributed the most to the aggregate revenue, just over 50% of the total revenue. Revenues from third-party sellers came in second with 19%. Also, the cloud business contributed around 13%.

How did Amazon’s e-commerce business start?

To understand how Amazon makes money, you should know how the business started. Bezos built the company brick-by-brick to the castle it is today. In 1995, Bezos officially kicked off his entrepreneurial venture to create an internet-based bookstore. Soon, the inspiration soon manifested into Kindle. Also, Bezos’s parents invested a sizable amount in getting the business started. The online bookstore thrived for the next two years. Finally, Bezos decided to list the company in NASDAQ. Initially, Amazon’s stock price at the time of its launch was $18. However, on May 16, 1997, its first day of trading, the stock closed at $1.73.

From an online bookstore, Amazon soon expanded into other product segments. Amazon.com listed music CDs, toys, electronic products, et cetera. Thus, the e-commerce portal was born. Bezos opened his online platform to third-party sellers in 2000. By this time, Bezos was familiar with selling products online as well as the logistics involved for delivery.

Today, Amazon is well-known globally as an online market place. It created such an image for itself that many of Amazon’s international customers are unaware of Amazon’s physical stores in the US. Yes, Amazon has physical retail stores where customers can walk in, select products, and take them while their Amazon account is charged at checkout. There are 20 Amazon Books stores, six Amazon 4-Star stores (with three new stores opening soon), Amazon Go Stores, and Presented by Amazon stores in four locations each.

How third party-sellers contribute to revenues

Jeff Bezos’s move to list third-party products was ingenious. By listing third party products on the website, consumers have a more comprehensive range of options to choose from. Of course, this made Amazon more popular among users. In the 2018 Letter to Shareholders, Bezos said that the third-party listings grew to such epic proportions that they are “kicking our first-party butt. Badly.” He’s referring to the increasing numbers of third-party sellers on his e-commerce platform. Amazon, in return for third-party listings, charges sellers a fee.

Currently, the e-commerce portal offers two types of selling plans to third-party sellers. The first is the Professional Selling Plan. The second is the Individual Selling plan. Professional sellers have to pay a monthly subscription fee of $39.99 in addition to the selling fees for each item. Individual third-party sellers get billed $0.99 per item sold. Even Individual plan members have to bear the selling cost, which varies depending on the category of the product.

Trivia: Bezos often mentioned that the key focus of Amazon is customer satisfaction. Have you ever noticed the arrow in the Amazon logo? The arrow starts from letter A and points to the letter Z. This is a symbolic gesture saying that the Amazon website features all products from A to Z. Also, the arrow gives the impression of a smile, something that customers sport when they order products from Amazon.

Delivery Service Partners programs

Although Amazon guarantees deliveries to customers, third-party sellers still pay for the shipping and logistics cost. The DSP (Delivery Service Partner) program is the company’s way of growing small business participation in its logistics network. The DSP program brochure forecasts an annual revenue stream in excess of $1 million for operating 20 to 40 delivery vans. It’s a great initiative to promote the Amazon brand. Delivery Service Partners generate revenues in three different ways:

  1. The first way is a fixed monthly payment decided based on the number of delivery vans.
  2. The second way is a payment plan based on the length of the delivery route.
  3. The third way depends on the number of successfully delivered packages.

The online e-commerce company estimates an initial start-up cost of $10,000 for DSP. Amazon already negotiated lease programs for the delivery vans, fuel programs, devices needed for delivery, et cetera. With every DSP onboard, Amazon is not only recovering some of the associated delivery costs but also churning out higher revenue volumes. Now that’s feeding two birds with one scone.

AWS Cloud Services

AWS (Amazon Web Services) is Amazon’s cloud computing business segment. Additionally, AWS is the leader in the global public cloud services market with a 40% share, as per the findings of Synergy Research Group. The e-commerce company’s cloud segment started in May 2006. Since then, it expanded to 190 countries across the world in 2019.

Also, AWS provides cloud infrastructure solutions to businesses. Cloud infrastructure solutions include cloud storage, virtualization software, access to servers and networks as well as SaaS (Software as a Service). Customers using the Amazon infrastructure are billed on a pay-as-you-go model. Also, it doesn’t charge any commitment fees or enforce a periodical contractual obligation. The AWS pricing model has three different categories, each with separate charges.

  1. Charges for Data Transfer.

AWS only charges for outbound data transfer. There are no charges for inbound data transfer or data transfer between regional AWS services. The outbound data transfer services are aggregated and charged on the monthly statements. It works on the model of economies of scale, so, with higher usage, cost per GB lowers.

  1. Compute Resources Usage.

AWS provides cloud processing capabilities to customers who often get charged depending on their hourly usage. The billing is triggered once the user launches a resource, and the timer continues until the resource is terminated. Also, in case of a sizable usage, customers negotiate the hourly rate and pay a pre-decided lump sum amount.

  1. Data Storage Services.

Storage services allow users to save data on Amazon Cloud. Charges for Data Storage services are based on the number of GB of files stored in Amazon servers.

Amazon Prime subscriptions

Launched in 2005, Amazon Prime is Bezos’s solution to get customers to spend more. Prime members get exclusive benefits, which tempt members into buying more products from Amazon.

The e-tailer held the Prime Day shopping festival from July 15 to July 16, 2019. As per CNBC’s July report, the company sold over 175 million products during this two-day event, which is open exclusively to Amazon Prime members. Currently, Amazon Prime charges a monthly subscription fee of $12.99 and a best value annual subscription of $119 per year. Additionally, Prime members have access to Amazon Prime Video, free delivery, unlimited access to music, ebooks, and photo storage. For members who opt only for Amazon Prime Video, the subscription fee is $8.99 per month.

As reported by Statista, there were 105 million Prime members in June 2019. The estimates suggested a 10.5% year-over-year growth compared to 95 million members in June 2018.

Revenues from Advertising Services

Amazon hosts a Demand Side Platform that gets revenues from online advertisements. Marketers can use the Amazon demand-side platform to showcase relevant ads to Amazon customers. The promotional content is targeted on mobile phones, smart devices, and PCs. Typically, advertisers can deploy in-stream and out-stream video ads, full-screen interstitial ads on mobiles, mobile banner ads, and web display ads to Amazon customers.

Conclusion

Gartner’s research released in April 2019 expects the cloud business could grow to $331.2 billion by 2022. CNBC reported that in the third quarter of 2019, the Amazon cloud business grew 35%. This is faster than Amazon’s overall growth of 24%. One might even wonder, is it feasible to spin off AWS and create an independent entity?

However, in terms of value, cloud revenues consist of only 13%, whereas the remaining 87% are from other revenue segments. Jeff Bezos leveraged every single opportunity to make money from Amazon’s multi-layered business. In my opinion, sheer genius is the key ingredient that catapulted him to the spot of the world’s richest man.

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