Last week, Amazon reported its 2017 Q1 financial results. With fresh numbers in hand, we can explore the age old question: how profitable is Amazon?
Amazon runs on thin margins. But how thin? And why are the margins so thin in the first place?
Revenue and profit
First, let’s look at Amazon’s all-in quarterly revenue and profit. The chart below shows this information.
We see that Amazon reported $35.7 billion in net sales for Q1, against $1.0 billion in operating income, and $0.7 billion in net income.
We see a healthy jump in year-over-year revenue, at 23%. (We call it a year-over-year jump because we’re comparing the same quarters in 2016 and 2017. If we were being precise, we would call this a year-over-year change in quarterly revenue. We can compare that to a sequential change in quarterly revenue, where we could compare 2017 Q1 to 2016 Q4, or sequential quarters.)
Even with an increase of $6.6 billion in net sales, we get a slight reduction in operating income, from $1.1 to $1.0 billion. But net income moves back upward, from $0.5 to $0.7 billion. So profit dollars are mostly flat, even though we see a sizeable revenue increase.
Let’s take this analysis one step further. We can look at revenue and operating income by Amazon’s reported segments: North America, International, and Amazon Web Services (AWS):
We see that Amazon reported $21.0 billion of net sales in North America, for 59% of its total revenue. International had $11.1 billion in net sales, for 31% of total revenue. That leaves AWS at $3.7 billion, contributing the last 10% of Amazon’s total revenue.
Operating income is a different, and very important, story. Amazon’s smallest segment by revenue, AWS, is its largest by operating income. North America ekes out 2/3 of the profit dollars of AWS, even though it generates over 5 times the revenue. And International operates at a loss.
It’s clear where Amazon’s bread is buttered, when it comes to profitability.
Amazon’s cost structure
The chart below is a waterfall, showing us a bridge between Amazon’s revenue and operating income. We have revenue on the left. Then we have each operating cost bucket, showing us how the various costs eventually get us all the way down to operating income, on the far right.
Amazon’s biggest cost bucket, by far, is cost of sales. That shouldn’t be surprising. Amazon sells an enormous volume of low-margin goods through its online storefront. That’s how it built its business in the beginning.
The next largest bucket, at least in 2017 Q1, was technology and content. Here is what Amazon had to say about this category in its 2017 Q1 10-Q report:
We seek to invest efficiently in several areas of technology and content so we may continue to enhance the customer experience and improve our process efficiency through rapid technology developments while operating at an ever increasing scale.
Technology and content is Amazon’s growth engine. When you think of Amazon reinvesting in its business, there is where you should look. Amazon’s management is fine with lower reported profits, as long as its investments yield future growth.
Next up is fulfillment, which is also related to Amazon’s traditional business. Cost of sales is Amazon’s cost for the products it sells. Fulfillment is Amazon’s cost to box and ship products, operate its customer service organization, and process payments.
The next largest bucket is marketing. Amazon pays a considerable sum of money to direct traffic to its website. In 2017 Q1, this cost was nearly $2 billion.
Finally, Amazon has some general and administrative costs, and some miscellaneous costs. Add it all together, subtract from revenue, and you get $1.0 billion in operating income.
Amazon compared to other large tech companies
Is Amazon’s reported profitability really that low, when you compare with other large tech companies? The chart below says “yes”.
We see that Amazon’s operating margin and net margin are lower than those for Apple, Microsoft, or Netflix. (Operating margin is operating income divided by total revenue. Net margin is net income divided by total revenue.)
Amazon’s profit being lower than Apple’s or Microsoft’s isn’t surprising. The latter are slower-growing. They don’t have to invest as much to maintain their business. But Amazon’s profit being lower than Netflix’s is somewhat surprising.
Netflix is much smaller than Amazon: $67.5 billion vs. $449.2 billion, by market capitalization. Netflix’s infrastructure is just as capital-intensive as Amazon’s. So why doesn’t Netflix invest more?
There are some big differences between Netflix and Amazon. A big one is that Netflix doesn’t have a product sales business. Without all the product and fulfillment cost, it can invest more in its business and still report a higher margin. Maybe I’ll write a more detailed Amazon vs. Netflix profitability post in the future.
How profitable was Amazon, in the first calendar quarter of 2017?
Amazon reported an operating margin of 3%, and a net margin of 2%, in 2017 Q1. It’s about 10 times less profitable, by these metrics, than Apple and Microsoft. It’s about 3 times less profitable than Netflix.
That’s all by design. Amazon is still growing rapidly, particularly on the Amazon Web Services side. Amazon knows the AWS game is all about scale. You have a set amount of fixed costs you can spread more efficiently, as you build out your infrastructure and serve more customers.
Amazon is a fun company to follow. As opposed to other companies that are content to sit on large piles of cash, Amazon reinvests heavily in its business. It has a reasonably clear road map, in terms of what it has to do to keep growing at or near current rates.
There’s a reason Amazon’s stock trades at 176 times its earnings, while Apple’s stock trades at 17 times its earnings. Investors are confident that Amazon’s investments will eventually yield higher earnings and improved cash flows. Only time will tell.