Amazon Doesn’t Have a Prime Problem

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In the future, Amazon (NASDAQ: AMZN  ) could find itself in a bit of a pickle. The company has been increasing costs faster than it can grow revenues, which, over the long term, is an unsustainable trend. A lot of the blame has been placed on Amazon Prime, despite being attributed with driving increased spending with members.

Last quarter, fulfillment costs rose more than 38% year over year, and technology and content costs rose 46%; yet total sales only grew by 22%. In other words, the short-term costs associated with running Amazon Prime appear to be far greater than the short-term benefit. Investors continue to justify this unsustainable trend because the company has made it clear that growth is currently a higher priority than profitability.

Quite frankly, investors are correct for making the assumption that profitability will come at a later time.

Plans B,C, and D
Between the third-party sellers, new fulfillment centers, and the prospect of creating an advertising network that could rival Google, the company has just a few margin-enhancing opportunities in the pipe. Naturally, some of these opportunities cost more than others to implement in the short-term.

Third-party sellers give Amazon an opportunity to collect commissions on items while incurring fewer costs. Last quarter, third-party sellers accounted for 40% of product sales, which represented an increase of 1% from the year prior. Should more third-party sellers look to Amazon as a commerce platform, it could provide an added boost to its razor-thin operating margin.

The fact that Amazon is planning to reduce its two-day shipping time by one day could have significant implications for the company's long-term profitability. In order to accomplish this, Amazon must make the necessary investments that will improve fulfillment efficiency and shipping times, which will ultimately reduce shipping costs and boost margins. The short-term consequence of this ambition is that fulfillment costs have temporarily ballooned, because Amazon is currently building out a network of strategically placed fulfillment centers.

As far as an ad network is concerned, Amazon is sitting on a treasure trove of transactional data that could prove to be extremely valuable against the likes of Google. Although Google understands user intent when they search for a product, it has very little information pertaining to the final sale. Knowing what a user actually purchases could translate into big advertising bucks for Amazon, which could provide a significant boost to margins. In terms of an addressable market, eMarketer believes the U.S. digital ad market will reach $50 billion by the year 2015.

Front-end loaded
Amazon is a company that has consistently told investors that it's willing to sacrifice profit so that it can invest in and grow its long-term addressable market. To that end, Amazon is currently making the necessary investments today so that it can secure its profitability in the future. Unless Amazon fails to deliver on this promise, there isn't much for investors to question here.

Everyone knows Amazon is the king of the retail world right now, but at its sky-high valuation, most investors are worried it's the company's share price that will get knocked down instead of competitors'. The Motley Fool's premium report will tell you what's driving the company's growth, and fill you in on reasons to buy and reasons to sell Amazon. The report also has you covered with a full year of free analyst updates to keep you informed as the company's story changes, so click here now to read more.

Read/Post Comments (3) | Recommend This Article (1)

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  • Report this Comment On May 11, 2013, at 11:55 PM, runbot wrote:

    See how AMAZON's sales will PLUMMIT if the collection of INTERNET state sales taxes go into effect. Us consumers know they've conspired with WALMART and corrupt state governments to be the tax collector for Obama's nanny state.

  • Report this Comment On May 12, 2013, at 11:23 AM, dogtracks39 wrote:

    I am an Amazon Prime Vendor and I can tell you what some of the problems are. Raising prices is not going to fix these issues unless it is to hire employees with more intelligence. This includes their customer service.

    The receiving people lose too much stuff. Then they have to pay me for it. Sometimes they find it, when I notice this, I will let them know because I am a person of integrity. What the customer service people tell me is there is nothing then can do. What. You over paid me $300 and there is nothing you can do about getting it back. If I was the owner we would be finding a way to get our $300 back. This has happened several times. I sent product up. Six to a case. They checked in as one unit. When I pointed this out they said they could not find the missing units. They had to reimburse me again for stuff they lost. This happens over and over. As a vendor with sales of $500,000 you would think there would be someone I could contact directly. But there is not. You have to use the non-caring, I don't give a crap customer service people who only know how to follow some stupid script that someone with no clue wrote up. Another issue that is unfair to the vendors is the rating and review system. A customer can give you negative remarks even when you have done everything right. There is no appeal process by people of intelligence.. Customers can review an item and often these reviews are not fair either. I sell seeds. I have never had a customer who bought seeds from me say they did not grow and it was their fault. It is always the fault of the seeds. When I get one of these complaints I pull a pack and plant it. 100% of the time they grow for me. I get bad remarks because the customer did not follow the right directions. Seeds want to grow but certain conditions must be met and they are not all the same. The next thing is their return policy. They try to have a WalMart style return policy. The only difference is WalMart does not have to pay shipping cost. With online retail there is always shipping. Who pays it? If a customer returns something just because they decided they did not want it, I can charge them for the shipping and a stocking fee. But if I do this, then they tear me up in the reviews and ratings. I have to pay these or take a big hit in the rating area. This is not fair to me. I am blackballed into accepting a loss I should not have to. There are constant changes and updates to the system--most do nothing for me. But tools I do need, do not exist. They need to break the US down into 6-8 shipping zones. I drop ship items. One item we sell we drop ship from CA. The person in CA has to pay the same shipping rate as the person in NY. If this was changed, I could be more competitive and sell more. Amazon takes a 15% commission. When I sell an item for $1,000 they make more than I do. This is not right. The commission should be a prorated percentage, not flat rate. When they return stuff to me, they way over kill it. I have received a 3 x 5 package of seeds back in a box that was 6 x 14 x 5. A small envelope would have done the trick. I could help them get back on track and become more profitable if given half a chance. Why? I have front line, practical experience. I did not learn this in an outdated book, in an outdated class, taught by a teacher who never spent a second on the front line.

  • Report this Comment On May 12, 2013, at 11:52 AM, yahoouser4529 wrote:

    i think i read this article several days back. Is this a repeat? it appears same articles are being re-run. No point in doing that

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