Amazon’s Next Big Thing

Amazon's latest venture combines Amazon Web Services with its Marketplace selling platform.

Jan 22, 2014 at 8:59AM (NASDAQ:AMZN) has come a long way from just selling books online. As an online retailer it dominates e-commerce to such an extent that Amazon is now bigger than the next dozen Internet retailers combined.

And Amazon is so much more than an online retailer. Over the last decade Amazon has transformed itself from just an online retailer to a technology company and e-commerce platform.

Third party Marketplace
Its Marketplace Sellers and Fulfilled by Amazon (FBA) program provide a platform for millions of small businesses to sell through on an equal footing to much larger retailers. Some $70 billion worth of goods are sold each year, netting Amazon billions of dollars in relatively higher margin revenue as compared to non-third party sales.

Amazon's Marketplace now rivals eBay's (NASDAQ:EBAY) in size and is growing at nearly 30% a year compared to only 15% for eBay's marketplace. In my view this is the principal reason why investors have become so excited about Amazon's stock over the last couple of years.

Amazon Web Services
Launched in 2006, Amazon Web Services (AWS) allows websites to rent computing and storage services from Amazon instead of hosting their websites on their own servers. Customers of AWS include everyone from Netflix to DropBox. AWS is on track to do $3.2 billion in revenue during 2013 and is growing at over 100% a year.

I'm not quite as enthusiastic about AWS as I am about Amazon's Marketplace platform. The problem with Infrastructure as a service, (IaaS) is that by its very nature there are few barriers to entry. Both Google and Rackspace Hosting (NYSE:RAX) offer their own computing services in this space and Amazon is required to constantly slash its prices to keep its competitors at bay.

Still, some analysts believe AWS could be worth as much as $50 billion by 2015. This isn't as crazy as it sounds since that's a multiple of slightly over 6X 2015's revenue of $8 billion. That's a higher multiple than the 3.4 price to sales given to Rackspace Hosting, but Rackspace Hosting is only growing at 15% per year.

There's one further reason to get excited about AWS and that's what I consider to be Amazon next big thing.

AWS Marketplace
Yes, Amazon is now allowing third party software companies to sell their services through the AWS platform, in return for a 20% cut. These services can either be priced on a usage basis, like AWS is, or by charging for a period of time-$99 per month, for example. This will generate much higher margins than what AWS is currently capable of. There are currently some 1110 different software products available and usage of the marketplace is projected to increase by over 700% over the next two years. Why is the Marketplace version of AWS so powerful?

As AWS Marketplace grows it will establish network effects: buyers will gravitate to the marketplace because that's the platform with the greatest variety of software offerings, and sellers of computing services will want to choose AWS Marketplace because that's where all the buyers are. This positive feedback loop is responsible for eBay's success in auctions and to an increasing extent, Amazon's success in its Sellers Marketplace.

How much could AWS Marketplace generate in revenue? Analysts predict that by 2015, 13% of AWS's total revenue will come from AWS Marketplace and account for 40% of AWS's value.

The bottom line
It's easy to have doubts about owning Amazon, given the company's rich valuation metrics. What investors in Amazon need to look for are signs the company is making good progress in new business areas, outside its bread and butter retail operations. Success in Amazon's third party sellers' platform, AWS and now AWS Marketplace, should go a long way to assure Amazon bulls that the company can still continue to innovate and to grow. 

Fool contributor Nathan Brooks has no position in any stocks mentioned. The Motley Fool recommends, eBay, and Rackspace Hosting. The Motley Fool owns shares of and eBay. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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