For the last decade Amazon.com (NASDAQ: AMZN ) has been the quintessential example of a company that's unfazed by the typical wants of Wall Street to boost profits. The company has said time and time again that it is focused on the future, making investments to become larger long term. But with $80 billion plus in 12-month revenue, the future is now, and investors want profits, as evidenced by the company's 10% stock decline during its last quarter. Thankfully, Amazon appears ready to give investors a solution, coming at the expense of Google (NASDAQ: GOOG ) (NASDAQ: GOOGL ) and Facebook (NASDAQ: FB ) , without hurting the consumer's wallet.
The Amazon problem
Amazon customers have grown to expect the lowest prices combined with the fastest and most convenient shipping options. But in an e-commerce segment that continues to grow more crowded, Amazon must keep making investments to ensure that it stays one step ahead of the competition.
The problem with building new fulfillment centers, investing in drones, and offering free shipping on many of its products is that costs remain high. During its last quarter, Amazon's revenue grew 23.2% to $19.3 billion, but selling, general, and administrative costs rose nearly 33% while research and development costs increased more than 40% year over year, thus driving margins lower.
The Amazon solution
So, Amazon must find a way to keep making these investments to maintain growth, but it also needs a large high-margin segment where it can earn profits to satisfy investors. With that said, The Wall Street Journal reported last Friday that Amazon is preparing its own online advertising platform that will be used on both its own site and for third-party sites.
Those who use Amazon have likely noticed suggestions and advertisements on the site. In the past, Amazon has used Google's platform for this service; Amazon is one of the search giant's largest customers. Therefore, it makes sense that Amazon would cut the costs associated with using Google's platform, create new revenue by allowing advertisers to use an Amazon advertising platform, and expand to third-party sites if the demand exists.
Why will this lead to profits?
While it is impossible to know how significant Amazon's new advertising platform will become relative to its e-commerce business, investors do know there is a big difference between margins in both industries. Specifically, Amazon has an operating margin of only 0.76% during the last 12 months, with nearly 95% of revenue coming from its core business.
Meanwhile, Google and Facebook, which earn the majority of their revenue from advertising, have operating margins of 23.4% and 43.5%, respectively. In fact, Amazon has created only $180 million in net income during the last 12 months, despite $81.7 billion in revenue. On the other hand, Facebook has net income of $2.37 billion with only $10 billion in revenue. Therefore, this would be a wise move on behalf of Amazon, a company with a lot of site traffic, to enter a high-margin low-cost business.
Already, we know there is great advertising demand on Amazon's platform, judging by it being one of Google's largest customers. However, let's just say it creates revenue of $2 billion by 2016 from advertising with a profit margin of 20%. This theoretic example would earn $400 million in profits, and would increase the company's overall margin three-fold!
Amazon could very likely grow into an advertising juggernaut, with many billions in quarterly revenue from the segment, which would clearly be great for shareholders. However, the big winner here is the consumer, who can be assured that Amazon can continue to keep prices low, make its services even better, while at the same time satisfying Wall Street's recent demands.
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