Amazon.com's (NASDAQ:AMZN) advertising business is still relatively young. It launched a self-serve platform for ad purchases in 2014, and analysts have only recently started paying attention to it as a meaningful business for Amazon.
Amazon doesn't report its advertising revenue directly. Instead, it lumps in results with a few other small revenue sources, such as its co-branded credit card. But the Other category grew 58% year over year in the third quarter to $1.12 billion. That's above its $1.07 billion in Other revenue from the fourth quarter last year, and an acceleration from 53% year-over-year growth in the second quarter.
Amazon's advertising business has quietly surpassed Twitter's (NYSE:TWTR), and it's bigger than Snap's (NYSE:SNAP). While it's still well behind Facebook (NASDAQ:FB) and Google, it's one of the few platforms in digital advertising that's able to differentiate and compete against the duopoly.
A fast-growing, high-margin business
Amazon has one of the fastest-growing digital ad businesses in the United States. "Its year-over-year growth rate is actually faster than the other revenue line item," according to CFO Brian Olsavsky.
Indeed, eMarketer estimates that Amazon is the second fastest-growing digital ad business of any U.S. platform. The only competitor ahead of it is presumably Snap, which analysts expect to grow revenue 117% globally, slightly slower in the United States. That said, Amazon's ad business is already more than twice the size of Snap's.
Amazon's ad business is still relatively small compared with its retail businesses. Amazon's retail business, which includes its online marketplace, physical stores (including Whole Foods), and its third-party seller services, generated over $38 billion last quarter. Advertising probably brought in less than $1 billion. Other revenue totaled $1.1 billion.
But advertising is a high-margin services business. Amazon's North American retail business generated an operating margin of 0.4% last quarter. International retail lost 6.8% of sales after operating expenses. By comparison, Google posted an operating margin of 31.8% last quarter. Facebook's was 47% in the second quarter.
Amazon's ability to grow its service businesses such as advertising are the key to its future profitability. While the retail business produces the bulk of the company's revenue, it's a relatively low-margin business. That said, the size of its retail business supports smaller service business, such as advertising or its cloud computing business.
Why Amazon is better positioned than Twitter or Snap
Google and Facebook absolutely dominate the digital-advertising market. Not only are they the two largest platforms in the U.S., but they also combine to capture nearly all of the growth in the market. Twitter and Snap are providing similar audiences as Facebook, Instagram, and YouTube, but without all the great targeting data and measurement capabilities of Facebook and Google.
Amazon, meanwhile, has carved out a very valuable segment of the advertising market -- product search advertisements. Product searches are extremely valuable, because they indicate intent to buy. And if a person is searching for a product on Amazon, that intent-to-buy signal is even stronger. Combine that with all the shopping data Amazon has on its users and its ability to easily measure conversions (they take place on Amazon.com), and Amazon provides a very attractive ad platform.
Amazon absolutely dominates product searches. A survey last year found that 55% of product searches in the U.S. begin on Amazon.com. The Amazon app is the must-have app for millennials. And Alphabet's (NASDAQ:GOOG) (NASDAQ:GOOGL) Eric Schmidt once said Amazon is Google's biggest competitor.
Amazon's ability to attract the majority of product searches is an effect of its growing Prime membership. Consumer Intelligence Research Partners estimates that Amazon has around 90 million Prime members in the United States. That's nearly double where it was two years ago. As that number continues to grow, Amazon's ad platform becomes increasingly attractive to ad buyers, since it gives Amazon a stranglehold on extremely valuable ad inventory that once belonged to Google.
While Snap and Twitter have growing daily users on their platforms, they're largely attracting brand advertisers from TV. Those advertisers are more likely to spend on Facebook and Google first. But as product searches shift from Google to Amazon, it's clear to advertisers where they need to spend their money.