The Amazon Web Services (AWS) segment continues to grow in importance for Amazon's (NASDAQ:AMZN) overall bottom line. For example, in Amazon's third quarter, AWS's operating margin (segment net sales minus operating expenses) came in at $1.17 billion, up from $861 million in the year-ago quarter. Better yet, these results were on total revenues of just $4.58 billion.
Amazon's North American retail segment, on the other hand, reported revenues of $25.45 billion and operating income of just $112 million (down from Q3 2016's $255 million).
But it's important for investors to keep in mind that, beyond AWS, Amazon's segments are extremely low margin. In fact, Amazon's international division actually lost $936 million in Q3 2017. Until it scores a win with another one of its businesses, Amazon will be dependent on AWS.
AWS vs. retail
AWS' rise over the past 3 years has been meteoric. Formed just ten years ago, it was broken out from the rest of the company's results in the first quarter of 2015. As part of that report, investors learned that for the previous year (FY 2014), AWS generated operating income of $458 million. Just two years later, in FY 2016, AWS generated a staggering $3.1 billion in operating profits on revenues of $12.22 billion.
Compare these results to the part of Amazon we are all familiar with: its domestic retail operation. Its North America segment generated $360 million in profits in 2014 and $2.36 billion in FY 2016. Decent, but nowhere near AWS's level. Last years results were at $79.79 billion in revenue.
When you buy shares of Amazon you own the whole company, but AWS's ability to generate billions in operating cash flow remains an increasingly pivotal contributor to the company's bottom line. The Amazon bull case revolves around the idea that Bezos & Co. will continue to disrupt any business they believe they can compete in. Only when Amazon attains dominant market share and operational scale in a given market will the company consider harvesting profits. Bezos said as much in his first letter to shareholders in 1997.
Bears, however, have pointed out that practically since the beginning faith in Amazon's plan is required by anyone who buys the stock. Further, they note that Amazon shares are impossible to value based on conventional financial metrics. Should Amazon fail in its quest for world domination, the whole thing could come crashing down.
To combat these perfectly reasonable criticisms, Amazon continues to use profits from it successes (like AWS) to expand its economic moat and enhance the value of its ecosystem. Its flagship North American retail operations are proof that Bezos & Co.'s strategy is working: the division was unprofitable for years, but is now solidly in the black.
Foolish bottom line
AWS's enormous operating margins and ability to pick up the slack for less profitable segments is exhibit A in the bull case. It is the dominant cloud service provider and produces billions in free cash flow because of it. Should any other AMZN business achieve similar market dominance, bountiful profits will likely follow.
Amazon's growth story is intact. For now, the company is over-reliant on Amazon Web Services to prop up the bottom line, but if Amazon's management can use AWS's profits to turn other divisions into similar success stories that won't always be the case.
John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Sean O'Reilly has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Amazon. The Motley Fool has a disclosure policy.