One of the standout segments from Amazon.com's (NASDAQ:AMZN) first-quarter earnings report was its "other revenue" line item that totaled $2.03 billion.
Amazon doesn't break down its other revenue category, but says it "primarily includes sales of advertising services, as well as sales related to our other service offerings." That's a slight change from the previous wording -- "certain advertising services and our co-branded credit card agreements" -- indicating that advertising accounts for an even larger percentage of the other revenue category.
The distinction also reflects an accounting change that was responsible for a $560 million increase in the first quarter, as some advertising services are now being included in revenue instead of a reduction of costs to sales. Even after adjusting for the accounting change, Amazon's other revenue line item increased 72% year over year. That's a significant acceleration from the 62% increase Amazon saw in the fourth quarter.
A "strong contributor to profitability"
During the earnings call, CFO Brian Olsavsky noted that advertising "continued to be a strong contributor to profitability."
Indeed, the biggest reason to get excited about a measly $2 billion (if that) in ad revenue when Amazon just posted $51 billion in total revenue is because of the relatively high margin. Olsavsky pointed to advertising as a big reason for Amazon's significant increase in its North American operating margin in the fourth quarter.
Amazon's operating margin on its advertising business is extremely high. Consider Facebook (NASDAQ:FB) just posted an operating margin of 46% for the first quarter as it increases hiring, and builds out other products that aren't generating significant amounts of revenue.
What's more, Facebook builds its platforms almost entirely to accommodate ads. Amazon, comparatively, already has a platform for retail, and it's now choosing to run ads on it. The only marginal cost is setting up ad products, ad-buying tools, and a sales team to support it, which means Amazon is undoubtedly generating huge operating profit margin on every ad sale it makes.
Amazon's overall operating margin for the quarter was 3.8%, which was boosted by Amazon Web Services, its cloud computing division. North American retail sales (including most of Amazon's advertising sales) had an operating profit margin of just 3.7%, and total operating profits were $1.9 billion for the entire company. So, a couple billion dollars of sales with greater than 50% operating margin can have a massive impact on Amazon's bottom line.
The future of Amazon's ad business
One analyst on the earnings call called into question Amazon's ability to keep growing the ad business at such a rapid pace, citing ad load concerns. Olsavsky was also asked whether Amazon plans to advertise within Prime Video.
Olsavsky noted Amazon is "always balancing the helpfulness of the advertising and try not to make it disruptive. But you're right, there are always pressures, and in that we will come down on the side of the customer." In other words, Amazon won't sacrifice its customer experience and retail sales for ad sales.
That said, Amazon likely has plenty of runway for increasing ad inventory. The growth of mobile, where Amazon is extremely popular, has created a huge inventory boon for both Facebook and Alphabet's Google. Likewise, Amazon continues to grab more product searches -- although it ceded some market share back to Google last year. Most importantly, Amazon's ad business is still largely concentrated in North America, while its retail business is increasingly global.
With regard to ads in Prime Video, Olsavsky said the company has no plans for it at this time. The only exception is Amazon's ad inventory for Thursday Night Football, which it packaged with display ads last year. Still, that remains an opportunity for Amazon, and it could be used to increase the scale of Prime Video by offering a lower-priced ad-supported option, offsetting the fixed costs of content acquisition.
Amazon's ad business had a great quarter, accelerating sales growth and driving operating profits. Based on the number of opportunities still available, investors shouldn't expect a significant slowdown in its ad business anytime soon.