Amazon's (AMZN +0.14%) advertising business has gained a lot of attention over the last couple years as it has gone from practically inconsequential to a $10 billion segment. But investors eyeing the "Other" revenue line in the online retailer's recent first-quarter earnings report may be disappointed with the 36% growth (on a neutral-foreign-exchange-rate basis) when compared to growth of 132% in the first three months of last year.
Granted, Amazon's advertising growth numbers were artificially inflated last year by an accounting change. Even factoring in those changes, though, Amazon's growth rate was cut in half.
The 36% growth is well behind expectations for the full year. eMarketer, for example, expects Amazon's U.S. advertising revenue to increase 53% this year. Meanwhile, Facebook (FB 0.04%) grew its ad revenue 26% in the first quarter, and 29% in the U.S. and Canada. Amazon is barely growing faster than the duopoly it's supposed to be disrupting.
Should investors worry Amazon's ad business won't be as big as originally anticipated?
Image source: Amazon.
Ad load may be a problem
CFO Brian Olsavsky faced a couple questions on the advertising business during the company's first-quarter earnings call. When asked about ad load and inventory, he declined to offer an answer.
Instead, he focused on what the company is doing to build out the ad business for the future.
"What we're focused on right now is driving relevancy and ensuring that we surface the most useful ads possible," Olsavsky told analysts. "It's more right now about tools and making better recommendations, making it easier to use Amazon demand side platform, things like that, operational improvements."
Amazon's search result pages have become increasingly crowded with sponsored listings and brand promotions. Olsavsky's refusal to comment on ad load combined with anecdotal evidence suggests inventory is a real challenge for Amazon's continued growth. And his answer about making ads more relevant suggests the company sees increasing the value of ads (and by extension, the price marketers will pay for them) as its biggest opportunity going forward.
Facebook faces a similar challenge with its feed ads. Both News Feed and Instagram feed have reached ad load saturation, and the company is using growth in average ad prices as the key lever to increase ad revenue for its core business while marketers are still transitioning to Stories products. Facebook management often talks about how it's adding tools and making it easier for advertisers to improve their return on ad spending, which eventually results in higher average ad prices.
"I would just say we're early on in this venture," Olsavsky added later in answering another question on advertising.
Where will growth come from?
There are a few major avenues for growth in Amazon's advertising business going forward.
The first, as Olsavsky alluded to, is increasing the value (and by extension, the price) of its ads. It can do that by making them more relevant to users, providing marketers with additional measurement tools to track conversions, and showing advertisers incremental audience reach from Amazon over, say, Facebook.
Amazon could also increase the value of ads by offering new ad products. It's reportedly working on video ads within search results on mobile, which could prove more valuable than standard sponsored listing or banner ads at the top of results.
The second way to grow the business is to find new surfaces to display ads. Amazon is investing in ad-supported video on demand with projects like IMDb Freedive. It's also reportedly looking to expand on Freedive with additional ad-supported video channels. Amazon also just started offering ad-supported music streaming on Alexa-enabled devices.
Facebook has taken a similar approach by pushing advertisers to Stories. It's also tried -- less successfully -- to grow its video platform, Facebook Watch, as another way of increasing engagement and expanding its ad inventory.
Finally, Amazon's ad business stands to benefit from the secular shift in ad budgets from television and older media to digital. Digital ad spending is growing by about 10% per year in the U.S. and even faster internationally. With its broad-based user traffic and valuable targeting data, Amazon's ad inventory will be highly sought after by advertisers that currently rely on television.
Amazon still has a lot of opportunities left in advertising. So far, it has merely plucked all the low-hanging fruit. Now it needs to work to develop more advanced ad technology to take full advantage of the data at its disposal. Meanwhile, Amazon can look to expand its ad-supported products and services as another means of growth.
