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3 Things About Amazon That Smart Investors Know

By Leo Sun – Dec 22, 2021 at 6:10AM

Key Points

  • Amazon’s advertising business could lure businesses away from Google and Facebook.
  • Its third-party marketplace might significantly boost its revenue and margins -- but it could also cause quality control issues.
  • Amazon’s Halo products and services could help it challenge Peloton, Fitbit, and Apple in the connected fitness space.

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Amazon's advertising business, third-party marketplace, and connected fitness business deserve a lot more attention.

On the surface, Amazon (AMZN -1.49%) is an easy company to understand. It generates most of its revenue from its retail business, but most of its profits come from Amazon Web Services (AWS), the largest cloud infrastructure platform in the world.

AWS' higher-margin revenue enables Amazon to expand its lower-margin retail ecosystem with steep discounts and loss-leading strategies. That ongoing expansion makes Amazon Prime, which surpassed 200 million paid subscribers globally earlier this year, even stickier.

An Amazon Go store.

Image source: Amazon

Amazon leverages its reputation as the 800-pound gorilla of the e-commerce and cloud markets to expand into newer markets like streaming video, streaming music, and video games.

But Amazon still has a lot of other moving parts. Let's take a look at three other important parts of its sprawling business that smart investors should pay close attention to.

1. Its advertising business could be the next AWS

Amazon owns the third-largest online advertising platform in the U.S. after Alphabet's (GOOG -0.74%) (GOOGL -0.97%) Google and Meta's (META -0.21%) Facebook, according to eMarketer.

Amazon quietly became an advertising leader by selling ads within its own online marketplaces and affiliated websites. Since many shoppers started their product searches on Amazon, more businesses started to buy ads within Amazon's online marketplaces instead of external websites.

Amazon doesn't break out its advertising revenue separately, but it accounted for most of its "other" revenue, which soared 49% year over year to $8.1 billion (7% of the top line) in its latest quarter. 

Amazon's advertising business likely generates higher operating margins than AWS, since advertising platforms like Facebook and Google typically generate higher-margin revenue than cloud platforms.

In other words, Amazon's advertising segment could become one of its core profit engines alongside AWS. If that happens, Amazon might consider spinning off AWS to split its retail and cloud businesses.

2. Its growing dependence on third-party sellers

In Amazon's earliest days, its online marketplace was a first-party platform that took on all of its inventories and fulfilled its own orders. But over the past two decades, it expanded its third-party marketplace to reduce its own expenses and broaden its product selection and geographic reach.

Amazon now generates most of its revenue from third-party sellers through commissions and fulfillment fees. In its latest quarter, its revenue from third-party seller services increased 18% year over year to $24.3 billion, or 22% of its top line. That's up from 21% in the prior-year quarter, and just 17% of its full-year revenue in 2016.

Amazon's growing dependence on third-party sellers exposes it to two long-term challenges. First, low quality, fake, and dangerous products could seep into its third-party marketplace as it courts more merchants in China and other overseas markets.

Second, Amazon's domestic merchants could struggle to match the cheaper prices of those overseas sellers. That cutthroat competition could force those sellers to leave Amazon's crowded third-party marketplace and set up their own stores on Shopify instead.

Therefore, Amazon's third-party marketplace is a double-edged sword. It might boost its revenue and margins, but it could also tarnish its reputation while attracting unwanted attention from regulators.

3. Its connected fitness ecosystem is expanding

Most discussions about the connected fitness market revolve around companies like Google's Fitbit, Peloton, and Apple. However, Amazon also jumped on the bandwagon a year ago with its Halo fitness tracking devices and apps. 

Earlier this year, Amazon launched its second-generation Halo View band, which tracks a user's heart rate, skin temperature, steps, and other health data on an AMOLED screen. It also rolled out two subscription-based health services, Halo Fitness and Halo Nutrition, which will compete against similar services like Fitbit Premium, Peloton's All-Access, and Apple's Fitness+.

Amazon probably won't generate much revenue from these new devices and services, but they'll tether its users even more tightly to its ecosystem -- which already includes its online marketplaces, Prime digital media services, Alexa-powered devices, and Fire TV streaming media products.

Amazon is still a great long-term investment

Amazon's stock remained relatively flat year-to-date as investors fretted over tougher comparisons for its e-commerce business in a post-pandemic market. However, Amazon's e-commerce and cloud businesses are still well-insulated from inflation, and it should remain a dominant force in both markets for the foreseeable future.

Amazon's core business is still firmly rooted in its online marketplaces and AWS, but investors should also pay attention to how its advertising platform, third-party marketplace, and connected fitness services could expand and strengthen its ecosystem over the long term.

Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool’s board of directors. Randi Zuckerberg, a former director of market development and spokeswoman for Facebook and sister to Meta Platforms CEO Mark Zuckerberg, is a member of The Motley Fool's board of directors. John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Leo Sun owns Amazon and Apple. The Motley Fool owns and recommends Alphabet (A shares), Alphabet (C shares), Amazon, Apple, Meta Platforms, Inc., Peloton Interactive, and Shopify. The Motley Fool recommends the following options: long January 2022 $1,920 calls on Amazon, long January 2023 $1,140 calls on Shopify, long March 2023 $120 calls on Apple, short January 2022 $1,940 calls on Amazon, short January 2023 $1,160 calls on Shopify, and short March 2023 $130 calls on Apple. The Motley Fool has a disclosure policy.

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