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Perspectives on building technology businesses and AcceleratorIndia from Cartezia

Amazon remains under pressure despite growth

Sunday, January 13, 2008, a US Fortune 500 company is the recognised global brand leader in internet retailing, with annual revenues over $15bn in 2007. It has grown customers, products and revenues consistently over the last decade, but did not record a profit until 2004. Over the last 3 years, profit performance has been far from impressive, with an average margin of just under 3% of total revenues. In spite of creating the formats and standards widely used in online retailing, Amazon now faces competitive threats from the major 'bricks and mortar' retailers such as Walmart and Tescos who are rapidly becoming large players in e-tailing.

Amazon has been a pioneer in the development of online retailing, developing many of the innovations we now take for granted when we search for, and buy, goods and services on the internet. Since it first opened its 'online doors' in 1995, it has consistently grown revenues year on year, as it has added more categories, products and customers, and expanded globally.

In spite of this first mover advantage, margins at Amazon have always been under pressure, and the constant mantra from Jeff Bezos, it's founder, has always been about 'building for the long term'. Amazon did not make its first profit until 2004, when it recorded a margin of 8.5% and promised to improve on this to deliver double-digit margins. Over the last three years, the profit margins have been 3.9%, 1.8% and 3.2%, and it is now clear that its relatively high cost model based on running its own warehouses and systems needs to keep growing volume to sustain profitability. 

Despite the managment teams constant emphasis on building for the long term, Amazon's performance relative to other 'internet' performers remains poor. The reality is that margins in retailing are much lower than in advertising or financial services, witness the much bigger profit margins achieved by Google and PayPal.

In order to protect and grow its business, Amazon has expanded into a range of related areas. Its operations now span the following areas:
  • The provision of branded retail web-sites across Europe, where customers transact directly with Amazon
  • Third-party seller sites operated by Amazon, where it is not the seller of record, but earns fixed fees, sales commissions, and transaction-based fees. Amazon Marketplace serves individuals and small businesses, enabling them to offer their products for sale alongside Amazon products. The Merchants@Programs serves larger, branded businesses
  • Provision of services to 3rd party retailers, including fulfilment services
  • Marketing and Promotional Services aimed at increasing traffic to retail sites
  • Web services for Developers, including Amazon Simple Storage Service, Amazon Elastic Compute Cloud, Amazon Simple Queue Service, Amazon Mechanical Turk, Amazon E-Commerce Service and Alexa's Web Services
  • Operation of 3rd party web-sites and Databases

As a consequence of these wide range of services, Amazon has diversified revenue streams covering the online shops, web services, technology platforms, the online music download service, widgets and affiliate fees. The core retailing business, however, remains under volume and margin pressures. Percentage margins have stubbornly refuse to improve, and are lower than many bricks and mortar retailers.

Emerging Competitors

The pressure on Amazon is set to increase as several big 'bricks and mortar' retailers have announced plans to expand their online operations. Walmart, which aleady claims over $2 bn of online sales, aims to emulate Amazon by growing its online activities in Asia and South America. To put this competition in context, Walmart reported 2006 revenues of $351 bn, with pre-tax profits of 3.2%, about the same level managed by Amazon in the same period. Tesco, the UK retailer, and Carrefour, the French retailer, have similar e-commerce ambitions, particularly in China and India.