By Neil Saunders
On the sales front, this quarter was another stellar one for Amazon with the topline expanding by 29%. While the pace has slackened since last quarter it has only done so slightly and Amazon remains on a growth trajectory that is far steeper than the prior year. Despite the solid uplifts, the company has missed its earnings estimates by a wide margin and this will, inevitably overshadow the more positive news on sales.
Despite falling short on profit, Amazon did manage to increase net income by 218% on a year-over-year basis. However, this equates to making 0.8 cents on every single dollar taken, which is a rather paltry proportion. More disappointingly it undoes some of the recent progress Amazon has made on the profit front and puts it back to the same kind of position it was in at the end of the last fiscal. By way of contrast, last quarter Amazon made 2.8 cents on the dollar.
There is no single reason for the more lackluster profit figures, but a couple of things do stand out as having eroded the bottom line.
Amazon remains an impressive player. It is still growing its market share, especially in more embryonic categories like fashion, and is increasingly winning in grocery, albeit in a more limited way.
The first of these is fulfillment where costs increased more sharply than sales, with the gap between the two widening since the last quarter. In our view some of this is likely to be down to Prime Day which was, once again, very helpful in accelerating transactions, but also generated significant fulfillment costs because of the availability of free delivery as part of the Prime subscription package. This, once again, underlines the fact that online, while lucrative in terms of growth, volumes and takings, is far less effective at generating profit.
The second point of interest is marketing spend which increased with greater velocity than last quarter. Amazon did promote Prime Day, which had some costs attached, but we also believe that the company ramped up advertising of its devices like Echo. Although this impacted costs, the decision could well pay dividends over the holiday season if Amazon manages to persuade customers to buy its latest gadgets.
Alongside both of these things, Amazon continues to make extensive investments in new technologies and ventures. This is a deliberate part of its business model which uses income from sales to create future growth through innovation. Traditionally the market has tolerated this — much more so than they would tolerate it from a traditional retailer — but the disappointment over this quarter’s numbers may signal increased scrutiny in the years ahead.
Another slight concern buried in today’s announcements comes from the forward view of the critical holiday quarter. Amazon has given wide estimates for sales and profit growth, with the former slated to rise in the range of 17% to 27%. Even if it reaches the top end of these forecasts, this would still represent the worst performance in growth terms of this fiscal year. Admittedly, Amazon already dominates online holiday retail in the U.S. — accounting for 22.6% of all online retail spend over the final quarter of the year — which makes gaining further share a challenge. Even so, with its growth in segments like fashion, its new devices, and the continued rise in Prime membership, we believe the company should be setting its sights a little higher.
If slower growth does materialize during the final quarter it will inevitably act as a drag on profits. Not least because Amazon is ramping up its costs with more hires and is likely to still have above average marketing and fulfillment expense compared to prior final quarters.
The cool spots in today’s numbers do nothing to take away from the fact that Amazon remains an impressive player and a threat to many other retailers. It is still growing its market share, especially in more embryonic categories like fashion, and is increasingly winning in grocery, albeit in a more limited way.
Looking ahead we see no reason for the dominance of Amazon to diminish. Indeed, we see some positive gains from services like music and we believe that over the course of the next fiscal, devices like Echo will sell well and become a more integrated part of users’ lives.
We also see some heightened costs. If the rumors about Amazon opening a fleet of grocery collection points or mini-stores are true, these will exert downward pressure on the bottom line. This is especially so given that grocery is low margin and Amazon remains a small player in a sector that requires volume in order for the economics to stack up. The collection points may well bring that volume, but there will be a lag between them being opened and driving up sales. That said, over the longer term Amazon’s investment in physical should help it get a tighter grip on fulfillment costs: something that could be transformative in terms of bottom line performance.
In this regard, short term profit and sales blips do not matter: Amazon is playing the long game. And it is winning.
Neil Saunders is CEO of research firm Conlumino.