Amazon case study

26 January,2015

Amazon: Marketing Success or Financial Failure?

UCD Michael Smurfit Graduate School of Business MKT40620: Corporate Marketing Strategy

08 Fall

Student name: Mai Pham Student ID: 14201496

Mai Pham Amazon: Marketing Success or Financial Failure?

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Executive Summary Founded in 1995, Amazon has transformed from an online bookstore to one of the largest e-commerce businesses in the world. The company has also become a textbook example of disruptive innovations, excellent corporate management, optimized logistics and exceptional marketing. Yet despite all these exciting hype, Amazon is also unique in a more perplexing way: it has consistently generated billions of dollars in revenue yet barely turned a profit. This reports sets out to examine Amazon’s success, or lack thereof, from a marketing and financial perspectives. The report starts off with an assessment of the company’s top-line market performance, followed by bottom-line financial indicators, taking into account Amazon’s cost structure and long-term strategic focus. At first sight, it is found that Amazon cannot be considered a success either from a conventional marketing or financial standpoint, as both require a measure of profitability. However, a closer examination of the company’s long-term direction set against the e-commerce market as a whole reveals that Amazon’s actual performance cannot be accurately measured using current indicators, as the company makes a deliberate strategic choice to sacrifice short-term profitability in order to invest in long-term sustainable growth. The report recommends that in order to achieve this goal, it is imperative for Amazon to make well-calculated investment decisions with careful planning and strong strategic focus. Business model: Jeff Bezos founded Amazon as an online bookstore in 1997. Over almost 20 years, Amazon has grown into one of the world's major e-commerce retailer, with global net revenue totaling $75.5 billion by the end of 2013 (Amazon, 2014) Amazon’s consumer base consists of retail consumers, third-party sellers and enterprises who make use of Amazon web-enabled services. The company primarily generates its revenue from selling merchandise and content to direct consumers and providing sales and fulfillment services to third-party sellers. Amazon also manufacturers and sells its own Kindle e-book reader and recently introduced Kindle Fire tablet, Fire TV streaming box and fire phone. With its mission of "being Earth's most consumer-centric company", Amazon builds its value proposition around three pillars: low price, great selection and exceptional convenience to consumers (Amazon, 2014) Market performance: Amazon boasts some of the best top-line indicators in the e-commerce business. In 2013, Amazon’s total e-commerce sales was the highest among US online retailers at $67.86 billion, more than the next 9 companies combined (Figure 1). Considering that the US total e-commerce sales was $263.3 billion (see Appendix 1), Amazon contributed roughly 25.8% total sales. Figure 1: The 10 largest U.S. online retailers in 2013 (based on worldwide online sales)

Source: Statista, 2014


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Amazon’s annual growth rate for 2013 was 20.4%, while the US e-commerce market grew by 16.9% (see Appendix 1 and 2). As figure 2 indicates, Amazon also grows faster than the US e-commerce industry as whole Figure 2: Amazon’s North America revenue growth compared to U.S e-commerce and store sales growth

Quarter E-commerce Stores Amazon Q1 2013 15.1% 3.6% 26% Q2 2013 17.7% 4% 30% Q3 2013 17.6% 4% 31% Q4 2013 15.7% 3.1% 26% Q1 2014 15.5% 1.7% 26% Q2 2014 15.7% 3.7% 26%

Source: Amazon Annual Report 2013, Quarterly Reports 2014, Internet Retailer 2014 In comparison, Walmart Online store, identified as Amazon’s rising competitors, lagged behind both in terms of sales volume and growth rate Figure 3:

Source: Internet Retailer, 2014 Amazon’s phenomenal growth has been attributed to a number of factors, the most notable of which is its relentless consumer focus. In order to consistently deliver on its value proposition of low price, large selection and exceptional convenience, Amazon has invested heavily in optimizing its operations both upstream and downstream. According to a 2013 report on global e-commerce by Morgan Stanley, Amazon operated the largest fulfillment network in existence with 87 fulfillment centers around the world. This number has increased to 139 by the end of 2014 (MWPVL International, 2015). Amazon’s fulfillment network has enabled the company to offer same-day, Sunday shipping, as well as free two-day shipping for Amazon Prime members. Amazon also opens its own platform to its smaller competitors, third-party retailers, which enables end consumers to have access to a large merchandise collection, select items that best suit their needs and at the most competitive price (Anon., 2012). Its e-commerce site is characterized by a number of innovations, some of which have now become industry standard: a search engine that enables consumers to look for products easily, recommendations of similar purchases that users might be interested in, price-comparison and order-tracking capabilities, “Look inside the book” and “Search inside the book” features, as well as “1-click” ordering which streamlines the order process and avoids the loss of consumers along the purchase funnel (see Appendix 3 for “1-click” ordering) By the end of 2013, Amazon was able to built up a user base of around 237 million active users (Appendix 4). As figure 4 indicates, Amazon is also the most popular e-commerce website in Q3/2014


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Figure 4:

Source: Statista, 2014

Financial performance:

Amazon’s bottom line indicators, however, are not too rosy. In 2013, net profit was a meager $274 million, representing a 0.4% net profit margin. Latest financial results in Q3 2014 show that while net sales increased by 20%, Amazon incurred a net loss of $437 million, representing a -2% profit margin (see Appendix 5 for selected financials).

This is not an isolated quarter but an ongoing trend. Figure 5 shows that while net revenue more than tripled from 2008-2013, profit margin had decreased by 100% to virtually zero.

Figure 5:

Source: Seeking Alpha, 2014


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In 2013, the company has the lowest net margin among big-box retailers:

Figure 6: Net margins among major retailers

Source: Jackdaw Research, 2014

To understand Amazon’s lack of profitability despite substantial revenue, this report examines the company’s strategic direction and cost structure.

Strategic focus

Amazon makes clear that its top strategic focus is placed on extending and solidifying market leadership, which the company believes will translate into higher revenue, higher profitability and shareholder value over the long term (Amazon, 2014)

Therefore, the metrics that matter to Amazon are not the year-on-year conventional bottom-line profitability indicators, but those that are “most indicative of our market leadership: customer and revenue growth, the degree to which our customers continue to purchase from us on a repeat basis, and the strength of our brand” (Amazon, 2014), all of which require substantial investments.

Also for this reason, Amazon believes free cash flow1 is a better indicator than profit margin (Amazon, 2014), as it shows how much money the company has left from its operations to reinvest in activities essential to increase sales, expand customer base and gain market share. Positive free cash flow is an indicator of the company’s operating efficiency. According to figure 6 and 7, Amazon’s free cash flow was $2.0 billion for 2013, compared to $395 million and $2.1 billion for 2012 and 2011. As Fox (2014) points out in his Harvard Business Review article, Amazon reinvests all of these earnings into fueling growth, which accounts for large costs and razor-thin profit margin. Figure 6: Cash flow statement

1 Free cash flow, a non-GAAP financial measure, is defined as net cash provided by operating activities less cash expenditures for purchases of property and equipment, including capitalized internal-use software and website development (Amazon, 2014)


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Source: Amazon Annual Report 2013 Figure 7: Amazon’s operating cash flow, free cash flow and net income, 2004-2013

Source: Harvard Business Review, 2014 Cost structure: According to figure 8, fulfillment cost consistently accounts for the largest percentage of net sales, as the company invests aggressively in fulfillment infrastructure. Figure 8:

Source: Jackdaw Research, 2014 The e-commerce business in the USA currently accounts for 6.4% of total retail sales, with double-digit growth prediction in store for the next 5 years (Appendix 1). The potential for growth is therefore enormous and largely un-tapped. In the e-commerce marketplace, achieving scale is central to achieving profitability, which in turn depends critically on fulfillment infrastructure (Morgan Stanley, 2013). Fulfillment networks are highly capital-intensive, and Morgan Stanley estimates that Amazon has invested $8-10B in its fulfillment network, not


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counting planned upgrades and repairs. Such investments are essential to maintaining Amazon’s market leadership, which also presents a major barrier to entry for would-be competitors (Morgan Stanley 2013). In addition to fulfillment, Amazon has made a variety of other investments in attempts to grow its customer base. Investments into hardware such as Kindle reader, Kindle Fire tablet, Fire phone and Fire TV streaming box are intended to lock users into an Amazon’s eco-system in which users use Amazon devices to purchase Amazon’s products and consume Amazon’s content (similar to Apple with its iPhone, iTunes, iPad and Macbook empire). This explains why Amazon has been selling its hardware at production cost and therefore makes no profit from these devices (Clay, 2012; Yglesias, 2014). All in all, Amazon has deliberately re-invested most of its substantial earnings into expanding its customer base and generating sales growth, albeit at the cost of low and even negative profit margin, with a strategic goal of translating scale into sustainable long-term profitability. It is worth noting that Amazon can choose to turn a quarterly or yearly profit should it reduce its investments, but that would potentially have negative impacts on sales growth and market share in the longer term. Conclusion and recommendation From the above analysis, Amazon cannot yet be considered a marketing or financial success, as both require a measure of profitability. Amazon itself admits that profitability, albeit not a short-term consideration, is the ultimate long-term end result (Amazon, 2014). Yet, as the analysis indicates, it is up to Amazon to decide at which point in the future it will have acquired enough scale to stop investing in growth and start turning profit. It is impossible to tell at the moment when such decision will be made and to which extent it will affect sales growth. It is certain, however, that judging Amazon from its current bottom-line indicators would be premature. Investor confidence has always been a good indicator of a company’s performance, and Amazon remains an attractive stock option despite its meager profitability (see Appendix 6 for stock prices). It appears that investors, like Amazon itself, are equally betting on the company’s investment in its long-term market leadership rather than current profitability. In line with this trajectory, this report recommends that Amazon make careful strategic investments in order sustain market domination. Expansions into digital content, grocery and hardware should be planned and executed with a clear strategic purpose and commercial viability. Amazon’s launch of the Fire phone, for instance, was considered a commercial failure when faced with intense competition from market leaders such as Apple and Samsung, even though it had a clear purpose of helping to funnel mobile shoppers to Amazon’s online store by making it easier to find and buy products.

Therefore, this report concludes that any measurement of Amazon’s success would have to be based on future, rather than current, performance, which very much depends on how well its costly investments will pan out in the long-term.


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Works Cited 1. Amazon, 2014. 2013 Annual Report. [Online] Available at: http://phx.corporate-ir.net/phoenix.zhtml?c=97664&p=irol-reportsAnnual [Accessed 23 January 2015]. 2. Anon., 2012. Learning from Amazon's success: Five‐point guide to get in the customer's shoes. Strategic Direction, 28(4), pp.19-21. 3. Clay, K., 2012. Amazon Confirms It Makes No Profit On Kindles. [Online] Available at: http://www.forbes.com/sites/kellyclay/2012/10/12/amazon-confirms-it-makes-no-profit-on-kindles/ [Accessed 22 January 2013]. 4. Dawson, J., 2014. Beyond Devices. [Online] Available at: http://www.beyonddevices/2014/07/24/thoughts-on-amazon-earnings-for-q2-2014/#disqus_thread [Accessed 22 January 2015]. 5. Fox, J., 2014. At Amazon, It's All About Cash Flow. [Online] Available at: https://hbr.org/2014/10/at-amazon-its-all-about-cash-flow/ [Accessed 22 January 2015]. 6. Internet Retailer , 2014. Amazon grows faster than U.S. e-commerce. [Online] Available at: https://www.internetretailer.com/trends/e-retailers/amazon-grows-faster-us-e-commerce/ [Accessed 22 January 2015]. 7. Internet Retailer, 2014. Amazon vs Walmart Online. [Online] Available at: https://www.internetretailer.com/trends/e-retailers/amazon-vs-walmart-online/ [Accessed 22 January 2015]. 8. Morgan Stanley, 2013. eCommerce Disruption: a Global Theme - Transforming Traditional Retail. Morgan Stanley Blue Paper. 9. MWPVL International, 2015. Amazon global fulfilment center network. [Online] Available at: http://www.mwpvl.com/html/amazon_com.html [Accessed 22 January 2015]. 10. Richter, F., 2014. Amazon's Online Sales Dwarf the Competition. [Online] Available at: http://www.statista.com/chart/2214/10-largest-online-retailers/ [Accessed 22 Jan 2015]. 11. Seeking Alpha, 2014. A Bearish Change In The Amazon.com Post-Earnings Trade. [Online] Available at: http://seekingalpha.com/article/2374095-a-bearish-change-in-the-amazon-com-post-earnings-trade [Accessed 22 January 2015]. 12. Statista, 2014. Most popular retail websites in the United States as of 3rd quarter 2014, ranked by visitors (in millions). [Online] Available at: http://www.statista.com/statistics/271450/monthly-unique-visitors-to-us-retail-websites/ [Accessed 22 January 2015]. 13. Yglesias, M., 2014. The Prophet of No Profit. [Online] Available at: http://www.slate.com/articles/business/moneybox/2014/01/amazon_earnings_how_jeff_bezos_gets_investors_to_believe_in_him.single.html [Accessed 22 January 2015].

Amazon case study

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