Amazon has a diversified business model. In 2019 the company posted over USD 280 billion in revenues and over USD 11.5 billion in net profits. Online stores have contributed to over 50% of Amazon revenues, followed by Physical Stores, Amazon AWS, Subscription Services, Third-party Seller Services and Advertising revenues.
While the core business model is based on its online store. Amazon has also launched its physical stores, which have already generated over five billion dollars in revenues in 2017.
Prime ( it's subscription service) also plays a crucial role in Amazon’s overall business model, as it makes the customers spend more and make them more loyal to the platform. Besides, Amazon also has its cloud infrastructure called AWS, which is a world leader and is a business with high margins.
Amazon also has an successful advertising business worth a few billion dollars. Thus, the Amazon business model mix looks like many companies rolled in one. Amazon measures its success via customer experience, lower prices, stable tech infrastructure and free cash flow generation.
Even though the USA represented the primary source of income for Amazon, it is expanding globally. Net sales have increased since 2014. In 2016 products represented close to 70% of total sales. Services sales have also been growing at a fast pace.
In terms of Operating Income, the growth is mainly driven by the high margins deriving from the services sales. If we look more in-depth at the revenue sources, subscription and AWS services have been growing. This denotes how Amazon is expanding globally by moving more and more toward services (like Prime subscription and AWS).
The fundamental principles that drive the company are:
The business model revolves around four main players
Consumers- They serve consumers through retail websites and focus on selection, price, and convenience. The company strives to offer customers the lowest prices possible through low everyday product pricing and shipping offers and to thus improve operating efficiencies so that they can continue to lower prices for the customers. They also provide easy-to-use functionality, fast and reliable fulfillment with timely customer service.
Sellers- Amazon offers programs that enable sellers to grow their businesses, sell their products on Amazon websites and their own branded websites and fulfill orders through the company. The company is not the seller of record in these transactions. Amazon earns fixed fees, a percentage of sales, per-unit activity fees, interest or some combination thereof, for these seller programs.
Developers and Enterprises- Amazon serves developers and enterprises of all sizes, including start-ups, government agencies as well as academic institutions, through the AWS segment, which offers a broad set of global compute, storage, database and quite a few other service offerings.
Content creators- Amazon serves authors and independent publishers with its Kindle Direct Publishing, an online service that lets the independent authors and publishers choose a 70% royalty option and make their books available in the Kindle Store, along with Amazon’s own publishing business arm, Amazon Publishing. The company also offers programs that allow authors, musicians, filmmakers, app developers and others to publish and sell content.
As far revenue generation is concerned, Amazon makes most of its revenues from the sales of products. However, these product sales also have high costs. Thus the margins Amazon makes on them is quite thin. Instead, on look at the operating income, one can see how this is fueled by the services, which comprises of seller services, AWS and subscription services.
The core business of the company is the foundation for other emerging businesses that run with a different logic to its online stores. Where online stores run at tight margins and high volume by taking advantage of the cash conversion cycles. Other parts of the Amazon business, like Amazon Advertising Services, Prime and Amazon AWS operate with much higher margins. Thus, Amazon’s online stores are the foundation for these other businesses that make the overall company more profitable in the longer run.
One of the main elements of the business model is the cash machine business strategy. In short, Amazon has operated for years at very tight profit margins on the online store. The company has willingly done so throughout so many years, as it made its prices low, made it more convenient compared to traditional physical stores and along with a fast and efficient delivery system, what Amazon calls fulfillment centers. Amazon collects payments quickly from customers, which it then pays to its vendors with relatively longer payment terms. This strategy gives Amazon short-term liquidity that it can invest back to speed up growth.
Amazon has also become a digital advertising provider. It has grown to be able to compete against the duopoly Google-Facebook. As of the first months of 2019, the Amazon advertising business netted more than six billion in revenues. With a huge infrastructure and many e-commerce hosted on Amazon, more and more entrepreneurs and marketers are willing to pay for Amazon advertising services. This part of the business has higher margins compared to the tighter margins of the online stores.
Like many other companies nowadays, Amazon has also shifted to the subscription business model. Amazon has converted part of its business to accommodate this major change. Prime is a critical component of Amazon’s growth strategy. The logic is quite simple, the more people join the Prime Memberships, the more products they purchase on the Amazon online stores. These members also enjoy faster delivery services besides the exlusexcl access to Amazon’s original content offered via streaming. This subscription model also creates a more stable and predictable income over a course of time.
What started as an experiment back in 2000, the Amazon AWS has now grown to become an over 17 billion dollars business by 2018. AWS also enjoys much higher margins and network effects. Amazon is doubling down on that as this business unit will be very critical to its future success.
Amazon financial model has always been structured. Rather than focusing on pushing profit margins, the company pushed to generate cash flows that could reinvest as much as possible in the growth of business, by being in a sort of continuous blizscaling-mode.
While today Amazon’s marginality has improved substantially, it is primarily due to other segments (AWS, Prime, and other revenue streams), while online e-commerce still generates higher margins compared to the other forms of revenue streams.
If we look at the current scenario, In Q1 2020, Amazon’s net sales have increased by 26.3%. Yet its operating income has decreased by 9.7% primarily due to a higher cost of sales (a 30% increase), incurred by Amazon due to the COVID pandemic, due to increased shipping and fulfillment costs and marketing expenses. Throughout the pandemic, Amazon has recorded a substantial increase in revenues that has also resulted in more cash from operating activities. However, this cash was spent from operations to expand shipping and fulfillment and from investing activities in increasing the capability of the Amazon tech platform (AWS).
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