Amazon in 2015

After a break for Christmas, I’m continuing my series on major tech companies in 2015. You can read the previous ones here: Apple, Microsoft, and Google. Today, I’m tackling Amazon. I’m going to keep the series going for at least another week or two – I’ve had some input from readers on which companies should be next, but feel free to chime in through the comments if you have a suggestion. I’m going to start with Amazon’s e-commerce business, and then move on to the other aspects of its business.

E-Commerce – Amazon’s unprofitable core

I’ve written before about the importance for successful consumer technology companies to have a highly profitable core and Amazon continues to be the exception to this rule among the big companies. Amazon’s core – e-commerce – makes up over 85% of its revenue and yet it’s not just moderately profitable but actually unprofitable. The challenge for Amazon is retail is an inherently low margin business and Amazon is dealing with the task of rapidly growing that business — which means making huge investments. The year 2014 saw increased investments across various areas and, as a result, Amazon dipped even further into the red than usual. I don’t see any change in this pattern in 2015. Amazon’s heavy investments in building additional capacity in more large markets such as the US and building basic infrastructure in some of its new markets will continue to drag down profitability. The big test will be whether investors continue to believe this scenario can change some day – there were certainly signs in 2014 some had lost patience. I continue to be skeptical that the point will ever come when Amazon can slow this investment and turn significant profits in e-commerce.

E-commerce in emerging markets – an uphill battle

Some of Amazon’s biggest investments are going into new markets such as China. However, in those markets, it faces formidable domestic competitors such as Alibaba in China and the much smaller Flipkart in India. It also faces very different models for online retail, with Alibaba and China in general favoring third party rather than first party fulfillment. It’s a model Amazon understands, but certainly not the main model Amazon has used elsewhere. Amazon has dominated e-commerce in certain Western countries, but it’s unlikely to be able to replicate that dominance in these new markets. Therefore, it’s questionable whether they can derive the same scale and scope of benefits it does in the US and other established markets. Meanwhile, building an equivalent infrastructure in a massive country like China, especially with the expectations its citizens have for timely delivery, will be almost impossible without the scale to justify that investment. In the US and other markets, Amazon pioneered a new model but, in these markets, it’s playing catch up.

Mobile e-commerce – Amazon’s Achilles heel

Another major weakness, in China in particular but also in many of these other emerging markets, is Amazon’s relative shortcomings in mobile e-commerce. The vast majority of Amazon’s transactions are completed on PCs rather than mobile devices and it has failed to build equivalent dominance in mobile e-commerce. Conversely, the mobile share of Alibaba’s revenue has risen from under 10% two years ago to over 30% today and continues to rise rapidly. Alibaba has successfully made this transition. Amazon has not. That’s partly a reflection of overall preferences among the users Amazon serves in its existing markets, but as user behavior there shifts to mobile devices, Amazon still needs to find a way to better meet those needs. The Fire Phone (more below) was clearly an attempt, in part, to change this but was a disaster for the company. 2015 is a key year for Amazon to figure out how to build a successful mobile e-commerce platform.

New domestic competition from Google and others

Amazon’s other problem is focused competitors have started to pick off some of the low hanging fruit and they’re doing it with a rather different business model. Whereas Amazon’s dominance and differentiation have been predicated on its massive investment in infrastructure, new competitors in the US market have leveraged existing third party warehousing and retail facilities while focusing on delivery. Whether it’s Google Express, Instacart, Zookal or Postmates (and potentially Uber), a variety of companies are focusing on areas Amazon doesn’t currently serve well and are doing so very effectively. Amazon is responding in kind with its own initiatives, including its own grocery delivery service and same day and Sunday deliveries in certain markets, but it’s always tough for a competitor that thrives on scale to compete on a focused, local basis. Meanwhile, many of these competitors are targeting what are likely Amazon’s most lucrative markets. In 2015, Amazon will have to demonstrate it won’t suffer the death of a thousand cuts as these competitors increasingly take share in key categories.

First-party hardware: a failing strategy

Amazon has had one massively successful first party hardware line — then there’s all the rest. Its successful line, of course, is the Kindle, which benefits from three key characteristics: it’s exclusive, it’s cheap, and it’s tied directly to purchasing Amazon’s content, and only Amazon’s content. Though Amazon has tried to replicate its success in e-readers in other device categories, it’s largely failed. Tablets were a temporary success early on when Amazon was able to undercut the competition on price (there’s that cheap characteristic again) but, as other Android-based tablets got better and cheaper, its brief advantage was eliminated. Meanwhile, tablets were open devices, allowing customers to download whatever content they wanted rather than just content from Amazon, which prevented Amazon from using the razors-and-razor-blades model it used with the Kindle. The Fire Phone, of course, was a complete flop, and the Fire TV has sold in small numbers too (though, once again, the Fire TV Stick, a cheap device, seems to have done better).

In 2015, Amazon has some major decisions to make about its first party hardware strategy. It’s becoming increasingly clear the Kindle was something of a one-off as successful first party hardware for Amazon, and the three characteristics that made it both appealing to customers and for Amazon simply don’t apply to the other categories it’s entered. Amazon neither makes lots of money from this hardware directly nor does the hardware drive sales of other products Amazon sells. So what’s the point? I expect Amazon will continue to produce both Fire tablets and Fire Phones in 2015, but it shouldn’t. There’s no good strategic reason for Amazon to continue to produce its own hardware when it doesn’t compensate for the problems that hardware causes for the company. The one exception may be the TV space, where Amazon has at least done something different by attacking both the video and gaming. I also think some of its other devices, like the Dash and the Echo, are at least innovative, and may have a role going forward.

Fire OS and the App Store: Amazon’s consumer platform

Closely tied to first party hardware, of course, are two other Amazon initiatives: Fire OS and the Amazon App Store. Both are necessary to Amazon’s current first party hardware strategy, but neither has great strategic value independently. Amazon has recently attempted to make the App Store more readily available on Android devices directly, but Google appears to be pushing back on this effort. Third party app stores have done well in certain countries on Android, but typically not those where Amazon has historically been successful. With few exclusives, many missing apps, and only the occasional promotional price to recommend it to mainstream Android users, it’s not clear the Amazon App Store has much of a future outside of Amazon devices. The one exception is BlackBerry devices where the Amazon App Store has now become the default store for consumer purchases. That further ties Amazon’s hands should it choose to abandon first party hardware but again I doubt it will be that bold, at least in 2015. And the number of devices BlackBerry will bring to the table isn’t big enough to make much of a difference in developer appeal.

AWS: potential to become Amazon’s highly-profitable core

AWS has been one of Amazon’s big success stories over the last several years, generating higher margins than e-commerce and growing extremely fast. But growth faltered a little in 2014, as competition, from Google and Microsoft in particular, intensified. The basic storage and infrastructure services are becoming rapidly commoditized, with plummeting prices and little real differentiation. As such, both margins and differentiation will move to what these companies build on the basic services; hence Amazon’s launch of Zocalo and other enterprise tools that sit on top of AWS. But here it is going up against Microsoft’s traditional stronghold and Google’s increasingly capable offerings. End user software hasn’t been Amazon’s strong suit, but it’s Microsoft and Google’s bread and butter. I remain skeptical of Amazon’s ability to successfully compete in this area. Meanwhile, others not in the cloud storage business are also building their own competing platforms at this higher layer, including Box, Salesforce and others. If AWS is to become the highly profitable core Amazon has always lacked, it needs to successfully compete at this layer as well as the basic services it has provided historically. It’s not clear to me Amazon will be any more successful at this in 2015 than it was in 2014.

TV and video: more exclusives, but to what end?

One of the most interesting things about Amazon’s TV and video strategy is the extent to which it’s fighting a totally different battle from almost everyone else in the business. Essentially, all other players derive direct revenue from their TV customers — whether through subscriptions, one off downloads or advertising (or some combination of those). Amazon on the other hand, doesn’t sell a TV subscription per se: instead, its TV subscription is merely a perk of the Prime membership. And Prime itself is essentially a money loser, costing more money in shipping than it brings in, at least directly. Amazon makes up the difference in more purchases of physical goods and services. This has always been a strategic tension for Amazon as it builds up a larger and larger library of content and more and more exclusive shows, but without a way to monetize them directly. It’s already had to raise the price of Prime once to paper over this problem, but it’s not going to get any better as Netflix and others continue to raise spending on content while monetizing usage directly. Amazon’s penchant for indirect business models across hardware and content makes it unique, but it also creates unique challenges. In 2015, we’ll see spending on original content continue to rise, but I’m not convinced Amazon will see equivalent benefits elsewhere.

2015: a year of testing and transition

Amazon ought to see 2015 as a year of testing and potentially one of transition. Its core model, and its heavy investment in growth, are increasingly being questioned by investors, and it needs to determine whether it can continue to create shareholder value by going down this path. Its first party hardware strategy is failing with only a couple of exceptions and it should look to exit several categories in 2015. AWS needs to transition from basic services to more differentiated and higher margin products, but it’s not clear Amazon has what it takes to succeed in these new areas. Overall, Amazon faces many tests in 2015 — I’m not persuaded it will pass many of them. In the meantime, its heavy investments in both growth and first party hardware are likely to drag down margins and their future growth opportunities seem less and less certain.

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Jan Dawson

Jan Dawson is Founder and Chief Analyst at Jackdaw Research, a technology research and consulting firm focused on consumer technology. During his sixteen years as a technology analyst, Jan has covered everything from DSL to LTE, and from policy and regulation to smartphones and tablets. As such, he brings a unique perspective to the consumer technology space, pulling together insights on communications and content services, device hardware and software, and online services to provide big-picture market analysis and strategic advice to his clients. Jan has worked with many of the world’s largest operators, device and infrastructure vendors, online service providers and others to shape their strategies and help them understand the market. Prior to founding Jackdaw, Jan worked at Ovum for a number of years, most recently as Chief Telecoms Analyst, responsible for Ovum’s telecoms research agenda globally.

9 thoughts on “Amazon in 2015”

  1. You may be technically correct when you call Amazon unprofitable but it seems a very misleading way to describe a company that’s expanding at the speed of light. Ask the brick and mortar retailers how they feel about Amazon being “unprofitable.”

    1. Your comment is bizarre. Jan is not “technically” correct when he says Amazon is unprofitable, he is literally correct.

      And Amazon’s competitor’s fear Amazon, in part, precisely because Amazon does not seem to care about making a profit.

      It seems like you’re trying to say that Amazon is still very influential — which it is. But your argument does not support your conclusion.

      1. When I hear about a company being unprofitable, normally I think that means its business is going poorly, but obviously Amazon’s sales are rising rapidly, and that scares brick and mortar retailers. Sorry if I wasn’t clear.

        1. “Profitable” means “makes a profit” – i.e. a positive difference between revenue and costs. Amazon is literally unprofitable in that sense. “Profitable” doesn’t mean “has more revenue this year than last year” or anything else like that. There’s a reasonable debate to be had about whether the correct metric is standard net or operating profit or something else like cash flow (which Amazon largely keeps in the black) but it’s utterly uncontroversial to say that Amazon is unprofitable, regardless of whatever else you might think about the company.

  2. Amazon contains a number of very profitable businesses, but in their reporting they are aggregated with unprofitable startup activities. For outsiders it is therefore very hard to assess the health of the profitable activities because effectively no information is provided. At the same time, most of the costs of failed/failing activities (hardware, exclusives, certain countries/product lines) are impossible to assess as well.

    In addition, Amazon has benefited from a very high share price, which they use as a currency to pay employees and acquisitions with. A hiccup in their share price may well have operational consequences.

    Many technology companies have struggled to make the transition from desktop to mobile (Microsoft, Intel, Google — just look where their profit is coming from). Given that Amazon’s desktop website is far too cluttered for mobile use and their mobile app is quite clumsy to use, they need to be mindful about the transition to mobile.

    1. I’m actually quite impressed with Alibaba’s mobile app. If you haven’t already, I think you should give it a try. It gives you an idea of how Amazon could improve its mobile application.

  3. For Amazon to make their core business profitable a radical change to its business model would be required. Changing a corporate business model is next to impossible to accomplish after having ingrained the old model as deeply as Amazon has.

  4. Amazon is my go-to retailer for almost everything I purchase online. There are three reasons:
    1. Ease of use – the app is very good and fast
    2. Quick delivery – I am a Prime member
    3. Price – Amazon is rarely beat on price (which includes shipping for most alternatives)

    The only way I can see Amazon making this business more profitable is to be able to raise prices offset by improvements in (1) and (2) above and still increase sales volume.

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