Amazon surprised investors last week with a bigger, and better than expected, quarter, blowing through estimates and sparking a sharp rise in its share price. However, while much of the focus has been on the impact of the dramatic growth and increased margins of the AWS business, that doesn’t tell the whole story. For Tech.pinions Insiders today, I’m going to run through some of the key numbers from Amazon’s big quarter to illustrate why.
AWS was a major factor
Whatever else contributed, it’s clear AWS did have a big impact on performance in Q2. The chart below shows revenues for AWS over the past two years or so (all the charts in this piece come from my Quarterly Decks subscription service):
As you can see, revenue growth has accelerated over the past year or so and this is now a $5 billion a year business and growing rapidly. But AWS also made an outsized contribution to margins – though it’s just 8% or so of Amazon’s revenues, it contributed $391 million to operating income, compared with $703 million for the North American segment, whose revenues are about seven times larger. It’s easy to see why many observers have credited AWS with both the strong revenue growth and the stronger margins this quarter, but it’s really not the whole story.
Seller units continue to have an impact
One of the things far less talked about but nonetheless also very significant to Amazon’s performance over the past several years is the growth of the third-party fulfillment business. The only real measure Amazon provides of the growth of this business is seller units as a percentage of total units sold (i.e. the proportion of all goods sold through Amazon which come from third parties rather than through Amazon itself). This number, as it turns out, tracks very closely to gross margins at Amazon:
As you can see, there’s a significant correlation between the growth in these two numbers over the past five years. Why? It’s quite simple: for its own sales, Amazon reports both the cost of the goods sold and the amount paid by customers for those goods. But for these third-party sales, it essentially only reports the fulfillment costs and revenue, which tend to have a far higher margin than Amazon’s own product sales. As a result, the increasing mix of third party units is driving gross margin up. Over the past few quarters, this correlation has become less clear, as AWS growth has begun to have a more significant impact on margins. However, the two combined are accelerating gross margin growth even further. As you can see during this period, Amazon’s gross margins have risen from the low 20s to the mid-30s and are, if anything, accelerating.
A bump in overall units
It’s also worth noting Q2 is typically a low quarter for Amazon – its lowest of the year, in fact. But this Q2 was actually up on Q1. Yes, AWS was again a contributor, but another contributor was the fact growth in total units actually sped up for the first time in a long time, as you can see in the chart below, which shows year-on-year unit growth:
It’s just a little blip for now – you can see it right at the end of the line that’s otherwise been trending downwards and then flat for a couple of quarters. But this unit growth, which was likely a mix of Amazon’s own and third-party unit growth, helped contribute to revenue growth too.
The margin question
Of course, with Amazon, the discussion always comes back to margins eventually. We’ve already seen AWS has outsized margins, but we’ve also seen seller units drive gross margins up and have done so fairly significantly over the last few years. Why then have operating margins and net margins not gone up by the same 10-15% over that period? The reason is simple: heavy investment, both in fulfillment centers to support the core e-commerce business, data centers, and related infrastructure for the AWS business. Depreciation and amortization has risen significantly at Amazon over that period, from under 2% of revenue five years ago to over 5% in the past few quarters. In essence, Amazon keeps reinvesting the gross margins into the infrastructure it needs to fund continued growth. In the AWS business, that investment is enormous, though the way Amazon accounts for it in its reported finances is a bit opaque and Amazon clearly believes it’s sustainable. But the end result of all this is, while gross margins have grown significantly, operating and net margins have remained largely unchanged until the last three quarters, when they’ve risen slightly:
But that margin picture is still the result of a mix of very different margins from Amazon’s three reported segments: AWS, where operating margins are now in the 20s; North America, with margins in the low-to-mid single digits; and International, where margins are fairly consistently a little in the red. I’ve written before about my skepticism about Amazon’s international business and my views haven’t really changed on this point. But overall, Amazon continues to be a fascinating experiment in mixing very different businesses, where the business that’s now performing the best is the one furthest removed from Amazon’s traditional core, and where the business Amazon started with – selling books and other media – is now the worst performing from a revenue growth perspective (declining by low single digits year on year).