The New Amazon
David is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Amazon (NASDAQ: AMZN) has come a long way since its founding as an online bookstore in 1994, in the most recent quarterly earnings Amazon’s net income dropped 35%, and on this news the stock was up over 14%. Right now Amazon is investing in long term strategic business ventures like new shipping centers and the Kindle Fire. The drop in net income was not as bad as expected during this heavy period of long term investment and thus the stock jump.
By the year 2000 Amazon was public and was dedicated to carrying every product from A to Z. Amazon is currently expanding their already excellent distribution network, especially in the area of robotics for their distribution centers to automate them and reduce their operating costs. These investments are important as the shipment of physical goods makes up the vast majority of Amazon's fifty billion dollar revenue, however Amazon is a low cost leader and as such they have a slim net profit margin, .31% as of the first quarter 2012. Amazon CEO Jeff Bezos saw in the 1990’s the potential of an online bookstore, and then transformed Amazon into an online retail giant. Amazon is currently undergoing the largest transformation in the company’s history which will see Amazon shift from an online retailer to a consumer electronics and digital services company.
Amazon is taking a comprehensive approach to this new business. The first step is to build hardware devices. These come in the form of the Kindle E-readers and the Kindle Fire Android tablet. The Kindle line was first launched in 2007 and since then it has broadened to include not only E-readers but an Android tablet as well. In 2011 one estimate was that Amazon was selling roughly seven million Kindles per quarter, though that number may have dropped in the first quarter of 2012. The Kindle line is built to be reliable, simple and affordable. The traditional E-Ink Kindles now start under one hundred dollars and the Fire is two hundred dollars, significantly cheaper than most other tablets. IHS iSuppli estimated when the Kindle Fire launched that Amazon was selling it at cost, or slightly less than cost and the same they said was true of the seventy nine dollar basic Kindle. Thus Amazon is making virtually no money off of the millions of Kindle’s they sell every quarter.
This low margin, or no margin, hardware is only the first and less important part of Amazons future, the other more important shift are Amazon’s new digital services. The first of these services was Amazon’s ebook store which is a digital bookstore not only for the Kindle devices but for other devices which Amazon has a Kindle app for, such as Android and iOS devices. For each one of these books sold, Amazon gets 30% of the selling price and in 2011 Amazon announced that for the first time ebook sales had surpassed traditional book sales on their website.
Amazon did not stop with just digital books, they launched a comprehensive music service, featuring a music store, online music storage and player and mobile applications. Along with the music service, Amazon has its own app store on the Kindle fire, instead of the Google App store (called the Google Play Store) and this Amazon app store is available for download on other Android devices. They launched a TV & movie instant streaming service that comes bundled with the already popular Amazon Prime service, which for an annual fee of seventy nine dollars gives customers free two day shipping as well as the new streaming service. Amazon also runs a popular web storage platform called S3 which they are constantly improving and innovating on. Dropbox, Tumblr and Minecraft are just a few customers of S3.
Combine these offerings and the Kindle devices (specifically the Kindle Fire tablet) become an ecosystem for Amazon, when you buy books, music, apps, a TV show or a Movie on a Kindle Fire you use an Amazon service and Amazon gets a cut. Amazon CFO Thomas Szutak said last year that the customers who have Kindles not only buy “a lot more” books than the average customer but they also purchase physical goods from the traditional Amazon business.
Over the past few years Amazon has seen strong gains in media, web services and digital sales and we will see margins continue to improve over the coming years as Amazon shifts from an online Wal-Mart to a technology company. Amazon will face stiff competition in its new markets from Netflix with streaming TV and movies, Apple & Google (NASDAQ: GOOG) for online music, ebooks and hardware devices and additional companies are likely to enter the digital services market as its potential is realized.
Google already offers competing eBook, TV, movie and music services under their ‘play’ brand, though at this point all of these services are lacking in selection when compared to Amazon’s offerings and their prices are comparable at best. Google has spent hundreds of millions to create original content channels on Youtube, it is clear that Google is in the digital content business for the long run and they will increase their offerings across all forms of media. Apple also offers all of these services though iTunes and has dominated the digital music market (mainly because their Ipod’s make up roughly 70% of the MP3 player market).
Though Apple’s services dominate their iOS platform they are not available on Android or the Kindle Fire. This has allowed Google’s services to dominate on Android as the Google services ship with almost all Android devices. Since Amazon removed the Google services from its Kindle Fire, Amazon’s own services are the only option for most of this digital content on the Fire; Amazon’s services are also available for download on Android devices, giving Amazon a monopoly on the Fire and a foothold in Android rite large.
Netflix meanwhile has made a name for itself by being available on almost every internet connected device you can think of and Netflix is on Android, iOS and the Fire. The ubiquity Netflix has their twenty million plus user base and their superior catalog of streaming TV and movies means that it will be an uphill battle for the Amazon Prime instant video service to compete.
However Amazon is no stranger to competition and the company weathered the dot com bust and ongoing pricing wars with other low cost retailers. Indeed, in the last earnings report we saw the largest single increase in gross margins in a decade for Amazon and that has Amazons stock trading at close to its 52 week high and a very high price to earnings ratio. Instead of stagnating like to many companies do, or making bone headed decision with a disastrous new business plan, Amazon once more has successfully shifted the company and going forward it will be more diversified, with reliable revenue coming not only from its position as a leading retailer but also as a digital products company.
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