Amazon Is Positioning Itself Well For The Long Term

Mike is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Amazon.com (NASDAQ: AMZN) is positioning itself for revenue growth, and is making various investments to achieve this. It continues to make acquisitions such as Goodreads, as well as invest in improving its core business. These investments often sacrifice margins for long-term growth, but this is a strategy that has worked for Amazon in the past and helped its stock outperform its large cap tech peers.

Amazon Prime

Amazon Prime customers account for around 15% of Amazon’s customer base, and their numbers are growing. They pay $79 a year for cheaper and faster delivery, access to lending library books, and other services. These customers spend 2-4x the amount of non-Prime customers annually. The percentage of customers who subscribe to Prime is expected to grow, as are the services offered. While Prime boosts revenue per customer, it carries a negative mix impact in the near-term.

Add Fulfillment Centers

Amazon has been building more and more order fulfillment centers every year since the downturn--20 in 2012 versus 13 in 2010. This will reduce shipping costs and improve customer service via reduced shipping times. Amazon’s value proposition has always included best in class customer service, and this investment helps it maintain the 2 day shipping policy for items sold to Prime customers. In the near-term, the investment and mix shift to higher cost Prime customers will negatively impact margins. That said, lower shipping costs through more ground vs. air shipments and an increased bundle rate will help to somewhat offset this.

Kindle Services

The Kindle offerings have expanded over recent years, and Amazon now offers a range of e-readers and tablets. The Kindle has positioned Amazon to benefit from the transition from buying physical books, music, and other physical media into the consumption of digital media. Selling the device allows the customer to purchase more digital media from Amazon versus competitors like Apple’s (NASDAQ: AAPL) iTunes. Amazon will continue to invest in devices and sacrifice margin to gain customers for its digital services.

Amazon also is expanding its digital media footprint via acquisitions. It announced it is acquiring Goodreads on March 28, 2013. Goodreads is the largest book recommendation website and reading related social media site on the web. It has 16 million users, 530 million books, 68,000 authors, and 23 million reviews. The terms of the deal were not disclosed. Goodreads will fit well into Amazon’s Kindle business and expands its core capabilities into social media. It also should have synergies with the Audible and IVONA acquisitions. Depending on the integration, and ultimately the promotion of Amazon products through Goodreads, Apple’s iTunes and Google Play (NASDAQ: GOOG) could lose some of their digital books market share to Amazon. Amazon currently makes up 27% of the book sales in the US, while Apple and Google sell much less.

As of Feb. 6, 2013, Apple's iTunes had sold 25 billion songs--however, iBook sales have been considerably lower.  Apple announced in October 2012 that book sales had reached 400 million units.  This would account for a very small portion of Apple's revenue.

Apple has also taken a shot at creating a social network with Ping. Ping wasn’t very successful and shut down in late 2012. Of course, Google has Google+, but it is currently not revolving around products such as books.

Amazon Web Services (AWS)

Amazon has increased its investment in its network, bandwidth, and storage businesses to create the division Amazon Web Services. Analysts estimate that since this segment's launch in 2005 it has been a primary driver of growth. It is a dominate player in cloud computing with a 35% market share of the $1.2 billion spent in Q4 2012.  

Going forward, Amazon will compete increasingly with Microsoft and Google in this area as they try to establish larger footholds in cloud computing. Google has its "Drive," which allows users to store 5GB free and 20GB for $4 per month.  Apple has a cloud service that can be accessed through its various devices and has a similar pricing structure.  For the iCloud, users don't pay for data under 5GB and pay $20 per year for up to 10GB.  Microsoft in particular is actively working to expand its presence in the cloud market.

Cloud services are still a small portion of sales for these tech giants, but it has become more important as consumers require an increasing amount of storage while wanting smaller computing devices.  As smartphones and tablets are the new norm for media consumption, cloud services offer a way to store large files, such as HD videos.

Key theme - Grow Sales, Margins will Follow

All of the growth drivers Amazon has implemented seem to negatively impact margins, at least in the short run. Management is focused on growing sales, and margins will come into focus at a later date. The track record of continued growth and maintaining a growth strategy has historically worked for the company and shareholders. Amazon's stock is up over 230% over the past five years, versus 130% for Apple and 46% for Google.

Conclusion

For competitors like Google and Apple, the purchase of Goodreads does not appear very significant at the moment. It is a small tuck-in acquisition that makes sense for Amazon because of its eBook business. While Google Play is in this market, this acquisition is of relatively small importance. It only matters if Amazon can increase the user base and leverage the social network traffic into sales.

Amazon’s strategy is to invest for the long-term, not get left behind, and to participate in high growth markets. Microsoft has struggled to push into higher growth markets and its stock has suffered as a result. Amazon is making the right moves for its future, and it has been the better stock so far this year. Microsoft is of interest because it has underperformed and if it can see success into the smart phone, tablet and/or cloud market, it could outperform its peers in the second half of the year. 


Mike Thiessen has no position in any stocks mentioned. The Motley Fool recommends Amazon.com, Apple, and Google. The Motley Fool owns shares of Amazon.com, Apple, and Google. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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