Prime members, cloud services, third-party trading markets, who is Amazon's fourth pillar?
By Wang Ziwei @ Retail Wei Observation
If you take a look at the financial reports of tech giants, you will find that they are all good at side businesses - of course, you can also call it "second curve growth". For example, Apple has developed wearable devices such as iWatch and AirPods, which brought in about $40 billion in revenue last year. Tesla's sales in 2022 were only $81.4 billion.
Amazon is no exception. In addition to its three main businesses - third-party trading markets, Prime membership system, and cloud computing, Amazon's advertising business is also growing rapidly. The financial report shows that in 2022, Amazon's advertising revenue reached $37.74 billion.
How much is this number? Let me put it this way, social media platforms like Twitter, image sharing platform Pinterest, and ephemeral social app Snapchat, these three platforms all earn advertising fees. $37.7 billion is roughly more than twice the total revenue of these three platforms last year.
Actually, this is quite ironic. After all, in 2009, Bezos publicly said, "Advertising is the price you pay for having an unremarkable product or service." I believe Bezos really thought that back then. But now, well, Bezos has been "retired" for several years.
[One] "Everything can be an advertisement"#
On Amazon, everything can be an advertisement.
You can replace Amazon with any e-commerce platform you know, such as Taobao, Tmall, Pinduoduo, and even live streaming and short video platforms. Intelligent algorithms will push content to you based on your preferences. As for the proportion of advertisements, it depends on the platform's conscience.
Amazon has always included its advertising business in the "Other" category in its financial reports. In February 2023, Amazon's 10-K filing showed that its advertising revenue in 2022 had reached $37.7 billion, compared to just $1 billion when advertising was first included in the "Other" category in 2015.
The growth of Amazon's advertising business can be described as rocket-like, and its annual revenue of $37.7 billion is only surpassed by Google's $224.5 billion and Facebook's (now called Meta) $113.6 billion.
[Two] Amazon's Attitude Towards Advertising#
In fact, in 2003, an article in IEEE INTERNET COMPUTING analyzed Amazon's recommendation mechanism, calling it "Item-to-Item Collaborative Filtering". For Amazon's users, the ultimate goal is personalized recommendations for their purchases, not advertisements.
The article stated,
"At Amazon.com, we use recommendation algorithms to customize personalized online stores for each customer. The store adjusts based on the customer's interests, such as showing programming products to software engineers and showing baby toys to new moms. This way, the click-through rate and conversion rate - two important metrics for the effectiveness of web and email advertising - can far exceed those of non-targeted advertising content."
However, in recent years, Amazon's "Customers who bought this also bought this" and "Customers who viewed also viewed" have been increasingly replaced. We now see "Sponsored products related to" and "Brands related to this category". Of course, we can still see the old recommendation logic of "Frequently bought together".
Perhaps in Amazon's eyes, since there are so many third-party sellers (accounting for 59% of sales in Q4 2022), why should I recommend this traffic to you for free? You'd better pay for the display space.
However, when Amazon first started selling ads, it was also taken advantage of: In 2005, Bezos asked to monetize the traffic under his control. According to The Information, the first batch of ads were regular display ads on product pages. Although these ads were bid on, the traffic went with them because the links pointed to other retailers!
So this project was quickly shut down.
A few years later, Amazon started to try its hand at advertising again, this time in a rapidly changing technological environment.
[Three] Embracing Advertising Again#
To understand why Amazon embraced advertising again, we need to go back to when Bezos was still making investments.
In 1998, Bezos wrote one of the most valuable angel checks in history. He gave $250,000 in startup capital to two Stanford University PhD students. Their names were Sergey Brin and Larry Page - yes, they are the founders of Google. The combined wealth of these two individuals is now $190.8 billion, while Bezos himself has a wealth of only $119.3 billion.
The book "The Everything Store" reveals the details:
"...The investment story began with Amazon's acquisition of Indian courier service Junglee in 1998, which ultimately failed. But this acquisition brought Ram Shriram to the Amazon team, which was actually a chance encounter for Bezos.
Shriram had been advising two Stanford University PhD students who were trying to invent a new way of internet search. In February 1998, Shriram became one of the first early investors in Google, investing $250,000. Six months later, Bezos and his wife were on vacation in the Bay Area, and he asked Shriram to arrange a meeting with the people behind Google. Shriram invited Bezos to have breakfast with Page and Brin at his home, where he demonstrated how the search engine worked. Bezos immediately told Shriram that he wanted to invest. Since the early funding round had already ended, Shriram took some time to convince them, but Bezos, as the CEO and with a net worth of $1.6 billion at the time, shook the confidence of Google's founders and eventually got Bezos to invest."
Later, when Bezos talked about this investment, he said, "They didn't have a business plan, but they had a vision, and it was customer-centric. That's how I fell in love with them."
Six years later, in 2004, Google went public, and Bezos owned 3.3 million shares of stock, worth about $285 million. He sold them, otherwise, the value would be nearly $13.9 billion today.
In the early 21st century, Amazon relied heavily on Google's search to drive traffic. According to The Information, Amazon even had a "Google Dependency Index" to track this reliance.
If Google's advantage is selling ads when people show purchase intent, then Amazon is the final step of the transaction: the purchase. Therefore, for third-party sellers, Amazon's transaction data is the most valuable. Otherwise, they would just be spending money on advertising without any sales.
However, recent data shows that over 60% of product searches start on Amazon. Since searches start on Amazon, it is understandable that Amazon makes money from searches.
[Four] What Does Advertising Mean to Amazon?#
Advertising may already be Amazon's most profitable business, although Amazon does not mention its gross profit or operating profit contribution. But if you compare it to Google's core advertising search business with a gross profit margin of 68%, you will realize that the advertising business may generate a contribution similar to Amazon Web Services (AWS).
After all, the more third-party sellers and SKUs there are on Amazon, the more they are tempted to advertise and sell their products. Similar to various advertising services on platforms like Taobao, Amazon also offers many services, such as "Sponsored Brands," "Sponsored Products," "Sponsored Display Ads," "Sponsored Posts," "Sponsored Videos," and so on - it is worth noting that in foreign countries, this type of paid content is generally labeled as "Sponsored," but not necessarily in China.
Although Amazon has said that its advertising business is "optional," the cost per click (CPC) of advertising is constantly rising, and it is not uncommon for some brands to spend 50% of their budget on advertising and listing fees.
At the 2022 Prime Day, which lasted only two days, Amazon's sales revenue driven by advertising increased 4.5 times compared to the average daily level of the previous 30 days. Amazon's advertising also made a lot of money: according to third-party data, the average cost per click for Amazon ads during Prime Day was $1.67, which is 58% higher than the market price during the same period in 2021.
Of course, after the privacy changes in Apple's iOS, if we only look at Amazon's e-commerce ecosystem, Amazon is actually the biggest beneficiary: after all, advertising companies and businesses can no longer track end users through iOS. At this time, Amazon third-party sellers have no choice but to advertise.
At the same time, the scale of $37.7 billion in revenue is great, but what is more worth noting is its growth rate: the annual growth rates in 2021 and 2022 were 58% and 21% respectively, and the strongest growth occurred when Apple disrupted the advertising industry. It is worth mentioning that although the 21% growth rate for the whole year of 2022 is a significant slowdown, it is still acceptable during the entire pandemic period:
If we only look at the fourth quarter of 2022, Amazon's advertising still grew by 19% year-on-year, while both Google and Facebook experienced negative growth.
Finally, as Amazon becomes more and more saturated, it is also looking for synergies within its entire ecosystem and constantly expanding its ecosystem. For example, Amazon acquired the NFL rights for 11 years (worth $1 billion per year) and gradually introduced ad-supported content for its IMDB TV streaming product. It also monetizes ads through the game streaming platform Twitch, and so on.
What is scary is that recent developments in the streaming media industry have also pushed Amazon's advertising. For example, Netflix has started adding ads in videos and shows. As streaming media customers become accustomed to ads on competitive platforms, this opens up the possibility for Amazon to start adding ads on its Prime Video platform.
Marketplace Pulse, a well-known Amazon researcher, wrote, "Advertising has distorted Amazon's customer focus" and "affected Amazon's ability to innovate in exploration, personalization, and any form of interactive shopping."
He is not wrong, but at least Amazon can still satisfy its shareholders.