Amazon’s success formula: move bits instead of boxes

Amazon’s success formula: move bits instead of boxes

3:17am EDT

By Alistair Barr and Ben Berkowitz

SAN FRANCISCO/NEW YORK (Reuters) – Amazon.com Inc appears to have figured out the secret to being more profitable: sell less physical stuff.

The company reported slowing revenue growth and offered a disappointing outlook for this quarter on Thursday, exacerbating uncertainty about the health of its business beyond the United States. But that may be masking a fundamental shift in its business on home turf. The Internet retail giant that once specialized in moving books and other physical items quickly is increasingly trying to do the same in the digital world, where profit margins are higher, partly because e-books, music and video files and are transmitted electronically at high speed. Throw in a fast-expanding third-party merchant business, where Amazon simply books a cut of sales from seller listings on its website, and the retail giant’s margin outlook is looking a lot better.

“Over the long term it does help margins,” said Ben Schachter, an analyst at Macquarie. “You don’t have to put these things on a truck and ship them.”

In the first quarter, net shipping costs stood at 4.7 percent of sales, down from 5.1 percent a year earlier.

Amazon has been doing all the things a retail business will usually do to goose margins, like putting its distribution closer to customers and charging partners more to ship goods.

But it has also diversified aggressively into other revenue streams like digital content, advertising and the Amazon Web Services cloud computing business.

In its news release Thursday, Amazon listed 14 highlights for the first quarter – all but one related to its digital businesses.

Chief Executive Jeff Bezos talked about Amazon’s effort to make its own TV shows, which will be delivered over the Internet, rather than in DVD form.

Notably, Amazon’s top-10 selling items in the first quarter were digital goods or Kindle gadgets, which are tablets or e-readers used to buy and consume digital content, Chief Financial Officer Tom Szkutak told analysts during a conference call.

“That is the first time that we have seen that,” he said.

DIGITAL EXPANSION

In the short term, the Internet retail giant that started out as a book-retailing business faces several challenges. Its business faces a sluggish European economy and inconsistent efforts to break into emerging markets such as China, where competition from the likes of Alibaba is intense.

Amazon’s shares slid 3 percent to about $267 in Thursday after-hours trade, after executives pointed out the macroeconomic challenges.

But longer term, analysts say Amazon’s focus on aggressively pushing digital content – such as by selling Kindles at close to cost, undercutting much of the competition – is a winning strategy.

Amazon has largely focused on using price as a lever to get its content in front of more customers.

Whether selling Kindle e-book readers and Kindle Fire tablets cheaply, or bundling on-demand streaming video with subscriptions to other services, Amazon has bet that it can keep people once it has their attention.

Lately, it has branched into creating original video content. Last week the company posted 14 pilot TV shows online, intending to let reviews decide which ones it turns into full series.

Amazon has also been gaining on Apple Inc in the digital music business, tripling its market share over the last five years – albeit to a level still just a third of Apple’s.

At the same time, the company has also made much of its cloud computing unit, Amazon Web Services, which provides data services to a broad range of companies. AWS, as it is commonly known, generated $1.8 billion in revenue last year and is expected to grow rapidly.

In the most recent quarter, net sales in Amazon’s “other” line, which includes AWS in North America as well as advertising services, rose 59 percent.

“What we’re seeing is that Amazon is really getting leverage from shipping costs. AWS is becoming a big part of their mix. They are also benefiting from a greater mix of advertising revenues. We’ll continue to see that improve,” Topeka Capital’s Victor Anthony said.