Amazon is in the Lending Business, Who Knew?

Amazon does just about everything: online retail, internet services, e-books, among others. But there is one business they operate that has less press coverage than my high school’s JV Golf Team (which I was a proud member of): Amazon Lending, which provides financing to its third-party sellers.

In the third quarter of 2016, third-party sellers were responsible for 50% of all items sold on the site, with the number of merchants using their fulfillment service growing 50% in 2015 (after a rise of 65% a year earlier), according to Amazon. The number of third-party sellers hovers around 2 million, which is comprised of businesses ranging from mom and pop operations to multi-million dollar revenue a year enterprises. In 2014, this specific segment of sellers represented an estimated $37–$40 billion of revenue.

So how does Amazon currently monetize these sellers? They do so in the following ways:

· Commission: 14%-40% of sales (excluding electronics)

· Fulfillment: fulfillment fees are charged for those that opt into fulfillment services

· Utilization of Fulfillment Centers: Amazon will charge between $0.48 and $0.64 per cubic square foot per month, in warehouses in rural areas where land is extremely cheap

· Shipment: most sellers are utilizing Amazon’s rates to ship their products

It’s clear that these sellers are quite profitable for Amazon, but let’s shift gears for a moment and look at this from the perspective of a seller. As an Amazon seller, the biggest constraint for growth is liquidity and ability to attain financing. If I have $50,000 and I want to buy $50,000 of iPhone cases for my inventory, I am left with $0 in my account and am forced to wait until a significant amount of the items have sold before being able to order more inventory. Sellers risk running into a situation where there is demand for their product, but no supply to match. This is true of all growing hardware sellers, not just those who sell through Amazon.

Online small business lenders such as Kabbage provide an interesting financing solution, but are not tailor-made for financing inventories, therefore payments are made on a schedule and not based on sales volume. Interest and principal may become due months before the items ever reach the retailer from the manufacturer, which may pose a major liquidity problem. This type of debt can also be quite expensive, with APRs reaching as high as 80% (after all fees and interest are paid).

I only recently found out that Amazon offered their own financing solution. Amazon Lending, which launched in 2012, is an invite only, inventory financing service offered directly by Amazon. They offer their financing solution to select sellers who qualify according to an internal algorithm which analyzes proprietary selling data. These loans are three to six months long and range between $1,000 -$750,000 and must be used to finance inventory that will be sold on, surprise, Amazon. Since the program started, they have extended hundreds of millions of loans. But why didn’t we know this (using the imperial we here)?

I raced through Amazon’s annual filings dating back to the launch in 2012 (natural exercise for a recovering banker) and found zero references to this particular business segment. No mentions in the document of “Amazon Lending” and no obvious inclusion in the financial statements, making me feel like the crazed significant other searching for a suspicious text they know exists in their partner’s phone, only to discover its only manifestation is in their own helpless neurosis. Amazon and other large tech companies (think Apple) are notoriously opaque on their financial statements, but it seems odd to completely exclude mention of the business.

Why haven’t they made a greater effort to market and expand this business, when increased liquidity for sellers can lead to accelerated growth, which in turn leads to more sales through Amazon? This is especially puzzling in the context of their robust data-set for underwriting these sellers: a key cog for more educated lending decisions. Scaling the amount of loans from a few hundred million dollars to the billions of dollars could have a major impact on thirty-party sales (which aforementioned is a profitable piece of Amazon’s business model). So why not pursue that strategy?

My best guess is this is due to relative valuations of tech companies versus financial institutions. As of January 2015, the average price-to-earnings ratio for banking firms was ~17.8. Technology companies broadly, are value at ~25.8 times earnings, according to Yahoo Finance. If Amazon began looking more like a financial institution that a tech company, the company’s valuation could be significantly impacted. The perceived riskiness of the use of balance sheet cash for small business loans could be another viable reason to steer clear from expansion.

So what does this all mean? There are still millions of sellers that market their goods on Amazon and are unable to obtain bespoke financing solutions for their products. While Amazon cherry-picks the most credit worthy borrowers according to their algorithm, many sellers who are equally credit worthy, go without a viable financing option. This has created an opportunity for companies who look to focus on financing this specific vertical. Kickstarter proposes an interesting alternative: instead of outlaying cash and being paid back at the end of the selling cycle, Kickstarter allows founders to receive the cash upfront, without sacrificing any equity or taking on debt. Essentially it is zero interest loan. Companies such as UpFund and Kickfurther, mimic Kickstarter as a crowdfunding source, but rather than receiving products in exchange for capital, “investors” receive healthy interest payments on the loaned capital. As companies mature and continue to grow, crowdfunding sources are not sustainable (or scalable) and require larger, more reliable financing opportunities (bank financing may still not be an option).

Companies that can provide this much needed liquidity to sellers on Amazon and in the more broader ecommerce vertical, will prove invaluable for the growth of hardware businesses and ecommerce platforms moving forward.