The Pandemic Has Gifted Amazon Record Profits
The timing could not have been more serendipitous. The day after a long and discursive congressional hearing into the competitive practices of America’s tech giants, the big four (Amazon, Apple, Facebook, and Google) released their Q2 2020 earnings. If the reaction from the market was anything to go by, investors are not betting on Washington. Nor are consumers.
Businesses might complain about the gangster-like behavior of Google and Facebook, who mercilessly shake down corporates for ad money, which gets siphoned into a black box of bids and target audiences. But for the average person who uses Google to search the net, and Facebook to see what their friends are up to, there is not much to complain about.
By now we are all used to seeing ads on social media. We tolerate them because they are necessary to maintain the service. We know we are the product and that businesses are paying for our attention. Why should we care if some businesses are being gouged for the right to pierce the social veil and sell to us while we are scrolling through posts from our friends and family?
Consumers struggle to see how their lives are adversely affected by the business practices of America’s tech giants. Most likely feel their lives are easier, more connected, and more affordable. Until consumers can draw a direct line between the market power of the tech giants and their own welfare, Congress will be pushing the proverbial uphill.
But as the pandemic catalyzes the merging of our physical and virtual worlds, it may only be a matter of time before consumers do start asking questions. As our behaviors are shaped by the pandemic, to what extent will these changes become entrenched? Before the Covid crisis hit, an online presence was critical for sellers but not their only channel (probably not even their biggest). Now, suddenly, it is the only game in town.
U.S. tech is immune to the levelling effects of Covid-19
The congressional hearings were described as “historical” with “exchanges likely to have lasting resonance”. Neither is remotely true. Industrial leaders and Wall Street oligarchs have invariably been dragged before congressional sub-committees to answer for their misdeeds. Often these hearings serve no other purpose than to draw public attention to conflicts of interest and dodgy practices that, while not strictly illegal, do perceptible harm to people on the street.
Red-faced executives bluster their way through rapid-fire questions from a few grandstanding members, promise to look into things and make some changes, then wait out the news cycle until the public moves on to something else. It captures our attention for a fleeting moment, then we all go back to what we were doing before (probably browsing Facebook).
For politicians, these hearings are an opportunity to attack a group of people who, at least for a few days, are less popular than they are. The only problem is, in the case of the tech giants, the average person on the street has little reason to feel aggrieved. Of course, if you ever wasted thousands of dollars on Facebook or Google ads and got nothing in return, you might think about getting these people alone with a blowtorch and pair of plyers. But for someone who simply enjoys posting on Facebook and sharing their photos on Instagram, they will not lose sleep over the fact that both platforms are owned by the same company.
If this hearing was the final word on big tech, then the critics have failed, and the debate will have to move on. These companies are getting more popular with their users and investors, not less. At this point, the chance of breaking up these giants is zero. Other regulatory measures will be necessary to tame their power, but users will have no interest in seeing government carve up these businesses for the sake of competition.
To understand how these companies have grown in favor even over the last few months, you only need to look at the performance of these shares in comparison to the rest of the market.
If Congress hoped that the Covid-19 crisis would have a levelling effect on these megacap stocks, it was sorely mistaken. The Q2 results are revealing because they show how revenue and costs are holding up through a full quarter of Covid-19 .Not only are these companies weathering the storm, they are thriving like never before thanks to a captive online audience and the need for businesses to pivot to online selling as quickly as humanly possible.
Amazon’s watershed quarter happened during the depth of the Covid crisis
Of the big four, it was Amazon that came out the biggest winner of the Covid quarter. Not only did it crush the market’s expectations, it reported the largest net profit in its history (nearly double that of the corresponding quarter in 2019). Net sales rose 40% to $88.9 billion compared to $63.4 billion in Q2 2019.
Around $46 billion was generated from online stores, up 49%, more than making up for the drop in sales from physical stores (including Amazon’s Whole Foods markets), which fell 13% due to lockdowns and social distancing. Amazon’s operating income rose to $5.8 billion compared to $3.1 billion in Q2 2019 and net income rose to $5.2 billion compared to $2.6 billion in Q2 2019.
While only $10.8 billion of sales came from the AWS segment, it contributed over half of Amazon’s operating income. Amazon’s quarterly update included a host of big names that had made the move to AWS and were using Amazon to help them reach customers online. According to its release, Amazon increased grocery delivery capacity by over 160% and tripled grocery pickup locations, while online grocery sales also tripled in Q2 2020 compared to Q2 2019.
As companies around the world slim down, Amazon has added 175,000 jobs since March and is in the process of bringing 125,000 of these into regular, full-time positions. Amazon spent over $4 billion on Covid-19 related costs in Q2, covering personal protective equipment, the cleaning of facilities, new safety process paths, backup family care benefits, and thank you bonuses to front-line employees and delivery partners worth over $500 million.
Amazon’s new open-source AI technology Distance Assistant helps keep employees safe by providing them with live feedback on their social distancing via a 50-inch monitor. A helpful piece of technology, but one still gets the impression that Amazon would be happier if it did not have to deal with the biological shortcomings of a human workforce.
What is incredible about Amazon is not just that it is growing consistently but that it continually beats even the top-end forecasts. Amazon regularly reports operating income above its guidance range or at the upper end. This has helped to drive its share price ever higher. This quarter, Amazon’s guidance pointed to Q2 operating income of between -$1.5 billion and $1.5 billion. It came in at $5.8 billion: $4.3 billion higher than the upper bound. Analysts who took a conservative view were blown out of the water, while even those who were bullish were left in a cloud of dust.
For the anti-trust brigade, third-party sales outstripped first-party sales, reflected in a rise in revenue from third-party services (although the underlying figures are unknown). Much of the congressional hearings centered on Amazon’s alleged practice of using its algorithm to squeeze independent sellers and push Amazon’s own-brand products to users. Amazon has denied this in the past, likely because it did not want to attract too much regulatory attention. But even though Jeff Bezos was caught red-handed, Amazon’s lawyers are not girding their loins.
Even in Europe, where competition laws are tighter than they are in the U.S., the legal case against Amazon does not quite stand up. While there is legitimate public anxiety, Amazon is not at the stage where it can muscle all of its competitors out of the ring. Even during the Covid-19 pandemic, there is little to suggest that Amazon’s success is destroying competition.
Amazon will not down its ratchet for a pandemic
Amazon’s power appears immense when you look at the share of online sales in the U.S. that are made through Amazon’s website. However, this metric alone does not tell the whole story. As journalist Brian Dumaine outlines in his book Bezonomics (2020):
“While Amazon controls nearly 40 percent of all online retail in the U.S., online retail only accounts for about 10 percent of all retail in the U.S. — nine out of every ten of our shopping dollars still go to brick-and-mortar stores. It turns out that customers like to try on dresses and shoes, squeeze cantaloupes, and compare HD TV screens before buying. That means that Amazon only controls about 4 percent of U.S. retail. Globally the situation is even starker. Amazon controls only 1 percent of retail worldwide, and formidable competitors such as Walmart and China’s three behemoths, Alibaba, Tencent, and JD.com, will make sure that Amazon will have to fight hard for every additional dollar of sales.”
Dumaine is right to point out that Amazon’s share of the total retail market is small. Nor does Amazon have much success in sinking third-party sellers. Amazon’s private-label products make up less than 1 percent of its total sales, which is far less than the likes of Walmart. However, while Amazon operates in a global marketplace, it undoubtedly wields a high degree of online market power in North America. As Covid-19 speeds up the long-running trend of consumers eschewing physical brick-and-mortar shops in favor of a more convenient online experience, Amazon will only add to its market share.
In the short-term, this might not be a huge problem for consumers, who are getting cheaper products delivered quicker. For a lot of businesses, it is not Amazon that threatens them but the internet itself. In the hypercompetitive world of e-commerce, there is no room for businesses that fail to adapt and respond to the needs and preferences of consumers. However, as the Covid-19 pandemic drags on, Amazon is one of the few businesses that stands to gain a great deal.
While its private-label products are not gaining as much traction as Amazon would like (and some critics claim), third-party sellers are becoming more reliant on the platform. Right now, Amazon can only hobble its major competitors without knocking them out. But as the algorithm improves and competitors with weaker balance sheets come under pressure from the pandemic, we should be aware of the potential threat that Amazon poses to competition.
Amazon’s strategy is to keep turning what Seth Godin calls “the ratchet”. It started with books, then it became movies, household products, furniture, clothing, and cloud solutions. By leveraging a trusted brand, Amazon earned permission from millions of customers to branch out into other products and services. Businesses cannot keep turning the ratchet forever. Eventually, competitors dedicated to doing things cheaper or faster will start filling gaps. But Amazon still has plenty of leverage left in its ratchet, and it is not putting it down for the pandemic. It might even start turning it faster.
Not all disruption is bad. Some of it is necessary and unavoidable. For consumers, the benefits of e-commerce have been immense: companies have become more focused on user experience, crafting better deals and promotions, and speeding up delivery. While not quite as revolutionary as electricity or air travel, the internet age has brought real, life-enhancing benefits. But we do not want to kill the goose that lays the golden egg. Too much power concentrated in the hands of a few will forestall innovation and harm consumers in the long run.
Amazon has not yet reached that point, but we should consider the possibility as we continue to change our behavior in the face of the virus. Amazon is not a single online gateway to consumers, but it is moving closer in that direction. Busting it up is not an option, but prudent regulatory measures may be needed if these trends continue.