Amazon — the everything store
It might be difficult to imagine how a US $1.6 trillion market cap company would double or triple in value. Nevertheless, recall that it was only two years ago that the company crossed the US $1 trillion market capitalization mark. Crossing this threshold does not have significance though. In the past, we have had companies with much higher valuations (the record is held by the East India Trade company at a record market cap north of US $8 trillion in today’s dollar).
But ambition is not something that Jeff Bezos and company lacks. Despite being the market leader in ecommerce, the company constantly experiments in order to acquire a greater share in consumer spending. Others view the company as a very strong disruptive force, so much so that every time the company announces a new project, the share prices of the incumbents in the respective sectors fall.
Note: even though the company is making significant investments in international expansion, this article will focus on Amazon’s expansion in the US.
Every year, the US Bureau of Labor Statistics publishes a report on the consumer spending patterns of the average US household. The data for 2019 is shown in Figure 1 below.
Two key observations:
- With more than 20% ecommerce market share, the company leads all other ecommerce platforms in selection. Despite this, the majority of Amazon’s sales is still derived from the sales of apparel, food, household goods and other discretionary spending. As you can see from Figure 1, these spendings still represent the minority of the consumer spending.
- The average Prime member spends US $1,400 per year and non-member spends US $600. Still, these spending levels are a far cry from the US $63,036 per year expenditures of the average household.
So, as dominant as Amazon is in the US, significant total addressable market expansion by Amazon can be achieved by selling more stuff.
In order to rapidly expand the realm of things that consumers can buy on Amazon, the company has taken two broad approaches (in addition to creating its own private label that encompasses more than 45 brands with some 243,000 products) — see Figure 2:
- Help other merchants sell stuff on Amazon.com by turning itself into a platform that hosts other 3rd party merchants.
- Expand into other difficult-to-penetrate fields, such as healthcare, groceries, entertainment, among others.
Amazon’s 3rd party seller platform
As of 2018, about 60% of merchandise sold on Amazon is from 3rd party sellers. In other words, 3rd party sellers contribute more than US $200 billion in GMV (note that Amazon’s 2019 total GMV, including its own 1st party products, is US $340.4 billion).
As a platform that enables entrepreneurs to start ecommerce businesses, Amazon directly competes with Shopify. When using Amazon’s 3rd party platform, you can easily start an ecommerce shop that has (1) website/mobile applications, (2) inventory and logistics solutions, and (3) payments baked into one integrated solution. In fact, Amazon has solved one of the biggest challenges in starting ecommerce businesses — getting traffic. Since Amazon is so ingrained in the day-to-day lives of Americans, 63% of shoppers search for items on Amazon before going elsewhere (this is why Amazon has expanded into streaming media — more on this later).
Amazon’s US $200 billion in GMV from 3rd party merchants (as of 2019) is 3X larger than that of Shopify’s GMV for 2019. Yet, at this writing, Amazon’s Enterprise value / sales — a measure of valuation — is 10X smaller than that of Shopify’s (and we haven’t even taken into account all other aspects of Amazon’s business — AWS, payments, etc).
One could argue that by this back of the envelope comparison Amazon is either undervalued or that Shopify is overvalued. Likely both are true.
Other categories that Amazon is pursuing
Pharmacy and healthcare
As you can see in Figure 1, healthcare and insurance combined equates to the third largest spend category for the average household. In fact, healthcare spending contributes more than 17% to the US GDP. Despite the very large total addressable market, innovating in healthcare is extremely difficult. The sector is highly regulated and has multiple stakeholders with diverging interests. Suffice it to say, it’s a difficult sector for any player to tackle.
In order to expand into healthcare, Amazon has employed a multipronged approach. At a high level, healthcare can be divided into three (overly-simplified) services:
- Getting access to doctors.
- Getting access to medications and prescriptions.
- Paying for the above two, mostly with insurance.
Haven: getting access to all three services
In order to tackle all three services simultaneously, in 2018, Amazon announced a partnership with Warren Buffet’s Berkshire Hathaway and Jamie Dimon’s JP Morgan called Haven. All three employed more than 1.5 million employees. With their large employee base, the three companies hoped that they could carry out data sharing, negotiate lower costs and develop new technologies to deliver healthcare and insurance. But after three years, the partnership called it quits for reasons yet to be made public.
Luckily Amazon is not one to fear failure.
Amazon has disparate teams running different efforts to potentially go after the same market. As such, the Haven project is not the only healthcare development that Amazon was running.
Amazon Pharmacy: getting access to medications and prescriptions
In 2019, Amazon bought PillPack, an online pharmacy start up, for US $753 million. It then turned it into the underlying engine that powered Amazon’s Pharmacy (see Figure 4). With this acquisition, Amazon could plug in its massive distribution and delivery network to PillPack, which had an existing user base and, more importantly, pharmacy licenses in almost all US states. At the time of the acquisition, PillPack’s average revenue per consumer was US $5,000, more than 3X what the average Prime member spends.
Amazon Care: getting access to your doctors — remotely
One trend whose adoption is accelerating during this prolonged stay-at-home period is telemedicine. According to McKinsey, up to US $250 billion in healthcare spend can be virtualized by telemedicine. Even after we return to normalcy, this trend is likely to endure since it is much more convenient. With telemedicine, patients can see their doctors much sooner (currently, in the US, the majority of patients wait more than 2 weeks to get an in-person appointment).
Now that Amazon has drug delivery capabilities, the next step is to gain the ability to deliver medical consultations. That’s where telehealth comes in.
Currently Amazon is piloting its telehealth platform, Amazon Care, to its employees living in Seattle (this is similar to how the company first piloted its cashierless stores to its employees before its launch). The telehealth platform allows users to have access to video consultation, in-person care, prescription delivery and chat service.
Clearly, there’s a limit to video and chat capabilities as diagnostic tools. This is why Amazon has joined the health and fitness wearables foray, competing with Apple Watch and FitBit (pending acquisition by Google), by launching Amazon Halo.
Halo is not a medical device; rather, it’s a band that tracks your activities, voice, and even measures body fat. On measuring body fat, Halo asks you to take selfies in tight-fitting clothings, then uses machine learning to calculate your body fat — privacy concerns aside (the company uses the same technology to sell customers custom-fit t-shirts …).
Groceries and food items are also a large spend category for the average US household. The company has spent years experimenting with different projects to get more revenue from this category.
The myriad of projects taken on by Amazon have left the consumer experience confusing. For instance, in 2017, Amazon bought WholeFoods for US $13.7 billion. On top of that, the company provided multiple offerings for groceries and household gods. It offers Amazon Fresh, a grocery delivery service that provides same day deliveries for perishable items (note: this is part of the reason why Amazon invests heavily on logistics to improve its ability to do 1-day deliveries). In addition, it also has Amazon Pantry, a recurring subscription service for everyday household goods.
Since Amazon recently shut down Pantry, we will focus our discussion on Amazon Fresh.
Generally, there are two approaches to online delivery services:
If you have an existing grocery store, you partner with a 3rd party delivery service (e.g. Instacart) to do the selection and delivery. The challenge is that it is difficult to gain enough scale to make this profitable. The typical grocery store has a margin of 2.2%. This is because these grocery stores typically sell low cost undifferentiated commodity items. For grocery delivery to work, you have to add variable costs to select and then deliver the items, making the effort deeply unprofitable. Yet, this is the approach that the traditional grocery stores take because they lack the capital to build their own delivery networks. So instead, they partner with 3rd party delivery services. The negative margin is absorbed by the delivery services, funded by venture capital.
This is not to say that it is impossible to be profitable in the grocery delivery business. Instacart turned profitable in Q2 2020 — it just took a massive surge in demand from a global lockdown to do so. To be profitable in this segment, you have to have dense enough orders per delivery run.
Adding on top of your existing delivery network
This is the approach that Amazon took. By building on top of its core delivery network that ships higher margin items, Amazon can add grocery deliveries to the outgoing delivery trucks, reducing the variable cost contributions from the low margin grocery orders.
However, unlike grocery stores, Amazon does not have an inventory and distribution system that is suitable to handle groceries (perishable items). That’s where the Whole Foods acquisition comes in. As the company was building new smaller distribution centers closer to city centers for grocery deliveries, it used Whole Foods to jump start its last mile delivery efforts.
In this category, Amazon’s efforts are wide ranging, broadly split into Audio and Video.
The company’s first foray into audio was through the acquisition of an audiobook service, Audible, in 2008. It then followed up with the introduction of Amazon Prime music in 2014 (a streaming music service for Prime members), which was then accompanied by an unlimited streaming service that competes with Spotify and Apple Music, launched in 2016.
For Amazon, music streaming does not have to be a profit driver. But rather, it is designed to create more touch points with users’ daily lives (the more Amazon you have in your life, the more you shop). The music streaming service is priced the same as its competitors’ US $9.99 / month, unless of course, if you are a Prime member, which it then costs US $7.99 / month. And if you’re an owner of the Echo smart speaker, the cost is even lower, at US $3.99.
From a pricing standpoint, it is clear that the effort is optimized for maximum adoption, and considering that more than 70% of US households are Prime members — this effort can significantly hamper adoption of Spotify’s and Apple’s services.
This is what the Amazon Video homepage looks like ( Figure 6):
The company’s video strategy has two broad objectives:
Get more viewers to get more Prime members
By purchasing rights to (1) live sports (a differentiated offering compared to Netflix or Disney+) and (2) movies/TV shows, Amazon can gain more of the user’s attention. The more time you spend on Amazon, the more likely you convert to join Prime, and the more you spend on the site.
For example, Amazon’s Man in the High Castle original TV show that came out in 2015 cost US $72 million in production and marketing costs. But it attracted 1.15 million new Prime subscribers. This means, the cost for the TV show yielded a Prime customer acquisition cost (CAC) of US $63 per member. Considering Prime membership cost US $99 per year at the time — Amazon achieved breakeven in less than 8 months.
This is why Amazon is spending more and more on tent pole shows that can attract global viewers. The company is reported to have spent upwards of US $1 billion for the Lord of the Rings TV Show alone.
This is also what makes Amazon’s content strategy competitive with Netflix. Yes — Netflix can spend US $17 billion per year on content, much more than its competitors, because it can spread that fixed cost over to its large user base ( 195 million and growing). In contrast, Amazon can spend as much (although in reality, the company spends about 1/3 as much) and monetize through Premium membership and ecommerce sales.
After acquiring lots of viewers, sell the ability to access them
After hitting a large scale, Amazon Prime Video Channel has become a destination for viewers. It can now sell other viewing options: (3) rent in-theater movies and (4) other streaming service subscriptions (refer to Figure 7).
In an effort to compete with Netflix, but lacking the same scale as Netflix and differentiated content as Disney+, other streaming services (Showtime, HBO, CBS, and others) rely on the likes of Amazon and Roku to acquire users.
- Amazon, through its widely viewed Prime Video Channel, becomes a user acquisition engineer for these other streaming services. It extracts a fee for every subscriber that these other streaming platforms acquire through Amazon. It is reported that this revenue is about US $3.6 billion in 2020.
- Roku makes streaming boxes and operating systems for smart TVs to aggregate viewers, and extract revenue from the streaming platforms in a similar manner.
In addition to getting revenue share from other subscription services, both companies also sell low cost streaming hardware and generate revenue from advertising.
We have discussed in depth the new space race, the effort to provide low cost global internet through low earth orbit (LEO) satellites has begun. The implications of this low cost global internet deployment can be huge:
“ Fast internet for everyone, everywhere. Whether you are in the rural United States, sub-saharan Africa, or rural India, you will have access to fast data speeds. What are the implications of this? Well, it could have a similar effect to the changes brought on by Jio when the company made the internet cheap and abundant in India. Internet penetration shot up, and demand for devices, media consumption and e-commerce transactions grew.
These benefited US companies such as Amazon, Netflix and Facebook in India. Reed Hastings (the CEO of Netflix) even went as far as to say that “We hope someone would do a Reliance Jio in every other country”. “
Currently, there are two chief players in this space: SpaceX and Amazon.
Amazon, through its investments in Project Kuiper, plans to deploy more than 3,200 LEOs to beam high-speed internet signals back to Earth. The company recently announced a breakthrough in the development of low cost receivers that can easily be deployed globally.
Vested is a US Securities and Exchange Commission Registered Investment Adviser. Our platform enables investors from India to invest in US stocks and ETFs easily.
This article is meant to be informative and not to be taken as an investment advice, and may contain certain “forward-looking statements,” which may be identified by the use of such words as “believe,” “expect,” “anticipate,” “should,” “planned,” “estimated,” “potential” and other similar terms. Examples of forward-looking statements include, without limitation, estimates with respect to financial condition, market developments, and the success or lack of success of particular investments (and may include such words as “crash” or “collapse”). All are subject to various factors, including, without limitation, general and local economic conditions, changing levels of competition within certain industries and markets, changes in interest rates, changes in legislation or regulation, and other economic, competitive, governmental, regulatory and technological factors that could cause actual results to differ materially from projected results.
Originally published at https://vested.co.in on January 11, 2021.