It's a modern miracle: Order any of the millions of items on Amazon (AMZN 2.19%), and most can be on your doorstep in 48 hours or less. Some items even arrive that very same day.
Consumers might be used to this level of speed by now. But two-day shipping was a novelty when Amazon launched its Prime subscription service in 2005. And I would argue that this impressive service absolutely catapulted the adoption of Amazon's e-commerce platform.
Consider that in 2004, the last full year before Prime, Amazon had revenue of $6.9 billion, and all of it was from e-commerce. The company did more than eight times this much e-commerce revenue in the third quarter of 2023 alone.
Through the first three quarters of 2023, Amazon has generated net sales of $405 billion across its entire business, and most of this was from e-commerce in North America. However, while this part of the business is enormous, the company has a shockingly low operating profit margin for North America: just 3% so far this year.
Indeed, most of Amazon's profits come from something else entirely.
This is Amazon's real moneymaker
Through the first three quarters of 2023, 74% of Amazon's operating profit came from its cloud computing platform, Amazon Web Services (AWS). And this has long been the case, as seen in the table below.
| Year | 2019 | 2020 | 2021 | 2022 | YTD 2023 |
|---|---|---|---|---|---|
| AWS operating income | $9.2 billion | $13.5 billion | $18.5 billion | $22.8 billion | $17.5 billion |
| AWS percentage of total operating income | 63% | 59% | 74% | 100% | 74% |
Data from Amazon's financial filings. Chart by author. YTD = year to date.
With Amazon's AWS, businesses can store digital data, perform complex computing tasks, and even experiment with artificial intelligence and machine learning. All of these features and more are in demand, and Amazon has a compelling offering, attracting lots of customers.
Fortunately for Amazon shareholders, AWS is also highly profitable. And without this solid source of operating income, the company would look very different than it does today. Moreover, returns for shareholders would likely have been lackluster.
For evidence, consider the chart below. It shows the clear correlation between Amazon's operating income and its stock price. The share price would likely be much lower without AWS because that's where most of the operating profit comes from in the first place.
Is e-commerce irrelevant for Amazon?
Here's another shocker: Amazon's operating margin for North America was better way back in 2004 than it is today. In 2004, its operating margin for North American e-commerce was 8.3%. Through the first three quarters of 2023, it's just 3.4%.
It's shocking to see Amazon's margins drop over nearly 20 years for this segment. But keep in mind that results in 2023 are actually an improvement from last year. In 2022, the company had an operating loss of $2.8 billion in North America.
Amazon's operations in North America are low-margin or even produce losses some years, but this business is far from irrelevant. In fact, as it did with AWS, the company is unlocking more profit streams thanks to its massive e-commerce platform.
For example, offering free and fast shipping to Prime members is an expensive endeavor, so it's unsurprising that e-commerce margins have fallen. Other perks such as Prime Video are also expensive -- original productions can cost tons of money to make, such as the $715 million Amazon spent on its Lord of the Rings series.
However, there are around 200 million members of Amazon Prime today, according to Statista. And members have access to Prime Video. This has traditionally been ad-free, but the company will begin displaying ads on videos to generate more revenue starting Jan. 29.
Indeed, Amazon is firing on all cylinders when it comes to digital advertising. The company has generated $43.8 billion in revenue over the last four quarters, and launching ads on Prime will only increase this number further and will potentially boost profit margins.
Boosting margins would lead to higher operating profit as well. And that would be good for Amazon stock.
In conclusion, Amazon has built a massive e-commerce platform that is almost impossible for most other companies to compete with. It might have little to no profits on its own, but e-commerce has allowed the company to branch out into other very profitable ventures including AWS and, more recently, advertising.
The ongoing growth of AWS and advertising should lead to higher operating profits down the road. And this expectation is why Amazon stock is still a good one to buy today.
