Under high inflation, Amazon’s “flywheel” can’t turn?

Source | East Brother Interpretation of E-commerce

Author | Jin Shan

Amazon’s performance is still in jeopardy.

Several major U.S. technology giants Microsoft, Google, and META have recently released financial reports one after another. Their performance was basically lower than expected. The pessimism spread across the entire U.S. stock market, and Amazon was not spared. Amazon’s revenue in the third quarter of 2022 was $127.1 billion, a year-on-year increase of 15%, lower than the market’s expected $127.6 billion; net profit was $2.9 billion, slightly higher than the market’s forecast of $2.25 billion.

Affected by the performance, Amazon’s stock price even fell by 21% after the market that day. The final close on Oct. 28 was $103.41. The market value has evaporated by more than one trillion yuan, and Amazon’s stock price has basically returned to 2020, when the epidemic began overnight.

What’s wrong with Amazon?

The inflection point has not yet come, and Amazon’s performance is still in trouble

Sacrificed net profit, less-than-expected growth.

The third quarter is considered to be the key for Amazon to get out of the haze. After all, the revenue growth rate in the first half of the year was only single digits, and the market’s confidence in consumption was pinned in the second half of the year. Amazon’s revenue was $127.1 billion, and the growth rate recovered to 15% as expected. Especially without considering the impact of exchange rate, the year-on-year growth rate reached 19%. Since the beginning of this year, the price of the U.S. dollar has continued to rise, mainly for international business and less revenue converted into U.S. dollars. The North American market has reached a growth rate of 20%.

Overall, although Amazon fell short of market expectations, its performance was acceptable and in line with the predictions of Amazon executives. The reason the market is still reluctant to pay is due to revenue drivers and guidance for the fourth quarter.

First, the revenue part is supported by the promotion of Prime Day. This year’s Prime Day was held in the third quarter, and last year’s date was the second quarter. The difference in time resulted in a low revenue base last year. Amazon CFO Brian Olsavsky also said that we celebrated our eighth Prime Day in July, which contributed approximately 400 basis points (4%) to our year-over-year sales growth in the third quarter.

Second, Amazon’s operating profit has almost halved in order to maintain performance growth, which is not a good sign. Just looking at the net profit indicator is not obvious, the revenue in the third quarter of this year was 2.87 billion US dollars, down 9% year-on-year. But this includes a pre-tax valuation gain of $1.1 billion, which is brought about by investing in the electric vehicle Rivian and has nothing to do with the main business.

Returning to the main business level, Amazon’s operating profit in the third quarter fell by 48% in absolute value, almost halved. Operating margins were just 2%, the lowest in recent years. There are two expenditures that have the greatest impact. Research and development expenses have increased by 36% year-on-year, and marketing expenses have increased by 38% year-on-year. A strong dollar affects absolute values, but hardly percentages. With the appreciation of the US dollar, the absolute value of revenue in the international market converted into US dollars has decreased, and the absolute value of costs has also decreased. The 2% operating profit margin shows that Amazon is weak in the face of the current economic environment and competitors.

What is even more worrying for the market is that the guidance for the fourth quarter has completely exploded . The financial report shows that revenue in the fourth quarter was between US$140 billion and US$148 billion, a year-on-year increase of only 2% to 8%. The guidance has taken into account the adverse impact of 4.6% caused by exchange rates. Operating profit is expected to be in the range of $0 to $4 billion, indicating that low margins persist.

what does that mean? Dolphin Think Tank estimates that the US dollar price has risen by 16% compared with last year, and the cloud business still maintains the same growth rate in the third quarter. Amazon’s year-on-year growth rate in the North American market in the fourth quarter is about 1.1% to 9.0%. You must know that the fourth quarter is the peak season for e-commerce, not only Black Friday promotions, but also Amazon’s first attempt at member early enjoyment day (also known as Prime Day 2.0). . This also means that the recovery expected by the market in the third quarter has not really brought about, and a large part of the revenue growth in North America may be brought about by rising prices, and consumer confidence is still insufficient.

Why is the fourth-quarter revenue guidance so low? What’s up with Amazon?

“Flywheel” traffic-side Prime members

Bezos, the founder of Amazon, once proposed the famous “flywheel effect”. The various business segments of a company promote each other organically, like meshing gears. The rotation of one gear will drive the entire business gear to rotate rapidly. Prime members, third-party sellers and AWS cloud business are the three major gears of Amazon, and Prime members are the core traffic side of Amazon.

Image source: Internet

The quantity has stagnated, and the price increase has resisted potential users . The subscription service segment representing members has a year-on-year growth rate of 9%, the lowest in recent quarters. This follows a massive hike in membership fees by Amazon in response to inflation and rising shipping costs. Prime members enjoy various benefits such as free shipping and content viewing, covering almost three-quarters of households in the United States, which is very sticky. The price increase will not affect core users, but it will lose potential users. Third-party data shows that Amazon’s membership scale has stagnated for the first time.

Member spending power declined . The economy is sluggish, and Prime members can’t buy it. According to data from EMarketer, this year’s Prime Day global sales were $12.5 billion, an increase of about 8% year-on-year, and the growth rate in previous years was more than 40%. In particular, this year, Walmart also held a membership day promotion against Amazon. The time was before the Prime membership festival, which had a partial diversion effect. Walmart’s dominant category is daily necessities, which are necessities under consumption downgrades.

Competed third-party sellers

Amazon is no longer the only attractive platform, and sellers are actively deploying new channels.

In the third quarter, third-party sellers’ revenue including commissions and fulfillment fees was US$28.67 billion, up 18% year-on-year; advertising services (commissions) were US$9.55 billion, up 25% year-on-year; the membership promotion improved the market, and Amazon’s revenue from third-party sellers increased The speed-to-ring ratio has been significantly improved.

For Amazon, the more members, the more things they sell, and the more they lower the price for suppliers; the cheaper the price, the more members they attract. But third-party sellers don’t think so, and lower prices mean lower profit margins. The strong growth of Amazon’s advertising business also means that the competition among sellers is getting fiercer. Especially in the case of a bad economic environment, cost control has become a must.

For small and medium-sized sellers, independent stations are expensive and need to consider their own operations, which is not suitable. Amazon’s various facilities are relatively complete, and it is still the main channel. Some brands and big sellers will accelerate the layout of independent stations and expand channels. Buy traffic from TikTok and META and convert it into a transaction. This trend has gradually strengthened after the seller’s title incident, and the seller realized that it is necessary to gradually put the control in their own hands instead of the platform. SHEIN and PatPat also showed the possibility of future development of independent stations.

Amazon’s operating cash flow has declined for five consecutive quarters, and free cash flow has gone from a net inflow to a net outflow for four consecutive quarters. These two indicators have always reflected that Amazon’s strong position in the industry chain has been loosened. On the merchant side of the “flywheel” Amazon took a hit.

AWS cloud business can no longer let Amazon lie flat

The AWS cloud business is a business that has continued to grow rapidly in recent years, supports half of Amazon’s valuation, and is also a key gear to generate profits for the entire business.

This year, Amazon shifted its capital spending focus for the year from logistics to the cloud business. But before that, Amazon officially admitted that it has frozen the recruitment of cloud business, saying that the business has different stages of development, corresponding to different recruitment needs. The market generally believes that this is the cloud business has also been hit. The financial report also shows that the growth rate of AWS cloud business in the third quarter was 28%, which was not as good as before, and the net profit margin also fell to 26.3%. Can the cloud business bring Amazon back to the peak of its valuation?

Microsoft’s differentiated competition . Amazon’s cloud services have occupied the market advantage under the low price strategy in the early stage, but the demand point of the current market has changed. Customers are no longer satisfied with basic services and are gradually moving towards higher-level SaaS. Microsoft Azure has long been considered a worthy competitor to the AWS cloud and is gradually closing the gap with Amazon. Amazon has the highest share of the global cloud market, but mainly provides IaaS (Infrastructure as a Service) and PaaS (Platform as a Service), with a small scale in SaaS (Software as a Service). IaaS is a basic service that can provide low-cost customer acquisition functions to meet the needs of enterprises to reduce costs. PaaS and SaaS can provide value-added services, create more income for enterprises, and have greater stickiness, and can also reversely drive the sales of underlying IaaS services. SaaS products are more advanced, but require perfect software development capabilities, which Microsoft is good at.

The structure of AWS cloud customers is currently less risk-resistant . The customers of AWS cloud services are more inclined to small and medium-sized enterprises, and the ability to resist risks in the general environment is weak, which may have an impact on the revenue of Amazon cloud. Comparing Amazon Cloud, Microsoft Cloud and Google Cloud, it can be found that among Amazon Cloud’s major customers, the Internet industry accounts for more, including social media META, Instagram, Netflix and so on. With the loss of traffic dividends, the advertising performance is not as good as before. These companies have a particularly strong control over costs and expenses, and their spending on cloud business will also shrink.

Faced with market uncertainty, customers are cutting budgets and trying to reduce spending in the short term, with global IT spending forecast to grow by 4% this year, down significantly from 10.2% last year. The revenue of all the major cloud vendors has declined, and AWS can no longer keep Amazon flat.

Under the influence of the weak macro economy in the United States and the strong dollar, it is difficult for Amazon to survive alone, and its valuation has declined. Under high inflation, costs and expenses will rise, and it is difficult to turn the “flywheel” that relies on traffic growth and sellers to settle in to achieve low prices. Amazon needs to get through a recessionary economic cycle first.