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Amazon’s Growth Strategy

Posted on Tuesday, Jul 30th 2013

According to recent Forrester research, the US online retail industry is projected to grow 10% annually over the next five years to be worth $370 billion by 2017. Online retail sales are expected to account for $262 billion this year. While European markets remain subdued, they are projected to show a faster growth rate of 10.5% over the period to grow to €191 billion (~$253.6 billion) by 2017 from €128 billion (~$170 billion) this year. International online retailing giant Amazon (NASDAQ:AMZN) is investing in its business to be ready for this growth.

Amazon’s Financials
Amazon’s Q2 revenues grew 22% over the year to $15.70 billion, short of the Street’s target of $15.74 billion. Continued investments in expansion and a weak European market sent Amazon’s earnings into the red. The company reported a rare loss of $0.02 per share compared with the market’s expectations of earnings of $0.05 per share. On a GAAP basis, the loss of $0.02 per share was lower than the earnings of $0.01 per share reported a year ago.

By segment, Media revenues grew 7% to $4.4 billion and revenues from electronics and general merchandise (EGM) sales grew 28% to $10.42 billion. In operating metrics, Amazon added 6 million active customer accounts to over 215 million. It ended the quarter with more than 2 million active seller accounts. Seller units represented 40% of paid units.

Amazon’s revenues from North America grew 30% to $9.49 billion. International revenues were hurt by the European market conditions and reported relatively subdued 13% growth to $6.21 billion. Adjusting for the exchange rate impact, international revenues would have grown 20% over the year.

For the current quarter, Amazon projects revenues of $15.5 billion-$17.2 billion compared with analyst projections of $17.0 billion. Amazon expects the losses to continue during the current quarter as it shows no signs of slowing down on its investment plans.

Amazon’s Grocery Expansion
As Amazon continues to build warehouses, it is also expanding the product lineup and the services it offers to customers. One such area is the grocery business. Amazon has been testing the grocery segment in Seattle over the past few years. It recently expanded the segment into Los Angeles offering access to the grocery segment to Amazon Prime members on a free trial basis. After the trial, Amazon is charging customers $299 a year for access to AmazonFresh. Besides product quality, same-day delivery is a big requirement for grocery products. Recently eBay and Google also began testing same-day delivery options in select markets.

Analysts estimate the US grocery market to be worth $650 billion. Even if 10% of this market were to be converted online, it reflects a $65 billion market. Surely retailers like Amazon would not like to pass up on such an opportunity. Amazon is expected to launch AmazonFresh in the San Francisco Bay Area soon as well. It plans to launch the service in 20 other markets, scudding some international markets, by the end of the next year. But it will be a tough market to break. Groceries have a short shelf life and are a low-margin sector, and Amazon will need to sustain its current levels of high customer satisfaction while meeting these high demands.

Amazon’s Digital Growth
Besides retail, Amazon is also investing in the growth of its digital services and is seeing strong growth in the segment. While Amazon does not break down sales by product, many believe that its cloud offering, Amazon Web Services, is giving bigger guns like IBM and HP a run for their money. Analysts estimate that AWS was operating at an annual revenue rate of over $2 billion last year and will be bringing in over $24 billion by 2022. Amazon did not give details on market expansion, but it is looking at international expansion for the cloud offerings as well.

In addition, Amazon is investing in the online video industry. It entered into several expensive contracts to build their digital media collection. Recently they entered into a multiyear agreement with Viacom to license television shows, including children’s shows like “Dora the Explorer” and “SpongeBob SquarePants.”

Within international markets, Amazon is looking at the high-growth market of China, where it recently opened the Appstore. Now consumers in China will have access to third-party apps being sold by developers through Amazon’s Appstore. Amazon already sells digital content through Kindle Stores in China. But given China’s highly government controlled environment, Amazon seems to be taking it slowly.

Amazon may have missed the market’s expectations on earnings, but analysts are pleased with the company’s long-term plans for growth. The stock is trading at $304.65, with a market capitalization of $137.7 billion.

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