Amazon’s Secret Weapon

Tony Clark, 2-Dooz Inc. – August 13, 2012 (Original Publication Date)

Amazon’s (AMZN) secret weapon isn’t related to its cloud services offerings (AWS); besides, that’s a bit too obvious for a “2-Dooz Strategy Talk” article.  Also, the secret weapon has nothing to do with the newly announced Amazon Game Studios (AGS), which enjoyed broad press coverage last week upon the release of its first title—“Living Classics.”  No, the part of Amazon’s strategy that I am referring to has mostly gone unnoticed and has received far less analysis.  Still, in spite of its stealth profile, it is having a profound effect on Amazon’s overall business performance.  Amazon’s secret weapon is called “3P.”

3P stands for “3rd Party” and is a reference to Amazon’s merchant partners.  Amazon benefits from these relationships in numerous ways including the following:  (1) 3rd party offerings allow Amazon to provide its customers with a larger (theoretically unconstrained) number of product selections, which in turn brings more people to the Amazon site; (2) by setting up competition among sellers with the same products, Amazon can deliver savings to its customers, while maintaining pricing advantages over its key competitors; (3) Amazon enjoys a higher utilization of their fulfillment infrastructure, for example, by putting spare compute capacity to work; and (4) Amazon collects a commission on each 3rd party product sell, in addition to collecting a commission on a growing list of related services, including shipping and fulfillment.

It is the impact of the fourth benefit on Amazon’s margins that is particularly noteworthy.  During its Q2 2012 Earning’s Conference Call, Amazon made it clear that though a number of factors have contributed to the improvement in implied gross margins during the quarter, it is the contribution from 3rd party sales that deserves the most credit.  Seller units represented 40% of all paid units in Q2.  This is an increase of 400 basis points over the 36% of paid units that seller units represented during the same quarter last year.  Though not explicitly broken out during the call, 3P margins are clearly greater than non-3P margins.  And, now that the company has more than 2 million active sellers, which are delivering a larger percentage of sales, Amazon’s implied margins are increasing.

Next week I’ll discuss why Amazon’s accelerating push into online advertising poses a legitimate threat to Google.

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