Is Amazon Finally Focusing On Profitability?

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AMZN: Amazon logo
AMZN
Amazon

For more than two decades, Amazon  (NASDAQ:AMZN) has been enticing customers through “discounted” prices, focusing on sales volumes over profit.  But the company is now dropping list prices from its products, with only the final sale price visible to customers. Being a firmly established e-commerce player, Amazon no longer needs to use discounts or best prices to attract consumers, in the view of many. Its loyal user base will continue to use the e-commerce portal for their online shopping needs, irrespective of whether they get the best deal or not. This strategy should help Amazon focus on both sales volumes and profits, allowing it to create a profitable product mix in its general merchandise segment. This move will also allow the e-commerce giant to mute controversies over fake discounts as it highlights real deals.

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Digital Education Should Become A New Revenue Stream For Amazon

While Amazon’s presence in digital education was limited to selling hard-copy and e-books in the past, the company has recently become more serious about this growing opportunity. In March, it secured a three-year contract worth $30 million from the New York City public schools to provide e-books to 1.1 million students.  Through the launch of Amazon Inspire, the company is aiming to provide a free marketplace for worksheets, lessons, student plans and other resources for all classes, ranging from kindergarten to Grade 12. This initiative should give the company a strong foothold in the digital education segment, as it builds a user base for this platform. This initiative initially should boost the sales of Amazon’s existing educational products, including e-books and the Kindle reader.  Over time, the digital education marketplace can become a significant new source of revenue of the company, in our view.

Attracting Consumers Through Better Service Over Low Prices

After establishing a strong base of loyal “Prime” customers, Amazon’s strategy to attract and retain customers  now appears to be more focussed on better service and faster delivery, rather than just cheaper prices. The company is working on several initiatives to shorten its delivery times, including setting up its own delivery network and providing several benefits to its Prime Members. These perks, along with high quality of service, should ensure the loyalty of its members.  The company no longer needs to compete on price alone to remain competitive. Selling products at competitive prices (not deeply discounted causing losses to the retailer) can positively impact Amazon’s operating margin and its valuation. After posting negative operating margins in 2014, Amazon showed improvement and reported a 2.1% operating margin in 2015. We expect Amazon’s General Merchandise EBITDA margin to increase moderately from around 9.9% in 2016 to 10.5% by the end of our forecast period.

However, a faster pace of increase in these margins (growing to reach 12.5% by the end of our forecast period), as the company moves away from a discounted price strategy, can lead to a 10% upside in our price estimate.

Amazon has succeeded in building a fairly large base of loyal customers in the U.S. and established itself as a strong e-commerce player. The company is now building on this volume and focusing on better services to attract and retain customers, while reducing the reliance on discounted prices. Amazon might continue to offer  flash sales and discounted deals in specific situations.  But increasingly it will be selling products at competitive prices that include a reasonable margin for the retailer. And this  will improve the profitability of the company.  Better margins in the long run will improve its valuation and benefit Amazon’s shareholders.

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