How Amazon Makes Money

Amazon.com Inc. (AMZN), the world’s largest online retailer, is rapidly growing in a broad range of businesses under founder and CEO Jeff Bezos, including its core e-commerce operations, cloud services, digital advertising, groceries and prescription drugs. It also sells Amazon products such as the Alexa personal assistant and ecosystem, and movies through its Amazon Video platform. The company's net income more than tripled last year to $10.1 billion on a 31% gain in revenue to $232.9 billion. It ranks as one of the world's top companies by market value.

While Amazon's e-commerce business has disrupted a long list of industries and put many traditional market leaders out of business, digital retailing isn't the major generator of the Seattle-based company's profits. Most of its operating profit is generated by its cloud services platform, Amazon Web Services (AWS), a pioneer in the fast-growing space. The unit accounted for 58% of operating profit in last year's fourth quarter, during a year when its cloud revenue rose by 47%.

But e-commerce, nonetheless, is the main catalyst of Amazon's expansion by paving the way for a long list of businesses that may generate large profits in the future, including its movie production and entertainment business, groceries, prescription drugs and its home products.

Amazon accounted for nearly 50% of all online sales in the U.S. last year, per eMarketer, generating $208 billion from retail operations in the U.S. and abroad. The unit gets most of its revenue by selling merchandise on its site through first-party and third party sales, inking sales arrangements with massive retail brands like Nike Inc. (NKE). But the company increasingly is building out its branded business with products such as its Alexa suite, the personal assistant driven by artificial intelligence. Amazon’s ever-increasing size has allowed it to gain market share with its ability to slash prices below competitors, as well as offer discounts, free shipping, and other promotions via its popular Amazon Prime monthly membership.

While Amazon is by far the leader in e-commerce, the business isn’t a huge cash cow for the company, and in some instances loses money. For example, the company lost $2 billion on $66 billion in international sales last year even though it made $7 billion in operating profit on $141 billion in sales in North America.

By contrast, Amazon's 13-year-old cloud services business posts very high margins, and makes up a larger share of Amazon's profit. AWS is a catch-all for the various cloud services Amazon provides that allow businesses to store information and deliver content. Amazon controlled 35% of the cloud market in 2018, more than twice its next closest competitor, per Business Insider, citing Synergy Group, The company competes against cloud providers including Microsoft Corp.’s (MSFT) Azure, and Alphabet Inc.’s (GOOGL) Google Cloud. In 2018, AWS booked almost $26 billion in revenue, a 47% increase from the year prior, and generated more than $7 billion in operating income.

Due to Amazon’s financial resources, the company has the flexibility to heavily invest in new markets, new products, and pricing wars that have eliminated rivals. For example, the firm’s $13.7 billion acquisition of organic grocer Whole Foods Market Inc. in 2017 has provided Amazon with a new beachhead to expand into several areas. For starters, owning Whole Foods has given it access to hundreds of physical retail locations and a stronghold in the grocery space. The move also is viewed as an opportunity for Amazon to build out other businesses such as pharmacy and apparel. In June 2018, Amazon made a stride into the prescription drug space with the buyout of online pharmacy platform PillPack for $753 million. As Amazon sees its online grocery business grow, it's testing out urban register-free convenience stores with Amazon Go. The company has been experimenting with other pop-up stores around the world.

To further bolster its competitive position, Amazon has been ramping up its delivery capability to more quickly get product to consumers. It plans to boost its fleet of cargo jets by 25% over two years to 50 planes, while it adds additional air hubs. Meanwhile, the firm added more than 8 million square feet of fulfillment center space across the U.S. last year.

Amazon has been aggressively investing in digital advertising, which is forecast to rise from $3.3 billion in 2017 to $15 billion by 2010, giving it a roughly 10% share of the market, according to eMarketer. This growth is likely to accelerate Amazon's profit growth. The company's digital capability is already apparent in its Amazon Video platform, which competes against entertainment leaders such as Netflix Inc. (NFLX) and Walt Disney Co. (DIS).

Despite Amazon’s nearly uninterrupted growth, it faces numerous challenges. The expectations of Amazon investors frequently is higher than the company's already lofty growth rate, leading to stock pullbacks even when it delivers stellar results. A much bigger overlooked risk may be more intense government scrutiny and changing regulations around the world, as well as anticipated increases in expenses. These could curb Amazon's growth. Despite its size, Amazon also faces equally powerful and well-financed rivals such as Walmart Inc. (WMT), which is mapping out its own plan to take market share from Amazon.