Amazon’s ad business a ‘mixed bag’ as Q1 sales soar, profits tumble

Dive Brief:

• Reporting on a period that came to be dominated by the COVID-19 pandemic,  Amazon​ on Thursday reported that first quarter net sales, including its AWS cloud services, rose 26% to $75.5 billion, according to a company release. Amazon’s advertising and other revenue increased 44% during Q1 for a total of $3.9 billion.
• Online product sales rose 24% year over year to $36.7 billion, falling from last quarter’s $45.7 billion, with physical store sales up 8% year over year to $4.6 billion. Revenue from sellers, who move more than half the goods sold on the site, rose 30% from a year ago to $14.5 billion, down from $17.4 billion in the fourth quarter.
• In the quarter, many essential items were shipped to customers at cost, CFO Brian Olsavsky said on a conference call with analysts. Expenses ballooned: Worldwide shipping costs in the quarter rose 49% and fulfillment costs rose 11%, according to a company press release. ​That hit profits hard. Net income in the first quarter fell 29% year over year to $2.5 billion, and operating income was down 10% to $4 billion.

Dive Insight:

Amazon’s e-commerce prowess was undermined in the first quarter, with low margins and high costs rendering a sales surge almost moot. 

In terms of advertising revenue, the first few months of 2020 delivered another strong quarter for Amazon, with Olsavsky saying during a conference call with analysts that the growth rate for its advertising business was consistent with the previous quarter. However, there was an impact from the coronavirus pandemic, with some advertisers pulling back and downward pressure on prices. Traffic to the site remained strong, which may have offset the negative impact, resulting in a “mixed bag” overall for Q1 advertising performance, per Olsavsky. The executive suggested that Amazon may fare better than other digital platforms right now since its advertising is mostly related to sales of products on the site and not things like travel and auto sales, two categories that have taken a big hit from the health crisis and related economic troubles. 

In recent weeks, with so many consumers stuck at home due to stay-at-home orders meant to slow the COVID-19 pandemic, Amazon, an e-commerce veteran of more than two decades, has been a logical place to shop. But the company struggled to meet the demand, which Olsavsky​ described as resembling the holidays or Prime Day, minus the time to prepare.

Furthermore, if anyone assumed that Amazon would profit from that, they were disappointed. Along with the sales surge, Prime membership grew, according to data from GlobalData Retail, which noted more consumers turning to Amazon Video for something to do. However, the e-commerce giant not only lost money, it also scrambled to get items to customers in its usual timely fashion.

“[C]laims that Amazon is finding the present challenges completely advantageous are very wide of the mark,” GlobalData Retail Managing Director Neil Saunders said in emailed comments, noting how shipping costs escalated in the quarter while operating income and net income significantly dropped. He also warned that “any advantage Amazon had from the enforced temporary closures of mainstream retail stores will wane rapidly” as those stores reopen, with stepped-up omnichannel services. 

Shipping costs rise as demand does, so that aspect is unsurprising, according to Brendan Witcher, principal analyst, digital business strategy, at Forrester Research. But Amazon also faced changes in customer behavior in the quarter, he said.

“The challenge is having so much consumer demand shift to the lower margin grocery category,” he told Retail Dive in an email. “Amazon’s model has been designed to serve general retail, where margins are a lot healthier. When demand gets heavily weighted to grocery, the profit on each order gets eaten by all the costs that could normally be absorbed by selling books and shirts.”

What’s more, fulfilling such orders isn’t Amazon’s strong suit, Saunders said. “Arguably, Amazon is somewhat less adept at fulfilling grocery and household goods and, in our view, remains at a significant disadvantage to traditional retailers like Walmart and Target which can use stores as points of distribution and fulfillment.”

Walmart on Thursday may have challenged its online rival further with its announcement of “Express Delivery,” a new service available in 100 stores now, expanding to nearly 1,000 early this month and nearly 2,000 in coming weeks. For an additional $10 fee, customers can order from an array of more than 160,000 items, including food, consumables and general merchandise, for delivery to their homes in less than two hours.

Meanwhile, Amazon’s much-touted one-day shipping seems like a distant dream at the moment, as the company worked to just get goods out the door. The investments Amazon has made to implement one-day shipping, which started almost a year ago, have come in handy during this time of high demand, Olsavsky​ said on the analyst call​. But he acknowledged that delivery times have been unusually slow.

“It’s really a combination of how long it takes to get things in stock, picked, packed and shipped,” he said. “The shipping is still pretty fast and is still coming quickly. It’s just, it’s taking longer to get things into our warehouse and out of our warehouse.”

Speeding that up has been a challenge he also said, adding that it’s hard to know when more one-day service will resume. “Right now things are still so up in the air that I can’t really project when that day will be or what point in Q2 or Q3 or beyond.”

Saunders is certain that it will, and in fact, expects Amazon “to double down on making shipping faster,” he said in an email to Retail Dive.

“They need to compete with the rise of curbside collection and collect from store options which offer the consumer immediacy,” he said in an email. “Without an extensive store network, Amazon needs to counter this trend and fast shipping is one of the ways it is able to do that. How profitable this is remains to be seen; but as we know, Amazon does not primarily focus on short term earnings, it is more concerned with the longer-term.”

In fact, when it comes to its retail operations, Amazon never has focused on profits, according to Nick Egelanian, president of retail real estate firm Siteworks​. “They don’t make money in retail and have been raising prices and pushing fulfillment off to suppliers as a result,” he told Retail Dive in an email, arguing that it will continue to be profits from AWS and other business lines that prop up Amazon’s retail side. “The pandemic caused a surge in sales, but also laid their fundamental flaw bare as costs surged and customer service eroded.”

The pandemic is also adding to Amazon’s expenses beyond shipping. The e-retailer is developing COVID-19 testing for its workers, which will help boost its $600 million COVID-related first quarter costs to “$4 billion or more in Q2,” Olsavsky said, declining to say whether that could expand into its own business. The additional expenses also include the hiring of thousands of workers in warehouses, and COVID-related supplies and actions unrelated to testing.