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What's Behind Amazon's Accelerating Ad Revenue

Amazon's (NASDAQ: AMZN) advertising business has quickly grown to become a part of the digital advertising triumvirate that dominates in the United States, alongside Facebook (NASDAQ: FB) and Alphabet (NASDAQ: GOOG) (NASDAQ: GOOGL) subsidiary Google. But while its fellow tech giants saw stable ad revenue growth last quarter, Amazon's "other" revenue segment, which consists primarily of advertising, accelerated 8 percentage points on a constant currency basis.

That acceleration brought Amazon's other segment growth to 45% for the quarter, and CFO Brian Olsavsky said "advertising grew at a rate higher than that 45%" during the company's third-quarter earnings call. The company is already at a $14 billion run rate for the segment, but the accelerating growth suggests there's still a lot of room left to improve that number.

Here's what's behind Amazon's accelerating ad revenue.

Image source: Amazon.

Improving relevancy

The vast majority of Amazon's ad sales come from search advertisements on its marketplace. When a customer types in a search query, Amazon will show sponsored brands and product listings from advertisers that bid on the keywords that a customer types into the search bar. That creates highly relevant ads based on customer intent, and it's the main factor that continues to drive the company's ad revenue growth.

Amazon generates over 70% of its U.S. ad revenue from search ads, according to an estimate from eMarketer. That number will remain above 70% for at least the next couple years.

"What we're focused on really at this point is relevancy, making sure that the ads are relevant to our customers, helpful to our customers," Olsavsky said on the call. Amazon's search results have become more and more crowded with advertisements over the last few years. The company can improve those search ads' value by using additional targeting data for customers combined with machine learning to determine which ads specific users are more likely to click, and thus pay out for Amazon.

Better ad relevance will also improve Amazon's display ad products. Facebook has leveraged its user data to become the leader in digital display advertising. Facebook's average ad revenue per user of $33.86 in the U.S. and Canada is well above its peers in the industry. Amazon arguably has even more valuable data than Facebook -- consumers' actual purchase histories -- that it could use to further improve relevancy.

Of course, a big part of Google and Facebook's ability to surface relevant ads to their users is the massive base of advertisers each has accumulated. Facebook counts over 7 million active advertisers on its platform. To that end, Amazon is making it easier for marketers to use its ad platform. "It's increasingly popular with vendors, sellers, and third-party advertisers," Olsavsky said.

Earlier this year, Amazon revamped its ad platform to make it easier for marketers to place ads across its various properties. Over the summer it opened the door for marketers to buy ads through third-party demand-side platforms. That increased demand is another reason the company's ad business accelerated last quarter, and it ought to remain elevated over the next year.

Video ads are still in the early days

Amazon has a large base of Fire TV users, but it only really started pursuing the advertising opportunity on connected television devices about a year ago. "It's still early in this space, but we've done a few things with IMDb TV, live sports, things like adding more inventory through Fire TV apps," investor relations director Dave Fildes said.

U.S. spending on connected TV devices is still relatively small compared to other areas of digital advertising. Marketers will spend about $7 billion on the ads in the U.S. this year but will double their spending by 2023, according to eMarketer.

Amazon still only has a small slice of that ad spend, but its growing base of Fire TV users and share of ad inventory on those devices should enable it to grow faster than the overall market. Still, it faces considerable competition from big names in the area, as well as some pushback from some of the bigger over-the-top service providers.

As the video ad business grows, it should provide a nice supplement to the core search ads on marketplace and other display ads on Amazon's properties. That should enable it to produce elevated growth rates with its ad business for several more years. And the high-margin revenue should help satiate its bottom line as Amazon continues to invest in other areas like faster fulfillment.

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John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Randi Zuckerberg, a former director of market development and spokeswoman for Facebook and sister to its CEO, Mark Zuckerberg, is a member of The Motley Fool's board of directors. Adam Levy owns shares of Alphabet (C shares), Amazon, and Facebook. The Motley Fool owns shares of and recommends Alphabet (A shares), Alphabet (C shares), Amazon, and Facebook. The Motley Fool has a disclosure policy.


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