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Why It's Impossible to Compete With Amazon

When it comes to online retail, there's Amazon (NASDAQ: AMZN), and then there's everyone else. And while big-box competitors such as Walmart (NYSE: WMT) and Target (NYSE: TGT) have seen phenomenal sales growth on their digital platforms, Amazon continues to gain market share despite its already dominant position.

Amazon's ability to grow absolute sales faster than its biggest rivals stems from the fact that it's no longer just a retail company. In fact, it makes greater profits from its cloud computing and advertising businesses than it makes from retail.

"We believe Amazon is intentionally selling goods to consumers at a loss," Citi Research analyst Jason Bazinet wrote in a note. "But, it is leveraging dual-purpose infrastructure (servers, fulfillment centers, web traffic) to profitably sell services to Enterprises."

Amazon has a bevy of business-to-business services: Amazon Web Services, advertising, various third-party seller services, and a potential logistics services business. While Walmart and Target might have their toes in some of those businesses, they aren't as robust and don't have the same scale as Amazon's businesses.

Image source: Amazon.

Ad-supported pricing

Amazon's advertising business has quickly grown past $10 billion in annual revenue. It's fueled in large part by the growing amount of traffic flowing through Amazon's online marketplace. Over 70% of its advertising revenue comes from search ads, according to an estimate from eMarketer.

Walmart and Target have advertising businesses as well. But most of their ads are shown in stores -- things like end-cap displays -- and their ability to offer targeted search ads on their websites is limited by their traffic and customer data. In fact, those in-store advertisements may be threatened by Amazon's ad capabilities.

With Amazon's climbing ad prices, Amazon can subsidize its pricing -- for both items and shipping -- and still generate a profit for the overall business. That allows it to scale its logistics operations, which grew from handling 15% of its own shipments in early 2017 to nearly 50% this year, according to Rakuten Intelligence. In turn, it can offer faster shipping to Prime members. That leads to greater order volume, which produces greater need for warehouse capacity, and it can increase the company's ability to offer inventory storage and shipping for third-party sellers. It's a virtuous cycle that's been evident in Amazon's top-line results since it announced the shift to one-day delivery for Prime this summer.

Walmart's head of e-commerce Marc Lore suggested the company's Delivery Unlimited same-day delivery service could eventually produce a profit in the same way as Amazon Prime. It's not profitable up front, but it could lead to greater traffic on Walmart.com, which leads to greater interest from profitable third-party sellers and advertisers.

On the other hand, Target's been operating Shipt for about two years, and it hasn't had much success with third-party sellers. Its digital sales growth stems from its strong portfolio of exclusive brands, not from an increased interest in shopping on Target.com thanks to same-day delivery. That said, Target has only just integrated Shipt with Target.com.

Head in the clouds

Amazon's biggest enterprise service is still cloud computing. Amazon Web Services generated more than two-thirds of the company's operating income last quarter.

AWS has grown well beyond Amazon's online marketplace at this point. Still, its scale enables it to offer services to Amazon customers at significantly lower prices than its competitors. Amazon's cloud helps it adjust pricing and fulfill orders. Amazon also uses the cloud for video and music streaming.

Meanwhile, Walmart is investing millions in its own server farms to produce its own private cloud in order to gain the same advantages AWS provides Amazon's e-commerce operations. Of course, it won't be able to do so as inexpensively as Amazon since Amazon can amortize its expenses across a much bigger customer base. Walmart will have to pass that inefficiency on to its customers at some point, or it'll find itself less profitable than Amazon in the long run.

Amazon's ability to subsidize the cost of its customer relationships with advertising and cloud computing put it at a huge advantage over other retailers. Selling goods at a loss, as Bazinet suggests, may end up being extremely profitable for the company in the long term, and it makes it practically impossible for Walmart, Target, and anyone else to compete.

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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. Adam Levy owns shares of Amazon. The Motley Fool owns shares of and recommends Amazon. The Motley Fool has a disclosure policy.


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