AMZN: Winning Christmas
With ~$250B in annual gross merchandise volume (GMV) and more than 250M active customers, AMZN, already 3x the size of its closest US online rival Ebay, is responsible for nearly 20% of global e-tail sales and is on a trajectory to catch and pass WMT to become the world’s largest retailer of any kind by the end of 2020. The inherent scalability of the online model, combined with AMZN’s size, unique capabilities and relentless executional excellence, allows simultaneous improvement in all 4 retail business drivers – price, selection, convenience and service – widening the company’s already considerable strategic advantages and closing gaps in areas that are minuses vs. brick-and-mortar stores. AMZN’s investment in shortening its delivery windows is opening up new markets as it continues to pressure traditional merchants in its core categories. Already able to address the majority of the $6T in US retail sales, we believe that it can successfully lever its extraordinary e-commerce operations toward the even larger B2B market, currently fragmented into the hands of thousands of mostly regional and specialized vendors. While heavy investment in international expansion, new fulfillment centers and IT capacity have obscured healthy underlying profitability, we believe that these investments will deliver handsome long-term returns. Adding in AMZN’s similarly dominant AWS IaaS business, which itself addresses a $1T potential market, we believe AMZN is positioned to exceed investor expectations for both top and bottom line growth.
AMZN on track to surpass WMT. Including 3rd party sales, we believe that AMZN will sell roughly $250B in merchandise in 2015, making it the #2 US based retailer with more than double the sales of #3, COST. On its current trajectory, AMZN’s GMV could make it the nation’s #1 retailer by 2020. Toward that end, AMZN is leveraging its scale, fulfillment expertise, IT skills and superior process design to simultaneously pressure traditional merchants on price, selection and convenience. As the shopping paradigm continues a relentless shift to digital, most traditional brick-and-mortar merchants are falling further behind despite considerable investments in their own online/mobile initiatives.
Cost dynamics shifting AMZN’s way. By replacing stores with massive fulfillment centers, AMZN saves dramatically on real estate, personnel and inventory. Those savings are reinvested in lower prices, but also in improving both product selection and shopper convenience. The big cost disadvantage to the online model is delivery. Here, AMZN’s buying power has wrested ongoing savings from FDX, UPS and the USPS, while it explores options for its own delivery service, including investments in drones. Accepting sales taxes raises prices, but allows fulfillment centers much closer to many cities, speeding delivery while shaving delivery costs. With these advantages, AMZN offers prices competitive with its lowest cost physical store rivals and largely better than online competitors on an all-in basis.
AMZN dominates selection. 380M separate products are available on AMZN, about 5% of which are fulfilled directly by the company and available for 2-day shipping. In contrast, WMT offers 4.6M products on line (less than 1.3% vs. AMZN) and about 150K in its typical Supercenter. Comprehensive selection, along with the deserved reputation for low prices, is the prime reason that 44% of shopping searches begin directly on AMZN, up from 30% 2 years ago. Wide selection also drives purchases of more commonly available items, which are often bought at the same time as a more esoteric product.
Gaining advantage in convenience. Shopping at home is an enormous convenience, but online shoppers cannot touch a product before buying, and cannot take it home immediately after. Liberal and easy return policies, trusted product reviews, and elite level customer service have helped to erode the first factor, and AMZN has invested billions to attack the second – shortening deliveries from days to hours in some markets. This opens new categories, like groceries, where immediacy is an important buying criterion, and improves the shopping experience. That overall experience is an important driver for AMZN – it accurately suggests products to buy, it eliminates the time and effort needed to go to a store, it streamlines finding the product in stock, and simplifies transaction completion.
Prime is the best loyalty program – by far. AMZN Prime has roughly 41M members, each paying $99/yr for free two day shipping, access to Prime Pantry, unlimited video and music streaming and a kindle e-book lending library. Prime is growing ~35%/yr and members typically spend 2x as much as non-members. AMZN has more than 250M active accounts spending nearly $1,000/yr apiece, and 60% of those accounts purchased something during the 2014 Holiday season. For each of those accounts, it has a name, address, email, credit card number, and a detailed record of both browsing and purchase history. 68% of all US smartphone users have installed and use the AMZN app. Meanwhile, brick-and-mortar retailers face substantial and unappreciated hurdles in transitioning their largely less than successful card-based loyalty programs into mobile apps.
Would-be online rivals are FAR behind. We believe that matching AMZN’s costs, selection and customer experience for online/mobile shopping will be impossible in the markets, like the US, where it has established a significant beachhead. AMZN’s hyper efficient fulfillment infrastructure, its world-class IT platform, and locked-in customer base are many years and billions of dollars of investment ahead of potential competitors – in particular those traditional merchants looking to repurpose logistics operations meant to stock store shelves toward a delivery model.
AMZN for Business is a huge opportunity. US B2B distribution is an $8T annual market, spread out over 35,000 largely regional and specialized companies, of which just 160 have sales of more than $1B. AMZN entered this market in 2005 with an acquisition, but kept its service as a Beta test product until earlier this year, when AMZN for business was formally launched, offering 2.2M products while the average competitor offers just 50K. AMZN has begun with high volume products, like office supplies or cleaning materials, that can leverage its existing process, and offers substantial discounts from a characteristically customer friendly site. With time, AMZN for Business could rival the e-tail flagship.
Including dominant AWS, AMZN set to beat long-term expectations. We expect AMZN’s B2C and B2B businesses to top $200B in reported revenues (and $500B in GMV) by 2020. AWS, itself dominant in an IaaS market that has begun to consume the $3.7B in annual enterprise IT spending, could be a better than $50B business in the same timeframe. We believe that this further scale will reduce impetus for investment as a percentage of sales, enabling substantial margin expansion from current levels. This prognosis is significantly above consensus, and, we believe, supports a target share price of better than $900 with the likelihood of strong 4Q15 results a potential catalyst.