Amazon and the Non-Level Retail Playing Field

“Amazon Profit Margins Evaporate.” That was The Wall Street Journal’s take on the retail juggernaut’s Q2 numbers. But this is cold comfort for Amazon’s competitors.

Last year, Amazon’s Q4 growth was double that of online retail overall. Competitors point to Amazon stealing share with offerings like Prime and the Kindle that lock up consumer spending in ways that few, if any, other retailers have the scale or resources to match. And “showrooming” is generally just another way of saying “Amazon.”

One often overlooked competitive advantage Amazon has is its non-retail revenue streams, which it can use to offset revenue lost to price-cutting. Amazon Web Services, Amazon Marketplace, and Amazon Product Ads all contribute serious revenues to Amazon’s coffers. Product Ads — where Amazon sells highly-targeted, competitive advertising across its internal search results and product pages — receives the least attention. But it poses the most serious competitive threat to retailers.

Why single out Product Ads? Because by supplementing product sales with ad revenues, Amazon is radically changing the terms of competition. It’s no longer bound to a model where you only keep score based on the percentage of visitors you convert to a sale. Instead, Amazon has the ability to monetize a far greater share of its traffic than the three percent who typically buy something. And with the WSJ citing the program at $400M last year — and Business Insider upping the number to $1B earlier this year — it has reached a scale at which retailers should take notice.

Why? Because Amazon generates more profit per visitor. And retailers who are not similarly monetizing their site visits are disadvantaged.

First, let’s remember that $1 of ad revenue equates to $5 to $10 of product sales. Unlike product revenue, ad revenue isn’t encumbered with a cost of goods, warehousing and fulfillment, or even marketing expenses.

That fundamentally changes Amazon’s math on customer acquisition. With the addition of advertising profit to the ROI equation, Amazon can outspend other retailers on a per-visitor basis, even if all other traditional retail metrics — conversion rate, product margin and cost to serve — are equal. This is a massive edge in performance marketing programs, where retailers spend up to a given percentage of attributed sales. Adding significant incremental profit per visitor means you can correspondingly spend significantly more on traffic acquisition.

Amazon can also plow media profits back into its shopping experience — and as noted, retail pricing. Wells Fargo research has shown, “Amazon prices are the lowest in retail by a significant margin, with or without the sales tax advantage.”

Interestingly, there is nothing stopping Amazon’s competitors from also safely monetizing their traffic with ad revenues. Walmart, for one, announced its intention to become an “experience platform” where brands not only sell to consumers, but also market to them, both online and off. Companies like Intent Media (where I work) are helping retailers to safely monetize their traffic with ad revenues. And the rapid spread of Google’s AdSense across retailers from Staples to Macy’s is a tentative acknowledgement of both the opportunity and the threat.

Amazon’s ad revenues may not be padding its bottom line, but those dollars are funding ongoing investments and innovation, which might be even worse for the competition. Amazon’s competitors need to successfully monetize the value of their site traffic — or continue to play on the non-level playing field Amazon has created.

Prior to co-founding Intent Media in 2009, Richard Harris was Senior Vice President, Strategy and Distribution at Travelocity. Earlier in his career, Mr. Harris worked at the Boston Consulting Group and Orion Consultants. He holds a BA from Harvard University and an MBA from INSEAD.