Last week, we interviewed a Former Finance Manager at Amazon who was partly responsible for collating separate country and retail product category financials into one consolidated AMZN P&L for Brian Olsavsky, AMZN’s CFO.

In this analysis, we breakdown AMZN’s non-AWS P&L to better understand the underlying e-commerce unit economics.

The first insight from the interview is that the S-Team looks at the retail P&L excluding ads and Prime.

If you include ads in the core consumer business, you are unable to assess the health of the business, at its fundamentals. When you think about core ecommerce, because the fulfilment network and those investments are so massive, there is a relentless focus on optimizing the opex/capex outlays associated with those operations…if you include the advertising numbers in the core consumer business, it entirely obfuscates how that business is operating independently of the advertising. - Former Finance Manager at Amazon

This is so AMZN: management doesn’t include advertising or subscription revenue when calculating e-commerce gross or contribution margins.

Some may argue it makes no sense; advertising is an online slotting fee and Prime revenue helps cover huge same-day delivery costs, etc. But management is focused on improving the operating cost per parcel shipped. If you include ads and subs, it hides the underlying retail operating efficiency. It could lead to the dreaded Day 2.

AMZN’s consolidated cost of sales includes product, shipping, video / music licensing costs, and Whole Foods COGS. If we assume WFM operates at ~35% gross margin, AMZN’s e-commerce cost of sales is split as follows:

Source: AMZN, IP
Source: AMZN, IP

To find a pure ecommerce gross margin, we net out Whole Food’s COGS and the content licensing expense, given the S-Team treats the content licensing cost as part of the ‘Subscription’ P&L.

We then net out total fulfillment expenses to find e-commerce contribution margins. Over the last 7 years, AMZN’s pure e-commerce gross margins have been fairly stable at ~22% yet its contribution margin has declined from 8.5% to -3.5%.

Source: AMZN, IP
Source: AMZN, IP

The gross margin is likely more stable because AMZN has improved its 1P buying power and can better manage its 1P / 3P product mix to manage gross margin.

The decline in the contribution margin is driven by AMZN’s push for same or next day delivery. From 2015-2022, fulfillment costs as a percentage of revenue has increased from 14% to 25.8%. Over the last two years, AMZN has barely covered the variable costs of shipping a product.

This negative contribution profit is the e-commerce margin after paying all variable costs when shipping a product. If we add back both subscriptions and advertising revenue, the gross and contribution margins look very different.

Source: AMZN, IP
Source: AMZN, IP

It’s no surprise that the advertising revenue is driving non-AWS margins. Advertising is generating ~50% of AWS’ revenue and at ~80%+ margins, it’s likely the most profitable business at AMZN.

Contribution margin excluding advertising has declined from over 10% to breakeven over the last 9 months. Prime subscription growth isn’t keeping pace with the growth in fulfillment costs. Advertising revenue is plugging the gap.

The full non-AWS business, including ads and Prime subscriptions, yields a ~40%+ and 16%+ fully-loaded gross and contribution margin, respectively.

Finding the underlying e-commerce EBIT margin is trickier.

There are three major opex line items; marketing, tech and content, and G&A.

The marketing expense includes advertising costs and sales FTE’s for both Amazon Advertising and AWS. The chart below shows how the advertising portion of the marketing line has declined from ~70% to 50% today. This is mainly due to the rapid growth in AWS’ expensive sales team. We only include the advertising cost in the retail P&L.

Source: AMZN, IP
Source: AMZN, IP

The tech and content line is the trickiest to decouple. This is the 10-K definition:

“Technology and content costs include payroll and related expenses for employees involved in the research and development of new and existing products and services, development, design, and maintenance of our stores, curation and display of products and services made available in our online stores, and infrastructure costs…Infrastructure costs include servers, networking equipment, and data center related depreciation, rent, utilities, and other expenses necessary to support AWS and other Amazon businesses. Collectively, these costs reflect the investments we make in order to offer a wide variety of products and services to our customers. - AMZN 10-K

Put simply, tech and content expenses are split between AWS infrastructure and all other R&D projects and overheads including Kuiper, Alexa, AMZN Media, etc.

During the interview, the executive estimated each opex line item between AWS and Retail as the following:

Source: IP Estimates
Source: IP Estimates

Using these estimates, we calculate the underlying e-commerce EBIT margin excluding and including subscriptions and ads.

Source: IP Estimates
Source: IP Estimates

The table below shows the components of the fully-loaded margin:

Source: IP Estimates
Source: IP Estimates

This is a consolidated P&L which includes both North America and International. The margin profile of the two regions is very different:

Source: AMZN, IP
Source: AMZN, IP

Even with the VC-like projects including Kuiper, robotics, etc likely expensed in the NA region, the segment has historically been profitable at the operating level.

One major question normalized margins is: what percentage of the tech and content line is pure venture spend?

This was the executive’s answer:

15% to 20%; maybe more. Let me help you view the business in the way that Brian Olsavsky views the business; it is called the contributions and investments page. The first half of this page is all the contributions, in terms of operating income, and it's broken out one column North America, one column international, one column stores, one column total…The way you think about the business is, we're building some profitable businesses and we're going to make a bunch of investments. We're structured as the world's greatest entrepreneurial organization. Every team is no bigger than two pizzas can serve and they're all inventing all the time. - Former Finance Manager at Amazon

15-20% of the tech and content line is potentially VC-like expenditure.

This highlights the major takeaway from the interview: AMZN behaves like the world’s largest startup.

What ‘retailer’ or ‘cloud computing’ company is trying to cure the common cold?

it is purposely hidden – the investment areas. [Investors] don’t know what is necessarily going to happen with Rivian or Project Kuiper. They don’t know that Amazon is attempting to cure a common cold which may or may not have been one of the grand challenges in the past. Amazon really does try to tackle very big problems…They are trying to find the next AWS. They have always realized that complacency leads to death. There is a nice Bezos quote on it about what day two looks like; you should look it up. That is the ethos of the company; it is that fear of day two. - Former Finance Manager at Amazon

The incremental return on these dollars invested is what worries some investors today.

For example, the chart below shows AMZN retail’s slowing revenue per square foot growth relative to AWS:

Source: AMZN 10-K
Source: AMZN 10-K

Is the mature ecommerce opportunity big enough for AMZN to earn a return on the capital it has invested in the fulfillment network?

The decline in the 3-year rolling ROIIC may suggest otherwise:

Source: IP Estimates
Source: IP Estimates

Given NA’s historical profitability and potentially 15-20% of the tech and content line being VC-like spend, it’s hard to question the underlying profitability of AMZN’s e-commerce business. At maturity, we believe NA could reach high-single digit EBIT margin and ~5% EBIT / GMV, fully-loaded including all revenue streams and assuming AMZN continues to invest through P&L in ventures.

But AMZN has significantly increased retail capex as NA e-commerce is potentially maturing and competitive and regulatory risks increase internationally.

Can International margins replicate NA? And if e-commerce penetration is maturing, how long may it take to recoup the required return on the recent significant capex?

Bulls believe AMZN logistics rails is the moat and e-commerce has a long runway ahead. And longer-term, bulls have to believe in AMZN’s ability to allocate capital effectively. Because you can be sure it will spend the FCF.

The more we study AMZN, the deeper our belief that Bezos’ genius is in orchestrating a scalable, innovation machine. Two pizza teams, Day 1 philosophy, 6-page memos, etc. It may seem cheesy, but this has laid the foundation to build probably the most entrepreneurial company that has ever existed.

AMZN is engineered to spend every dollar it earns. It has two great businesses to build the future, but its Day 1 philosophy means investors may never ever fully see the FCF. It’s simply invested to find the next AWS. In times like today, this can be too much to ask for some investors.