Amazon Becomes an Advertising Powerhouse

Jon Markman

Buried in the fine print of Amazon.com's earnings release a couple of weeks ago was a revelation that might blow you away.

It turns out that the retail conglomerate now spends more on ads than any other brand in the country. The kicker, we learned in an Ad Age report, is that its ad selling business makes it all back, and then some.

This is a potentially huge new business segment that most investors are neglecting.

Advertising may not be the first thing that pops into your head when you think about money-making at Amazon.com (AMZN) -Get Report. Jeff Bezos, chief executive officer, used to hate spending money to tell others about products. He famously said ad spending was a tax for an unremarkable product. It’s a cute line, remarkable even, but something changed in 2018.

That year the Seattle, Wash.-based company bought $1.8 billion worth of ads, a 72.5% increase from 2017, according to Kantar Media, a marketing analytics firm. The Ad Age data shows spending jumped all the way to $6.9 billion in 2019.

Some of the new spend was run of the mill branding for the online store, Alexa and Whole Foods, its grocery business. Managers spent $470 million on network TV ads and another $532 million for cable television. They even spent $52 million on outdoor billboards. However, the bulk of the new spend went into measured categories like desktop search and internet display ads.

It may be surprising but Amazon.com, despite all of its brand identity and reach, is still dependent on online search links to drive traffic to drive sales at its store. Most of this is buying up keywords in Google Search.

If you’re searching the internet for a summery+ polo shirt, it’s likely that the first paid link is for Amazon.com. As you click through web pages in your browser, you’re probably going to come across Amazon.com display banners for the same product. This is all fairly standard stuff.

What’s interesting is Amazon.com also competes in these categories. Specifically, the company sells paid search on its online store. And it turns out those searches are way more valuable than basic internet rummaging.

Although Amazon execs do not break out ad sales, analysts believe the business in 2020 is operating at a $10 billion annual run rate, according to a report at Fortune.

Also keep in mind, Amazon managers are spending about $5 billion to generate traffic. This one reason the business has certain flywheel quality.

The Amazon.com flywheel is a business model based on customer experience, platform traffic and third party sellers. Great experiences lead to increased traffic, that attracts even more third party sellers, bringing lower prices and even more traffic. Once that wheel begins to spin, momentum keeps it going.

It’s a super simple model that has produced incredible organic sales growth year after year. For example, the company had revenues of only $107 billion in 2015. By the end of last year sales were $281 billion. And Amazon.com, last week, reported 2020 second quarter net sales of $88.9 billion, up 40% from a year ago.

Now Bezos is focused on building a massive advertising business using many of the same concepts. He’s buying internet traffic on the cheap using keywords on Google Search, bringing those potential customers inside Amazon.com, where they are more valuable to advertisers, then re-selling that traffic and scraping the profit.

In theory, the only limiter of this model is investment in cheap traffic.

Analysts at Juniper Research believe Amazon.com ad revenues will swell to $40 billion by 2023. Some of this is sector growth. Most of paid advertising is moving toward measured, digital platforms. TV, radio and outdoor billboards are great but nothing beats digital click through rates and pageviews for measurability.

Ad Age found that 59.6% of ad spend is expected to be devoted to pure-play internet by 2024. Television ad spend is forecast to fall to 24.2%, while magazines, newspapers and radio should trend toward low single digits.

Amazon.com is a great business with the best management in the corporate world. Shares are up 70% in 2020, pushing the market capitalization to $1.5 trillion. And at 5.1x sales, the stock is no longer undiscovered.

Still, investors are likely to be surprised by the ultimate size of its advertising business. Buy Amazon.com shares into weakness.

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