Amazon's Local Services Market Place Will Add Much-Needed Margin To The Bottom Line

Jun.13.14 | About: Amazon.com, Inc. (AMZN)

Summary

Amazon already runs a market place with more than 2 million third-party vendors.

Amazon needs to increase margins or they will continue to be punished by investors.

Their product market place has reduced the impact of losing the sales tax exemption.

A local service market place would add value to the current market place without significant risk or capital investment.

Amazon.com, Inc. (NASDAQ:AMZN) has capitalized on their retail success by creating a massive third-party market place. The market place has over 2 million different third-party vendors. Amazon has utilizes the market place to sell third-party items alongside their own items. This has made Amazon the default website for online shopping. Why go to several different websites? When Amazon allows consumers to search for new or used products and purchase them through countless third-party vendors.

The market place is a great service for customers and is highly profitable for Amazon. Third-party items are subject to referral fees and closing fees. The majority of the market place's revenue comes from referral fees. A referral fee can range from 6% to as high as 25% of the items selling price. For a company infamous for thin profit margins, the market place is an operating segment producing significantly high margins.

The market place is so profitable because it requires little capital and risk. Unless fulfilled by Amazon (fee required), third-party vendors are responsible for storing, processing, and shipping items. Unsurprisingly, Amazon is trying to expand the market place into other business areas. According to Reuters, Amazon plans to open a local market place for professional services. The market place has been extremely valuable to Amazon's business but the market place's value may become even more important in the future.

Amazon Needs To Increase Margins

Over the years, Amazon has been able to rapidly increase revenue but operating profit growth has been an issue. For the Q1 2014, Amazon's operating profit margin was .7%. This is razor thin even for the retail industry. In Q1 2014, Wal-Mart's operating profit margin was 5.4%. Additionally, Amazon's margin problem is occurring in an area with the most potential growth. Amazon's United States profit margin was 4.7%, for Q1 2014. This is comparable to Wal-Mart's operating margin. However, Amazon's international profit margin was negative, for Q1 2014. This isn't good for a company in need of operating income growth.

Also, Investors have started to punish Amazon for their lack of operating profit. Amazon's stock has fallen from over $400 to around $325. The decline started because Amazon missed analyst's net income estimates by $0.15, for the 4th quarter of 2013. The earnings miss resulted in a one-day decline of over 10% on January 31, 2014. This shows investors aren't satisfied with just revenue growth but need to see significant revenue growth.

Losing Sales Tax Exemption Is Hurting Main Business

Amazon has lost the battle against collecting sales tax. Normally, a business isn't require to collect sales tax as long as they don't have a physical presence in the state. However, New York set a precedent by forcing Amazon and other online retailers to collect sales tax without having a physical presence in their state. Currently, sales tax is collected in many major markets such as New York, California, Florida, and Texas. Amazon collects sales tax in 21 of 50 states. Amazon has even admitted defeat by supporting a national sales tax law. Stating in their Q1 2014 10Q "We support a Federal law that would allow states to require sales tax collection under a nationwide system."

Amazon is supporting a national bill to help create a fair competitive landscape. According to a Bloomberg article, eliminating the sales tax exemption has reduced purchases made directly from Amazon. The elimination of the sales tax exemption has driven consumers to third-party sellers still exempt from collecting sales tax. Throughout the years, Amazon has had one major advantage over brick and mortar retails which was the sales tax exemption. However, Amazon is now at the same competitive disadvantage. The loss of the sales tax exemption hasn't been a total disaster. The article demonstrates the value of Amazon's market place. Although direct sales decreased, consumers used Amazon's market place to purchase items from tax exempt third-party retailers.

Local Market Place

Amazon's market place has shielded it from the full impact of losing the sale tax exemption. The introduction of professional services will only further bolster the market place's importance. Amazon has a large customer base which will allow professionals to target a large local audience. Amazon's size will give them significant pricing power over professionals which Amazon has shown a willingness to use. There are few large corporations offering professional service market places which should allow Amazon to quickly gain significant market share. The introduction of services would increase the value of Amazon's market place and provide much-needed high profit margins.

Amazon Needs To Grow Net Income

Amazon has always focused on delivering the best customer experience possible. This has meant making little profit on items and making money based on volume. However, Amazon's current size will hinder their ability to grow net income through increased revenue only. The market place has and will continue to be an important part of Amazon's business. With the elimination of the sales tax exemption, Amazon's market place was able to limit the full impact. Amazon needs to push their margins higher and grow net income. The introduction of a local market place for services would be a great addition. The market place will push margins higher and require no significant risk or capital.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.