Amazon.com's AWS Unit Is Starting to Enjoy Operating Leverage

By Evan Niu, CFAMarketsFool.com

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This should come as no surprise, since cloud infrastructure businesses are fundamentally scalable once upfront investments are made, but Amazon.com's (NASDAQ: AMZN) all-important Amazon Web Services (AWS) segment is starting to enjoy the benefits of operating leverage. The e-commerce giant reported third-quarter earnings last month, and AWS continues to steal the show in terms of profitability.

AWS revenue jumped 55% last quarter to $3.2 billion, while AWS operating income doubled to $861 million. That actually accounted for more than 100% of Amazon's consolidated operating income; international e-commerce operating losses of $541 million more than consumed all of North America's e-commerce operating income of $255 million and AWS was able to bring Amazon to an overall operating profit. Within the segment, operating margin (excluding stock-based compensation) has now hit an impressive 32%.

Data source: SEC filings and author's calculations. Chart by author. SBC = stock-based compensation.

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This performance is even more impressive when you acknowledge that AWS is engaged in an ongoing pricing war with other major cloud infrastructure providers. Amazon is constantly and aggressively cutting prices to remain competitive, yet is still able to grow the top line while also expanding profitability. Most of the time when an industry is engaged in a price war, everyone loses in the form of margin contraction. Not so with AWS.

That's what he said

On the earnings call, CFO Brian T. Olsavsky expressed confidence in AWS' competitive position:

Amazon is also doing some hand-holding in terms of helping customers transition their IT needs from on-premises solutions to the AWS cloud, assisting with things like database migration. Making it easy to migrate to AWS is a key initiative at Amazon. Amazon continues to expand its AWS team, and has been aggressively hiring there. That will put upward pressure on stock-based compensation expenses within AWS (which are excluded from the chart above), which were $160 million last quarter. Still, Amazon has established itself as the leader in cloud infrastructure, and it's going to play major defense.

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Evan Niu, CFA has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Amazon.com. The Motley Fool recommends VMware. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.