Amazon.com (NASDAQ: AMZN) is viewed differently by investors and consumers. Consumers know the company for its ubiquitous e-commerce business. But investors and analysts often ignore Amazon's retail operations in favor of the company's high-margin Amazon Web Services (AWS) business.
At first glance, this makes sense. Last year, AWS produced operating profit of $4.3 billion, which was more than the company's consolidated operating income total of $4.1 billion. However, a critical part of Amazon's success is the company's North American retail operations. Here's what investors need to know.
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North America retail is getting more profitable
Due to sheer size and scale, Amazon's North American retail operations matter. Last fiscal year, North American retail contributed $2.8 billion to the company's operating profit, and segment operating profit has grown approximately 25% annually since 2013. While this division trails AWS' total operating income, it still makes up a large part of Amazon's profit haul and helps offset Amazon's operating losses in international retail.
While the company's thin operating margins (Amazon uses a low-cost provider strategy) won't convince many skeptics, it's impressive that the retailer was able to grow revenue at a 27% annualized clip while essentially maintaining 2013's operating margin. However, there are a few catalysts in the offing that could lead to more profitable North American operating margins in the years to come.
Amazon has multiple levers for margin growth and expansion
Look for Amazon to continue to grow and expand margins in North America retail. In January the company announced an increase in Amazon Prime membership fees only for customers on a monthly payment plan. Amazon doesn't disclose how many Prime members it has, nor does it reveal the mix of monthly versus annually billed subscribers, but the decision should immediately increase operating income and margins.
Another source of margin expansion is both nonorganic and organic -- the company's Whole Foods acquisition. In Whole Foods' fiscal 2016, its last full year of operations, the organic grocer reported an operating margin of 5.5%, double that of Amazon's North America retail segment. At approximately 15% of Amazon's North American sales, Whole Foods should contribute to margin expansion.
Finally, the company is looking to monetize its Amazon Marketplace more effectively by increasing selling fees for third-party sellers of apparel and accessories. While the decision has the potential to decrease operating income if it forces a seller exodus and push down margins if it precipitates a large shift to the company's private-label clothing (seller fees are reported on the income statement on a net basis; inventory sales on a gross basis), it's my view that neither of these events will occur and Amazon's decision will lead to higher margins.
For years, investors have concentrated on AWS as Amazon's profit machine while treating all retail operations as a loss leader. It's time investors give North American retailing the respect it deserves.
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John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Jamal Carnette, CFA owns shares of Amazon. The Motley Fool owns shares of and recommends Amazon. The Motley Fool has a disclosure policy.