If there's been one knock against Amazon.com (NASDAQ: AMZN) as an investment, it's been the company's lack of substantive profit. Still, investors have been willing to afford the company nosebleed valuations based on its considerable growth.
Amazon produces most of its revenue, 91% as of fiscal 2016, through its low-margin retailing business (international and North America). Founder and CEO Jeff Bezos is hell-bent to compete on price with a mantra "Your margin is my opportunity." The company has not only survived in this notoriously cutthroat industry, but has thrived thanks to its aggressively low prices (even when it meant sacrificing margin).
After decades of producing losses, the company has recently become reliably profitable on the back of its higher-margin Amazon Web Services (AWS) division. However, it's another division that Bezos could focus on if the company wants to see its stock push higher, at least in the short term: international retailing.
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Axing international retail could make Amazon significantly more profitable
In the company's annual report, Amazon reports revenue and operating income from three business segments: North American retail, international retail, and AWS. Below are revenue, operating income, and operating profit margin attributable for each segment for the last three reported years.
| Metric | 2014 | 2015 | 2016 | CAGR |
|---|---|---|---|---|
| North America Revenue | $50,834 | $63,780 | $79,785 | 25.3% |
| North America Operating Profit | $360 | $1,425 | $2,361 | 156.1% |
| North America Operating Margin | 0.7% | 2.2% | 3.0% | |
| International Revenue | $33,510 | $35,418 | $43,983 | 14.6% |
| International Operating Profit | ($640) | ($699) | ($1,283) | |
| International Operating Margin | (1.9%) | (2%) | (2.9%) | |
| AWS Revenue | $4,644 | $7,880 | $12,219 | 62.2% |
| AWS Operating Profit | $458 | $2,233 | $4,186 | 202.3% |
| AWS Operating Margin | 9.9% | 28.3% | 34.3% |
Source: Amazon's 10K. All dollar figures are in millions. CAGR equals compound annual growth rate.
Although Amazon's AWS division produced only $12.2 billion in revenue in 2016, the division produced the bulk of the operating profit due to its 34% operating margin. While the company is mostly known for its e-commerce business, Amazon's North American retailing contributed approximately 50% less to operating income than AWS with significantly higher income due to its much lower profit profile. At these profit margins, North American retailing would need to produce 11 times more revenue than AWS to surpass its profit.
Which brings us to international retailing: Despite generating $44 billion in revenue, international retailing remains unprofitable. Even worse, the company's operating margin continues to deteriorate even with sales growing at a rapid clip, growing losses in the division and pointing to dis-economies of scale. If this segment wouldn't have existed, Amazon's operating income would have been 31% higher in 2016.