Investors believe Amazon is winning the retail war with Walmart. Amazon’s market cap is twice that of Walmart’s. When it comes to retail, Walmart’s most important retail operations (Walmart U.S. and Sam’s Club) are more than four and a half times larger than Amazon’s main retail operations (Amazon North America) and the operating income is almost nine and a half times that of Amazon. Investors clearly value growth over profitability.
Amazon’s U.S. retail sales increased by over 25 percent. In contrast, Walmart U.S. grew by a paltry two percent and Sam’s Club by just 0.5 percent. Nevertheless, if things were to continue as they are it would take Amazon over a decade to achieve the same level of profitability (measured by operating income) as Walmart currently has.
It is hard not to look at those numbers and wonder if Amazon is overvalued or if Walmart is undervalued. In terms of Walmart’s valuation, Warren Buffett’s Berkshire Hathaway last summer had holdings in Walmart that were worth $3 billion, as of February of this year they were down to less than $100 million. One of the greatest investors of all times believes that traditional retailers will have an increasingly hard time competing with Amazon.
Amazon has upped its game. Two years ago, Amazon’s ecommerce operations lost money and retail was subsidized by profits from their web services business. Today their ecommerce operations are profitable. One modest explanation is that Amazon Prime, the free two-day shipping program, raised its fees to a $100 per year from $79 per year a couple years ago.
Further, Amazon’s expensive warehouse building binge, which is continuing, allows them to ship goods significantly more cheaply than Walmart. Amazon’s annual security exchange commision report shows that they lease and own about 100 million square feet of warehousing and data centers (but mostly warehousing) scattered all over the U.S. Walmart ships from five dedicated eCommerce distribution centers.
This means Amazon parcel shipments don’t travel as far and thus cost less. It is also true that Amazon has moved from working with the high priced national overnight carriers to also using a variety of lower cost regional carriers. The result? Analysts report, Walmart’s online shipping costs from five to seven dollars, while Amazon’s averages three to four dollars per parcel. Walmart can also ship from many stores, but the world’s largest retailer reports that shipping from their warehouses is more profitable.
That does not mean Amazon excels at shipping. Amazon Prime’s two-day shipping guaranty results in heavily subsidizing shipping. They lose 8.7 billion dollars on shipping per year. But their losses, as a percentage of shipments revenues, are narrowing year by year.
It is also clear that the Amazon marketplace, where third parties can sell their goods, is much more profitable than Walmart’s and helps explain how Amazon can make money at ecommerce while so many of their competitor’s struggle. In the first quarter of this year, 50 percent of paid units on the Amazon marketplace were sold by third-party sellers. Analysts report that on average, the ecommerce giant makes a fifteen percent commission on these sales. And about 50 percent of third party goods use the Fulfillment by Amazon service which makes these products eligible for the Amazon Prime shipping program. It is doubtful that Amazon loses money shipping third party goods. In fact, based on the margins, it looks like third party sales are a leading explanation for how Amazon makes money at ecommerce despite the two-day shipping guaranty for Prime members.
Strategically, Walmart’s focus on everyday low prices in their stores is outdated. The number of items sold by Amazon dwarfs that of the products offered by Walmart. This means that all too often an Amazon product, often from a third party, is cheaper than what is being sold by Walmart.
The convenience is also a differentiator, even though Walmart customers who are economically less well off than the average Amazon shopper. Almost three out of four Walmart shoppers bought something on Amazon during the yearend holidays, up from two-thirds who said the same back in 2014.
Does that mean Walmart is doomed to lose? I don’t think so. But they must change the way they play the game. I’ll share some thoughts on this in a future post.