Amazon: Control Costs While Not Damaging Prospects

The following is a summary of the Amazon 4Q22 conference call, for a detailed financial analysis please refer to "Can Amazon survive without Bezos?"

I. Management Remarks

1. AWS Cloud Services

Starting in the mid-third quarter of 2022, the year-on-year growth rate of this business has declined as various-sized companies evaluate how to optimize their cloud spending in response to the challenging macroeconomic situation. As expected, the optimization work continued until 4Q.

Looking ahead, spending optimization will continue to hinder AWS's growth for the next few quarters. In the first few months of this year, AWS's revenue growth was around 15% year-on-year. However, the new customer channel is still healthy, and many customers continue to plan to migrate to the cloud and promise to use AWS for a long time.

2. Pan-Retail Business

1. Retail

Due to economic instability and sustained inflationary pressures, customer consumption behavior is cautious. The spending on non-essential categories has decreased, shifting to low-priced electronic products and value brands; spending on daily necessities remains consistent, such as consumer goods, beauty products, and clothing.

Third-party sellers remain the key factor in expanding the selection range, with 59% of unit sales in 4Q coming from sellers, a record high.

1. Advertising

Despite the weakening macro environment and tightened marketing budgets, sellers, suppliers, and brands continue to rely on Amazon's advertising capabilities to attract customers during the fiercely competitive holiday season. Excluding the impact of exchange rates, advertising revenue in 4Q increased by 23% year-on-year. Prime membership is still valuable to customers, and improving Prime benefits is a continued part of the investment strategy.

1. Prime Video

In addition to competitive prices, a wide selection, and faster delivery speeds, the growing entertainment content is highly favored by Prime members. This quarter, the first season of "The Lord of the Rings: The Rings of Power" was launched, becoming the highest-rated Amazon original series globally, with an audience of over 100 million, and during this time, driving growth in global Prime registered users (its release window is longer than other Prime Video content).

As the exclusive broadcaster of Thursday Night Football's first season, Amazon attracted the youngest audience (median age) of NFL broadcasts since 2013, with a year-on-year increase of 11% in audiences aged 18-34, who were difficult to reach.

Overall, Amazon invested around $7 billion in 2022 in original Amazon content, live sports events, and third-party licensed video content included in Prime, an increase from approximately $5 billion in 2021. The cost of digital video content is included in the income statement's cost of sales. The company regularly evaluates the return on this expenditure and continues to be encouraged: video has proven to be a powerful driver of increasing Prime membership engagement and acquiring new members. 3. Financial Indicators

1. The operating profit for this quarter is USD 2.7 billion, but there were additional expenses of USD 2.7 billion this quarter (including employee layoff fees, impairment of property, equipment and operating leases, and estimated changes in self-insurance liabilities) that mainly affected the North American department. If these costs are not incurred in 4Q, the operating profit will reach approximately USD 5.4 billion.

2. On the transportation side, the demand for workforce and the entire operating network is more closely aligned this quarter. The efficiency of the transportation network continues to improve, and the improvement of processes and technology has increased the productivity and line-haul utilization rate of Amazon Logistics. In addition, strong holiday transaction volumes have brought good leverage.

3. Layoffs: Considering macroeconomic instability, a difficult decision was made in 4Q to cut more than 18,000 positions, which mainly affected the store and equipment business and the human resources team. Incurring layoff fees of approximately USD 640 million, which are recorded in the technical and content, fulfillment, and general administration in the income statement.

4. Impairment of Property, Equipment, and Operating Leases

Mainly related to Amazon Fresh and Amazon Go physical stores. The company is constantly improving store formats, establishing grocery brands and expanding, and closing certain stores with lower growth potential.

The capitalized costs and related values of leased buildings are impaired, with impairment costs of USD 720 million included in other operating expenses in the income statement. Still believe that grocery brands have great potential and focus on providing services to customers through multiple channels such as online delivery and in-store shopping.

1. Estimated Changes in Self-Insurance Liabilities

The estimated costs of claimed and unclaimed costs have changed this quarter, increasing the general product reserves of automobile self-insurance liabilities, resulting in additional costs of USD 1.3 billion, recorded in the cost of sales in the income statement. The company's business has grown rapidly in recent years, especially with the establishment of fulfillment and transportation networks, and the amount of claims has increased. Therefore, continue to evaluate and adjust the reserves of these two claims and the estimation of unproven claims.

1. Rivian

Net income includes a pre-tax valuation loss of USD 2.3 billion on common stock investment in Rivian Automotive, recorded in non-operating income. This is unrelated to Amazon's ongoing operations, but is related to the quarterly fluctuation of Rivian's stock price.

Q&A Section

Q: How do you view the profit potential of North American retail business given the warehouse growth in the coming years, what are the warehouse networks, and what are the target efficiency factors?

A: At the end of 2019 and early 2020, when the company launched the one-day delivery service in North America, it had a clear expectation of the cost structure. However, due to doubling of the logistics network within three years, there have been significant changes in cost expectations. Now we are trying to return to the past cost structure, balance and more effectively use the assets that have increased over the past 2-3 years. Simultaneously identify areas that need to be adjusted, and expect significant improvement in North American operating costs by 2023.

Q: The key to driving sustained growth in North American retail business for many years.

A: 1) The most important is customer experience. In North America, everyone is striving to reduce costs globally, but we will not give up long-term strategic investments;

1. The primary issue for North American retail is to reduce the service costs of the operational network. At the same time, a transportation network has been established for the "last mile" (Last Mile) within a few years, which is equivalent to the scale of UPS. However, it is necessary to pay attention to how to connect the network nodes and make effective use of all links. Good progress has been made in 4Q, and work will continue until 2023.

Secondly, speed up the delivery of products to customers' hands, and promote higher conversion rates. Reasonable prices are very important in an uncertain economy, and the company will continue to strive to maintain price advantages.

Thirdly, strive to improve customer experience. For example, add Buy with Prime, allowing Prime users to use Prime discounts on other websites outside of Amazon; or add RxPass in the healthcare field, and major customers can pay $5 a month to get unlimited access to all the drugs they are using; or provide customers with a try-on experience when shopping for clothing.

Q: Efforts in the grocery store sector and key steps to increase market share in the grocery store sector

A: Grocery is a very important strategic area, it is a very large segmented market, and consumers have high frequency and many ways of shopping. Over time, grocery stores will become all-channel. However, the market share of fresh food is very small, and physical stores are needed to increase the share of this field.

Currently, a considerable number of experiments have been conducted in these stores, and physical stores will not be expanded until the appropriate differentiation and economic value are found. The company is and will continue to build a fairly extensive grocery network across online and physical stores.

Q: Impact of layoffs and reorganization on operating income guidance for the new quarter

A: The personnel reductions in 4Q resulted in a cost of 640 million U.S. dollars, but most of the remaining will fall into 1Q in mid-to-late January. For January layoffs, the first three weeks' wages are included in 1Q's operating performance.

Q: How do you view the growth and profit margin changes of international business in the next few years?

A: The compound annual growth rate from 2019 to 2021 is over 30% in the UK, 26% in Germany, and 21% in Japan. However, the company has not yet returned to this growth rate.

Now the company has a large scale in developed markets, and macro environment changes have a great impact on the company's performance. Taking Europe as an example, the inflation rate is high due to the impact of war, and energy and commodity prices are rising, which affects business performance.

The emerging market is in a different stage, and investment and returns take time.

Q: AWS business revenue decline, reasons for recovery, and whether profit margins will rebound.

A: Clients are cutting spending during economic downturns, and we are working with them to optimize their spending. It's even more important in the current environment to help clients find cost-effective solutions.

Since its launch in 2006, one of AWS's advantages is that it can seamlessly scale up when demand exceeds expectations and scale back when demand decreases, and you no longer have to pay for it.

Benefiting from AWS's stronger security and operations performance and larger partner ecosystem, it is estimated that AWS will achieve more growth than its competitors when the US dollar increases year-on-year.

Q: How do you increase Prime membership engagement, improve monetization, and what are your future directions?

A: Prime membership growth remains strong, and so does per capita Prime member spending (with geographic variations). Last year, we launched a lot of video assets such as "Thursday Night Football" and "The Lord of the Rings: The Fellowship of the Ring," which set a record for Prime membership registration. This not only helps to gain new members but also helps to retain members. This engagement is directly related to the high purchase volume of daily products on the Amazon website.

In addition, many peers' subscription prices are $14-15 per month, higher than Prime Video, which is not cost-effective. Users can enjoy entertainment content, fast shipping, music, games, photos, and other advantages on Prime Video, and can also use Prime subscription on other websites. For example, the newly launched RxPass allows users to buy commonly used drugs at an unlimited price of $5 per month. The company will continue to add content to Prime and continue to try many different features and advantages, but it is still too early for now. As services and functions continue to improve, people will spend more on Amazon's various businesses.

Q: Why will AWS's growth rate remain around 15% in the next few quarters despite the continuous deterioration of corporate demand? What changes in personal or corporate priorities occurred when Andy became CEO?

A: The customer base is changing, making it difficult to predict AWS's growth rate. In the short term, many companies will tighten their infrastructure spending, but the long-term trend remains. To be frank, the quickest way to save money is to use the cloud.

In 2022, as the macroeconomic situation changes, the company has examined the cloud business from a high level and hopes to achieve full economic cost, but without giving up critical long-term strategic investments.

Therefore, the company chose to pause the increase in staff numbers, cancelled projects such as fabric.com, Amazon Care, and Amazon Glo, and slowed down the expansion of physical stores in the grocery field.

Although progress is slow in some aspects, the company is very enthusiastic about investments in streaming media and entertainment devices, Kuiper satellites in low-earth orbit, healthcare, and other areas. Will every new investment be successful? Time will tell. As long as 1-2 of them become the fourth major pillar, Amazon will become a very different company. Overall, we will consider cost reduction very seriously, but we will not give up long-term investment.

Dolphin's Research on Amazon:

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