U.S. Markets close in 1 hr 49 mins

Amazon's Ad Business Still Has a Lot of Opportunities

Adam Levy, The Motley Fool

Amazon's (NASDAQ: AMZN) ad business has been one of its biggest bright spots over the past two years, as it's grown to become a $10 billion business. Amazon's "other" revenue line item, which consists primarily of ad sales, grew 37% year over year in the second quarter, in line with the company's first-quarter results.

That 37% growth rate outpaces both its biggest rivals in digital advertising: Facebook (NASDAQ: FB) and Alphabet (NASDAQ: GOOG) (NASDAQ: GOOGL) subsidiary Google. Facebook grew ad revenue 28% in the second quarter; Google grew 16%. Granted, both are building off much larger bases.

Several big opportunities still lay ahead for Amazon's ad business, though. If the online retailer can capitalize on them, it should enable the company to continue outpacing the growth of its rivals for years to come.

Screenshots on a laptop and a smartphone highlighting promoted brand ads on Amazon's marketplace.

Sponsored Brand ads on Amazon's marketplace. Image source: Amazon.

Advertisers are getting more for their money

Sponsored listings on Amazon's marketplace account for the bulk of Amazon's ad business today. But sales growth for both Sponsored Products and Sponsored Brands has slowed considerably. Sponsored Product spend in the United States increased just 12% year over year last quarter, according to Merkle's second-quarter digital marketing report. Sponsored Brand spending decreased 2%.

But advertisers are getting much more for their money. Sales stemming from Sponsored Product ads more than doubled year over year, while Sponsored Brands produced 53% more sales than in the second quarter last year. In other words, advertisers are seeing huge improvements in their return on investment.

Amazon has made some meaningful improvements to its ad-buying platform to help marketers improve their targeting and place their ads more efficiently. That's translated into more sales for advertisers, but those results haven't yet flowed through to Amazon's ad pricing. As Amazon attracts more advertisers to its platform, it should be able to push its average ad price higher thanks to the higher returns its ads are now providing.

It's worth pointing out that Facebook has faced a similar dynamic for the last few years. It started warning investors about ad load saturation in 2016, but it's consistently grown ad revenue for years as marketers continue to get increased value from Facebook ads. As a result of the improved value, Facebook's average price per ad increased.

Video ads are just getting started

Amazon made a major change to its Fire TV platform in September last year. The company started requiring most ad-supported video on demand apps to provide it with 30% of their ad inventory to sell on its own. With 34 million active accounts, that adds up to a lot of video ads for Amazon to sell. That change will continue to have an outsize impact on Amazon's results through the third quarter.

Amazon also started offering its own ad-supported streaming service, IMDb TV, earlier this year. It's seen good results so far, and it's increasing its investment in content for the service.

"We'll continue to do things like add more [over-the-top] video supply, just things like Amazon Publisher service integrations and simplifying access for third-party apps and add more inventory through things like Fire TV apps and IMDb TV," Dave Fildes, director of investor relations, said on Amazon's second-quarter earnings call.

As Amazon ramps up its video advertising, it should provide a nice supplement to sponsored listings on its marketplace.

The international market is practically untapped

Another big opportunity for Amazon's ad business is expanding what's worked in the United States to more markets internationally. "We're really excited about the international opportunity. A lot of the tools that we've rolled out and introduced in places like the United States aren't available in many of the international regions," Fildes told analysts.

While the United States remains the biggest market for consumer spending (and therefore advertising spend), there's still a lot of room for Amazon to grow internationally. More than half of Facebook's ad revenue came from outside the U.S. and Canada last quarter. Alphabet reported just 46% of its revenue came from the United States.

If Amazon can replicate the results of Facebook and Google in terms of geographic mix, it could practically double its ad revenue over the long term just by expanding its services and tools to more markets.

With some big opportunities ahead for Amazon's ad business, investors should expect the relatively high-margin segment to keep growing considerably faster than its rivals and its more mature businesses.

More From The Motley Fool

John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Randi Zuckerberg, a former director of market development and spokeswoman for Facebook and sister to its CEO, Mark Zuckerberg, is a member of The Motley Fool's board of directors. Adam Levy owns shares of Alphabet (C shares), Amazon, and Facebook. The Motley Fool owns shares of and recommends Alphabet (A shares), Alphabet (C shares), Amazon, and Facebook. The Motley Fool has a disclosure policy.