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Amazon's Ad Business Is Taking Steps Beyond Amazon.com

Adam Levy, The Motley Fool

Last month, Amazon (NASDAQ: AMZN) suddenly stopped buying Google's product listing ads. It's now clear why.

Amazon is reportedly testing its own ad product that will show display ads on other publishers' websites to draw consumers back to Amazon. The e-commerce giant previously purchased product listing ads from the Alphabet (NASDAQ: GOOG) (NASDAQ: GOOGL) subsidiary on behalf of its advertising customers. Now, it'll sell these new ads directly to advertisers instead of acting as an intermediary with Google.

That's a major step for Amazon's ad business, which management described as "a multi-billion-dollar program and growing very quickly," on the company's recent earnings call.

During that discussion, one analyst called into question Amazon's ability to increase its ad load, or the number of ads shoppers see, without hurting the customer experience. Amazon's solution? Expand beyond Amazon.com.

Closeup of hands typing on a laptop computer.

Image source: Getty Images.

A massive opportunity

Last year, Google generated $17.6 billion in gross ad revenue from its network members. That revenue come from sites or apps using Google's AdSense or AdMob products, with which Google shares its ad revenue. Google paid out a whopping $12.6 billion, but still kept nearly $5 billion in net revenue for itself. For reference, that's bigger than Amazon's entire ad business last year.

And that revenue from network members is extremely high-margin. Google simply provides the tools for publishers to display AdSense ads on their sites or AdMob ads on their mobile apps, but it doesn't have to maintain the sites or apps like it does with its owned and operated properties.

Amazon could quickly start taking share of the digital display ad market with its new ad product. The company's ads will show web browsers items in which they've previously expressed interest, but didn't purchase, which can produce high conversion rates.

Additionally, Amazon has developed a technology for website publishers called a header bidding wrapper to help them maximize the value of their ad inventory by collecting bids from multiple suppliers. It's allowed smaller supply-side platforms to compete with Google in recent years. As such, Google has seen the growth in network members revenue slow while its revenue share increased.

Winning twice

Amazon may be able to offer better incentives to both advertisers and web publishers for using its ad products because it has the opportunity to win twice with these ads. The first is just the same as Google: When someone clicks on the ad, Amazon gets paid.

But that ad will take web browsers to Amazon's marketplace, where they can purchase the advertised item as well as pretty much anything else you can think of. Whenever someone purchases an item on Amazon, Amazon wins again -- even for third-party merchants.

Amazon collects certain fees from its third-party merchants for services like Fulfillment by Amazon or just a simple product-listing fee. Last quarter, third-party seller services revenue increased 39% year over year on a constant currency basis. Third-party sales are an increasingly significant part of Amazon's total revenue.

Google has far fewer opportunities to win twice like Amazon can with its advertisements. That puts it at a potential disadvantage when it comes to how much revenue it can share with network members or what kind of pricing it can offer publishers. Amazon, on the other hand, has lots of levers it can pull to take share of the third-party display ad market quickly and keep ramping up its ad business by stepping outside of Amazon.com.

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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. Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Adam Levy owns shares of Alphabet (C shares) and Amazon. The Motley Fool owns shares of and recommends Alphabet (A shares), Alphabet (C shares), and Amazon. The Motley Fool has a disclosure policy.