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Amazon's Digital Ad Business Surges

- By John Kinsellagh

Using resources from its dominant platform as the largest online retailer, Amazon.com Inc. (AMZN) has quietly but methodically been expanding its advertising business and is now poised to become a digital marketing Goliath. Given its sheer size and the outsized influence it exerts on numerous industry groups, Amazon's rise in the online ad space is a direct challenge to the two Silicon Valley giants who have dominated the business for the past 10 years.

According to eMarketer, Amazon's ad revenue is on track to double this year to $5.83 billion. Furthermore, the company's advertising operation has already developed into an extremely lucrative, high-margin business. Currently, the company's high-operating margin AWS cloud business provides the bulk of its overall profits. Analysts anticipate that by 2021, the company's ad business will surpass AWS as its principal revenue generator.

Although Amazon currently occupies the number three slot behind Facebook (FB) and Alphabet's Google (GOOGL), with 4% of the market, it has embarked on an aggressive plan to expand its presence in this highly profitable business. And, the company has the resources to catch up to its competitors. What advantages does Amazon enjoy?

The greatest resource Amazon can employ in its quest to compete with the dominant players is its giant and indispensable AWS cloud services data warehousing capabilities. Amazon's cloud computing advantages, in no small measure, has been responsible for its unfettered rise as an online behemoth. The company currently maintains a mountain of information stored on its AWS database servers about every facet of a customers' interaction with the site, from sign-in to log-out; Amazon has been collecting this targeted marketing-rich data for the past 10 years. The type of data culled from site visits includes customer geographic location, amount of time on the site, purchase amounts, personal preferences and much more.



This provides Amazon with a tremendous advantage over Facebook and Google because it can use and offer brands actual purchase data culled from consumers who have shopped on their site.

Most of the company's ad business presently comes from its retail site, where brands pay to be listed as a "sponsored product that places their merchandise at the top of the results from customers search queries."

However, Amazon enjoys an enormous home-field advantage in giving its own private-label brands top billing. The company's products not only appear at the top of customers' search results, but also appear multiple times under the Amazon's Choices location. Even though some competing brands may balk at their placement in the search results listing, most realize they have no choice but to have a presence on Amazon.

Google and Facebook have enjoyed a duopoly over the online marketing business. Advertisers would be delighted to have the option of doing business with another major digital player to make the online ad market more competitive. Amazon is well positioned to fill that need.

A number of items are worthy of note for purposes of ascertaining online advertising revenue growth potential for Amazon. Firstly, Amazon may presently be ahead because of the tremendous advantage it enjoys by leveraging detailed consumer data stored on its AWS servers in its retail business. However, that dominance is now being challenged by Microsoft (MSFT). Since 2013, most of Microsoft's rapid growth can be attributed to successfully implementing its business strategy of becoming a dominant player in the cloud services sector. The software company is slowly making headway against Amazon as a viable alternative to the AWS customized database services.

As an indication of the viability of Microsoft's Azure platform for retailers, the company recently entered into an agreement with Walmart (WMT). Walmart is seeking to replicate Amazon's online retail strategic business plan, which has heavily relied on its massive database of customer information obtained and supported by its AWS unit to fine-tune its customer offerings as well as to determine the optimal use of its resources of other parts of its business operations. These data warehousing capabilities have helped Amazon secure its coveted position as the largest online retailer in the world.

Walmart will now have some of the same data sharing capabilities that Amazon has long since enjoyed and upon which it has capitalized or leveraged to establish its massive internet-only retail presence.

For those retailers seeking to find an alternative to Amazon, Microsoft's Azure services would allow them to determine various customer profiles matched to its products. This detailed information could then be used to purchase the most relevant and targeted keyword-specific advertisements. Until recently, Amazon was the only company who had the IT capabilities to provide retailers this marketing data.

Second, retailers who currently place ads through Amazon to put their brands before the public are growing leery of continuing the practice. The e-commerce giant's own brands compete with their name brands and always appear higher on the search results for the site. Since they directly compete with Amazon, many retailers are reluctant, if not loathe, to use its AWS services, as it simply provides them with a rope to hang themselves.

Disclosure: I have no positions in any of the securities referenced in this article.

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This article first appeared on GuruFocus.