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Analysis: Amazon growth result of advancements on several key fronts

Despite its enormous size and previous run of strong growth, Amazon has had no problem in delivering another good set of numbers [in its second quarter]. The company’s strong revenue growth, which saw product sales up by almost 30% over the prior year, underlines its growing grip on the retail market and its ability to persuade an increasing number of customers to buy an increasing array of things from it.

While Amazon makes growth look easy, its advancement is the result of significant effort on at least three fronts.

First, it innovates and tries new things like no other retailer. The laundry list of projects Amazon is working on is extensive and this heady pace of creativity is the key reason why it stays several steps ahead of the market and is able to generate so much growth. Much of this is the result of a company culture of never settling and not being afraid to fail. In our view, other retailers would do well to take a leaf out of Amazon's playbook on this front.

Second, across all of the things it tries and tests, Amazon is extremely customer-centric. It rarely innovates by increments, but instead looks to find problems consumers face and then uses technology in creative ways to help solve them. This means that innovations usually result in increased customer loyalty, improved conversion and transaction rates, and ultimately increased sales. Looking at the market from the point of view of the customer also allows Amazon to retain an edge over other retailers.

Third, Amazon has created a compelling ecosystem which permeates many aspects of people's lives. Prime is at the heart of this and membership makes it both easy and financially sensible to buy into the many products and services Amazon has to offer. In our view, while Prime is fairly mature in a market like the U.S., the integration of Whole Foods into the mix is bringing on board even more customers. Meanwhile, in other countries, Prime has a lot more runway for growth.

For all the success on the sales line, Amazon used to post fairly anemic profits. However, that has now changed as previous investments start to bear fruit. Over last year, operating income rose by an impressive 375% while net income increased by a phenomenal 1,186%. Admittedly, all of the profit is coming from either AWS or North America, with the international division still in the red to the tune of $494 million. However, in our opinion, this only underscores how much forward potential Amazon has to grow its bottom line as it drives further growth in foreign markets.

Looking ahead, we are particularly encouraged by the ongoing developments in own brand. Amazon is driving more sales via its own labels, especially in categories like apparel and electronics. Thanks to Whole Foods, Amazon now also has a very credible own-label offer in the grocery category. This is important for two reasons. First, it is margin enhancing which is helpful to the bottom line. And second, it helps to differentiate Amazon from rivals and makes it even more of a destination for consumers.

We are also more than satisfied with the pace of innovation. Amazon is investing more than ever in various new ventures which will be capable of delivering future growth. Particularly exciting is the acquisition of PillPack, which we believe will be the start of a bigger push into the lucrative healthcare space. New devices, such as the Fire TV Cube and Fire TV Edition smart TVs should help Amazon to compete more effectively in the media space. Meanwhile, the Prime Wardrobe service will help Amazon to build out more market share in the clothing and footwear segment.

Finally, it is also worth mentioning the progress at Whole Foods. While we believe that Amazon has a lot more work to do in optimizing the proposition, especially in terms of price, we think the progress made to date has been solid. Whole Foods is now a much more commercially focused company and our data suggests it is attracting more customers. The expansion of online food delivery will bolster this success in the medium term. Over the longer term, we believe Amazon will transform Whole Foods into a very successful part of its operation. However, this change will take time, both so as not to disrupt the business model and because there are a lot of changes that still need to be made.

Overall, Amazon is a firm that has worked hard for its success. The accusation that it is a monopoly is sometimes levied. However, we dismiss this. Amazon's behavior shows no signs of being monopolistic. Its profits are too thin, it innovates too much, and it has nowhere near a monopoly market share. Its growth has been earned through smart thinking and hard work.
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