Amazon's Advertising Tax

There’s an unwritten truth in tech.

Every tech company eventually becomes an advertising company.

Google wanted to “organize the world’s information.” It ended up selling ads.

Facebook wanted to “bring the world closer together.” It sells ads.

Amazon wanted to be “the world’s most consumer-centric company.” Now it sells ads.

While this is annoying as a user, it’s informative to understand how companies make money from advertising, how ads work within their business models, and who has the financial upside from building an ad business.

Why Tech Companies Love Advertising

Advertising allows tech companies to monetize their customers without putting a price tag on their products. It’s as simple as that.

Facebook, Google, and Spotify are all free to use…as long as you don’t put a dollar value on the value of your attention. That attention is monetized through ads.

At their best, ads are introducing you to a new product you didn’t know you wanted or needed. Last year, I highlighted this power shift from supply to demand in Internet Economics.

For companies that are connecting a user with intent to a business with a product or service to sell, ads can be a distraction, but they goose margins. Sure, Google could show you the pair of shoes you explicitly searched for, but why not show an ad or two first?

And ads are a huge business.

The key for each of these companies is reaching scale. Once you have a user base at scale you can turn on the ad business and print money without being the one putting a price tag on your product.

Profit without sticker shock. No wonder tech loves advertising.

Amazon’s Ad Shift

How does Amazon fit in this world? I’m going to let you in on a little secret.

Without advertising, Amazon’s retail business wouldn’t be profitable.

This chart shows Amazon’s operating income outside of AWS and it’s overshadowed by advertising revenue by a wide margin. Advertising is nearly pure profit, so without it, the business would be losing money.

Both ads and Prime (in green below) subsidize Amazon losing money on the core e-commerce business.

The move to monetizing through ads makes sense from a business standpoint.

For marketplaces that sell goods — like Amazon — advertising is an invisible tax users pay but isn’t charged directly by Amazon. If you search for “Bose Headphones”, JBL jumps the line with an ad. How does JBL justify the ad? A subset of people buy JBL headphones. But this is a lost sale for Bose.

Now, Bose and JBL BOTH need to raise their prices to offset the increased cost of ads.

Like on Google, Amazon advertising incentivizes companies to pay to compete for the best ad space instead of earning the best space.

This is a reality of the internet. Once you reach scale, ads are an easy way to suck more out of the ecosystem without putting a price tag on it.

Where I get concerned is advertising that changes the user experience, indirectly raises prices, and distorts the incentives for the platform.

I think Amazon has been the most egregious in distorting its incentives. Below are three product searches I did on Amazon. Notice how much space is taken up by ads and how much space is taken up by the product I’m explicitly searching for!

If Amazon is indeed “the world’s most consumer-centric company,” it should show me what I’m asking for.

However Amazon is increasing its take rate on each sale at the expense of the user experience. As a result, Amazon’s prices are on average higher than competitors, the platform is flooded with cheap crap that leverages advertising, and many big brands explicitly avoid the platform to go direct to consumers.

On the flip side, Amazon can do this because it has power. Nike left Amazon as a first-party seller a half-decade ago but still needs Amazon’s reach so you can find products there. Amazon has the customers retailers need to find…

Amazon has also made a tax out of advertising.

Maybe Amazon had to turn to advertising because the core e-commerce business was never going to be profitable.

The Next Wave of Internet Taxes

You can see why I’ve never bought into Amazon’s business model (to my detriment). I think the marketplace the company has built and delivering packages to homes is both more costly and a worse user experience than alternatives.

The same can be said for businesses like Doordash and Instacart, who have higher food prices than in-store to offset their costs and are adding advertising as another invisible tax on the platform. And they’re still not profitable…

While there are some advertising businesses that I question, this case study highlights why companies like Spotify (in audio streaming), Disney, and Netflix (in video streaming) see so much potential in advertising. They can generate increasing amounts of revenue from the attention we give their platforms.

What makes these more palatable than a marketplace trying to suck money from users is it’s not interrupting explicit intent with unwanted ads. If anything, ads on YouTube, Spotify, Disney, Netflix, and even Google are a cost we’re accustomed to and willing to pay for the value they’re adding.

You’ll see across the Asymmetric Portfolio that I’m long ads as a monetization strategy because it’s proven extremely effective for platforms like Google and Meta.

But I’m not buying into ads as a tax on an ecosystem at the expense of the user experience. Sorry, Amazon.

Disclaimer: Asymmetric Investing provides analysis and research but DOES NOT provide individual financial advice. Travis Hoium owns shares in all Asymmetric Portfolio stocks. All content is for informational purposes only. Asymmetric Investing is not a registered investment, legal, or tax advisor or a broker/dealer. Trading any asset involves risk and could result in significant capital losses. Please, do your own research before acquiring stocks.