Why third party business is key to Amazon’s future profitability

April 18, 2019 12:26
Amazon's third-party sales soared to US$160 billion last year from US$100 million in 1999, or an annual growth rate of 52 percent. Photo: Reuters

Third-party sales have grown to 58 percent of the total last year from just 3 percent in 1999, Amazon.com founder and chief executive Jeff Bezos highlighted in his 2018 letter to shareholders.

In my opinion, that’s part of the reason why Amazon’s share price has skyrocketed in recent years.

What’s the difference between first party and third party?

First-party business means Amazon sells directly to users. Under this model, it has to deal with stock keeping, which not only incurs warehousing costs but could also result in some inventory becoming dead stock and eventually written off.

In third-party business, on the other hand, Amazon simply collects sales commissions from third-party sellers without incurring too much extra costs. The rapid gains in third-party business have greatly improved Amazon's cash flow over the last decade.

Merchants are happy to move their business online since the cost of doing business is less.

In fact, Amazon’s first-party sales also surged to US$117 billion last year from US$1.6 billion in 1999, representing an annual growth of 25 percent.

Yet third-party sales revenue has grown much faster, to US$160 billion from US$100 million in the same period, with an annual growth rate of 52 percent.

By contrast, another online shopping site, eBay, only registered an annual growth of 20 percent.

Why has Amazon outperformed rivals?

Because e-commerce is a lot more than just maintaining a website; efficient warehousing and logistics are equally critical.

Amazon’s fulfillment centers are almost fully automated, allowing the website to promise delivery within 48 hours for Prime members across the United States.

Currently, third-party sales already account for 58 percent of Amazon’s revenues. Does that mean the company will soon hit a growth ceiling?

First of all, even if the growth clip slows, Amazon’s profit margin will continue to rise as third-party sales will dominate the marketplace in the future.

Second, as long as it’s more cost-effective to sell online, and more customers prefer to shop online, the overall market will grow and Amazon will be able to expand its business.

This article appeared in the Hong Kong Economic Journal on April 17

Translation by Julie Zhu

[Chinese version 中文版]

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Columnist at the Hong Kong Economic Journal