Prime Day: The ad business behind the discounts

Amazon's tenth annual Prime Day brought in an estimated $14.2 billion in online sales, a record. Retail analysts know where the profit comes from, and it is mostly Amazon's high-margin retail advertising business rather than the discounted goods.

The event began in 2015 as a birthday sale to mark the company's twentieth anniversary and has since turned into a fixture of the American retail calendar, with Walmart and Target now running rival promotions in the same week. What has changed most over that decade is not the size of the discounts but the business that sits beneath them. Amazon's advertising revenue reached $46.9 billion last year, a figure that puts it among the largest digital ad sellers in the world.

Sellers pay for the discounts

Third-party merchants, anxious to be seen in Amazon's crowded search results during the 48-hour event, bid billions of dollars for sponsored product slots. That advertising money, earned at high margins, in effect pays for the deep discounts shoppers see. More and more, Amazon's marketplace works as a delivery system for its dominant and very profitable advertising business.

How the money moves

The mechanics are simple enough. Independent sellers account for most of the units sold on Amazon, and each of them competes for the top of a search page that shoppers rarely scroll far beyond. Sponsored listings are sold by auction, paid per click, and prices rise when many sellers chase the same shoppers at once, which is exactly what happens during Prime Day. A merchant that cuts its price for the event also has to pay more to make sure anyone sees the cut.

That money flows to Amazon almost as pure margin. Selling a discounted blender requires warehouses, lorries and drivers; selling a click requires servers the company already owns. Add the referral commissions that Amazon takes on each sale and the fees it charges sellers who use its warehouses and delivery network, and the retailer earns several layers of revenue on a transaction whose headline price has just been cut.

A toll with few exits

Sellers put up with this because the alternatives are thin. Amazon controls the largest share of American online shopping, and for many brands a strong Amazon ranking matters more than their own websites. Walmart, Target and newcomers such as Temu offer other routes to customers, but none comes close in volume. That imbalance is what allows Amazon to raise the effective cost of selling on its platform without losing many merchants.

Regulators have noticed. The Federal Trade Commission and a group of states sued Amazon last September, arguing among other things that it fills search results with paid placements that make shopping worse and that the combined fees it charges sellers push up prices across the internet. Amazon denies the claims, and the case will take years to reach trial. The lawsuit nonetheless describes the same machine this column does, from a less charitable angle.

The defence of the model

The strongest argument on Amazon's side is that sellers get something real for their money. Prime Day brings tens of millions of shoppers to one place at one time, and an ad slot there can introduce a small brand to customers it could never reach alone. Shoppers, for their part, get genuine discounts, and many of the sponsored results are relevant to what they searched for. Amazon also uses the event to sign up and retain Prime members, whose annual fees and extra spending are worth more than any single day of sales.

That argument has force, but it does not change who bears the cost. When advertising becomes a condition of visibility rather than an optional boost, it works like a rising rent. Sellers can either absorb it, squeezing their own margins, or pass it on in higher prices on the days when there is no sale.

Retail as a media business

Amazon is not alone in this shift. Walmart, Target and large grocery chains have all built what the industry calls retail media networks, selling ads on their websites and apps to the brands whose products they stock. The idea echoes the slotting fees that supermarkets have long charged suppliers for shelf space, updated for an online store with infinite shelves and a single search box. Amazon added another channel in January, when it began showing ads to Prime Video viewers by default.

For investors, the attraction is plain. Advertising carries far higher margins than retailing, and it lets Amazon earn more from the same volume of goods. The Prime Day sales total grabs attention; the more useful figures will come when Amazon reports its second-quarter results at the start of August, including how fast advertising revenue is growing.

The shift also changes how Amazon's results should be read. Retail sales growth measures how many goods move through the site, while advertising growth measures how much sellers will pay to be seen, and the two can diverge for long periods. A marketplace whose sales grow slowly while its ad income grows quickly is extracting more from each transaction, which helps Amazon's margins at the merchants' expense. Valuing the company on retail volumes alone understates how much profit it earns from each shopper's visit.

The record sales matter less than who paid for them. Third-party sellers are funding more of Prime Day's discounts through advertising fees, and Amazon will probably keep raising that toll for as long as they have nowhere else to go. Unless the FTC case or a rival marketplace changes the balance, expect advertising to keep outgrowing retail sales at Amazon for the next few years, with small sellers' margins and everyday shelf prices absorbing the difference.