Amazon 3Q24: Strong Beat Overshadows Rising Temu Risk
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Summary:
- Amazon reported a strong set of results, driven by strength in ecommerce and rising AWS margins.
- Deceleration in third-party services implies merchant migration to competing platforms.
- Recent Temu restructuring poses a long-term risk to AMZN’s e-commerce moat.
Images By Tang Ming Tung
Amazon (NASDAQ:AMZN) reported a very solid 3Q24 result characterized by accelerating growth in the marketplace, strength in international revenue and margins, expanding margins on AWS, and better-than-expected Q4 guidance. The print was a clean beat across the board and underscores AMZN’s ability to balance growth and investment, particularly in AI.
Consistent with the prior earnings, much of the post-earnings call was focused on AWS margins, capex, and the progression of AI data centers reaching parity with AWS. The marketplace side of the business was once again overlooked and understated.
We believe that many investors in the US and globally take the marketplace’s competitive positioning for granted and that the investment community continues to overestimate the economic moat behind AMZN’s e-commerce business. Notably, merchant migration away from AMZN and Temu’s recent restructuring could pose a medium-term threat to AMZN’s marketplace growth.
First, on merchant migration. As we have previously highlighted in our report on PDD (see: PDD: Shop Until You Drop), we believe that Temu has the potential to become a dominant global e-commerce player by first capitalizing on the discount e-commerce vertical that has been largely neglected by the majority of the ex-China e-commerce platforms, and then gradually leverage its traffic and user base to attract brands onto its platform in order to compete with the global incumbents (see: PDD Holdings: Brand Migration Driving Long-Term GMV).
PDD has successfully executed this strategy in China. Over the past six years, we have witnessed PDD surpassing JD and Alibaba in terms of users to become China’s second-largest e-commerce platform in terms of GMV. Temu is likely to replicate a similar strategy to take on AMZN on the global stage.
During AMZN’s call, a question was asked regarding consumer behavior toward lower ASP items, and management acknowledged that lower ASP products had impacts and signs of trade-downs.
Interestingly, management pointed out that “… it’s easy to lower prices, but it’s much harder to be able to afford to lower prices. And the same thing is probably true about lower ASP items. It’s pretty easy to choose to supply them but it’s much harder to be able to afford to economically supply them.”
In other words, while it is easy to cut prices, actually doing it in a way that remains profitable is challenging.
We find this surprising, given that AMZN’s scale should allow the platform to access low-cost suppliers and deliver low-cost products at a sustainable level. The only rationale that we can think of is that many of the low-cost suppliers are siding with PDD for China and global cross-border e-commerce opportunities, given the volume growth that PDD offers to merchants.
AMZN’s filings show evidence of merchants gradually migrating to PDD. We note that third-party sellers’ services revenue continues to decelerate to +10% y/y (down 300bps sequentially) vs. +18% y/y a year ago. Given that Chinese merchants account for the majority of third-party seller services, we suspect merchant migration partially resulted in the growth deceleration in this line item.
Second is the recent restructuring of Temu’s semi-fulfillment model, which warrants investor attention.
Temu’s business model operates on a full fulfillment and a semi-fulfillment model. The full fulfillment model allows merchants to sell the items to Temu so that Temu oversees the product’s pricing and fulfillment.
On the other hand, the semi-fulfillment model allows the merchant to oversee the pricing and shipping, while Temu provides storefront and fulfillment support. Temu initially started with a full fulfillment model and launched the semi-fulfillment earlier this year to expedite its expansion overseas, as this is more suitable for overseas merchants where products are based in the local market.
Temu recently restructured its semi-fulfillment model after witnessing strong growth since its launch. The restructuring aims to integrate technical and market analysis teams to deliver more precise service and enhance user experience.
Key changes include:
The merchant acquisition team has been changed from one team focusing on all categories to category-specific teams, such as one team focusing on apparel, the other on cosmetics, and so forth.
Merchant acquisition and buyer group will be combined into a category operations team to facilitate merchant support and conversion. The buyer group was previously more involved in the full-fulfillment model.
Finally, every employee in Temu is taking a crash course and is ongoing in English to improve global communication.
These changes are intended to accelerate product updates, improve user feedback, and allow the platform to respond more effectively to user needs. Additionally, Temu is actively expanding into international markets to attract more cross-border consumers, increasing the diversity and engagement of its user base. When combined with Temu’s ongoing investment in logistics and warehousing to reduce delivery time, Temu’s overall user experience in terms of the value of money, product quality, and delivery time could resonate well amongst global consumers and position Temu competitively against AMZN.
The effectiveness of Temu’s restructuring is also worth considering. If proven to be effective, Temu’s semi-fulfillment model could draw other cross-border e-commerce players, such as Alibaba and TikTok, to replicate similar models in the US, putting further pressure on AMZN as competition intensifies.
In conclusion, we remain bullish on PDD and cautious about AMZN’s long-term ecommerce prospect, given the rising competition from low-cost Chinese players. We believe this is one area that is underappreciated by many investors and could catch many off-guard when AMZN operating metrics start to turn.
The key risk to our thesis remains the U.S. election risk on whether elevated tariffs could make Temu less competitive. However, our view is that retail is a less strategic sector compared with semiconductor and biotech, which warrants greater U.S. government scrutiny.
Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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