Discover more from How They Make Money
☁️ Amazon: LLM as a Service
How the company is going after the three layers of the AI tech stack
Greetings from San Francisco! 👋🏼
Welcome to the new members who have joined us this week!
Join the 46,000+ How They Make Money subscribers receiving insights on business and investing every week.
Amazon (AMZN) reported its Q2 FY23 earnings last week.
The company’s trailing free cash flow went from $23 billion in the red to $8 billion in the green. What a difference a year makes.
But this massive rebound in cash flow was probably not the main focus for Wall Street. Instead, eyes were on the optimistic tone around a possible bottom for the workload optimization at AWS.
Today, we’ll cover the following:
Amazon Q2 FY23.
Recent business highlights.
Key quotes from the earnings call.
What to watch looking forward.
For Big Tech, AI has once again been the center of attention this earnings season.
Ever found yourself lost in the AI jargon? 🤖
Generative AI has been taking the world by storm, but how does it actually work?
Check out our latest video on our YouTube Channel, where we explore Large Language Models (LLMs) and demystify them for you!
🧠 How do LLMs predict, learn, and evolve?
📚 Tokens, parameters, GPT, what does it all mean?
🔎 What are the challenges in the quest for reliable AI?
Comment below to share your thoughts on this format. If you enjoy watching these videos as much as we enjoy creating them, you're in for a treat!
1. Amazon Q2 FY23
Here is a bird’s-eye view of the income statement.
💻 Online store (39% of overall revenue): Amazon.com +4% Y/Y.
🏪 Physical store (4%): Primarily Whole Foods Market +6% Y/Y.
🧾 3rd party (24%): Commissions, fulfillment, shipping +18% Y/Y.
📱 Subscription (8%): Amazon Prime, Audible +14% Y/Y.
📢 Advertising (7%): Ad services to sellers, Twitch +22% Y/Y.
☁️ AWS (16%): Compute, storage, database, & other (B2B) +12% Y/Y.
Other (1%): Various offerings, small individually +26% Y/Y.
Revenue grew +11% Y/Y to $134.3 billion ($3 billion beat).
The fastest-growing segments were:
Advertising (+22% Y/Y), accelerating from +21% Y/Y in Q1.
3rd party seller services (+18% Y/Y), vs. +18% Y/Y in Q1.
Subscriptions (+14% Y/Y), vs. +15% Y/Y in Q1.
North America grew +11% Y/Y to $82.5 billion.
International grew +10% Y/Y fx neutral to $29.7 billion.
Gross margin was 48% (+3pp Y/Y).
Operating margin was 6% (+3pp Y/Y).
AWS had a 24% margin (-4pp Y/Y and flat Q/Q).
North America had a 4% margin (+5pp Y/Y).
International had a -3% loss margin (+4pp Y/Y).
EPS (earnings per share) was $0.65.
Cash flow (trailing 12 months or TTM):
Operating cash flow TTM was $61.8 billion (+74% Y/Y).
Free cash flow TTM was $7.9 billion compared to an outflow of $23.5 billion in Q2 2023, primarily driven by the improvement in operating cash flow and, to a lesser extent, a decline in purchases of property and equipment by 9% to $54.0 billion.
Cash, cash equivalent, and marketable securities: $64 billion.
Long-term debt: $63 billion.
Q3 FY23 Guidance:
Revenue growth between +9% and +13% Y/Y ($2 billion beat).
Operating margin between 4% and 6%.
So what to make of all this?
Amazon had a strong quarter, with overall revenue exceeding expectations, and the AWS slowdown was not as bad as feared.
The Q2 performance of AWS outpaced concerns, and the accompanying commentary provided optimism. As most of Amazon's valuation relies on AWS's long-term potential, any surprise for this high-margin segment can lead to significant stock price fluctuations.
Advertising delivered an impressive +22% Y/Y growth, an acceleration from the +21% Y/Y in Q1 FY23.
Operating margin improved by 3 percentage points, driven by cost efficiencies for the non-AWS segments. Regionalization was an important factor, with fewer miles traveled and fewer touches leading to less cost.
Operating cash flow TTM grew +74% Y/Y to $61.8 billion as a result of the cost efficiencies.
Free cash flow TTM improved for the fourth consecutive quarter. Management expects CapEx to drop to $50 billion in FY23 (from $58 billion in FY22). Lower fulfillment and transportation Capex will be partially offset by increased infrastructure CapEx related to AWS and Generative AI efforts.
Revenue guidance for Q3 (+11% Y/Y in the mid-range) was $2 billion ahead of expectations, a highlight of the report with no slowdown in sight.
2. Recent business highlights
Amazon's investments in Large Language Models (LLMs) and Generative AI have positioned them at every level of the AI tech stack.
CEO Andy Jassy reiterated during the earnings call that most people talk about the application layer, specifically OpenAI’s ChatGPT. But LLMs have three key layers in which AWS is investing heavily. So let’s revisit them.
First layer: Infrastructure (Trainium and Inferentia)
At the bottom of the stack are the compute hardware and chips to train foundational models. Amazon has been developing customized machine learning chips like Trainium for training and Inferentia for inference. Jessy believes that the price-to-performance ratio of these chips sets them apart from competitors.
Second layer: Models (Bedrock)
The middle layer is essentially LLM as a Service. It takes billions to build an LLM. So instead of building it in-house, companies want to access LLMs and customize them with their data with all the security and privacy features managed for them. That's the aim of the recently announced Amazon Bedrock. Customers can run foundational models from Amazon's Titan or use LLMs from other providers like Anthropic, Stability AI, or Cohere.
Andy Jassy explained:
“We're democratizing access to generative AI:
Lowering the cost of training and running models;
Enabling access to large language models of choice instead of there only being one option;
Making it simpler for companies of all sizes and technical acumen to customize their own large language model and build generative AI applications in a secure and enterprise-grade fashion.
These are all part of making generative AI accessible to everybody.”
Third layer: Apps (CodeWhisperer)
The top layer has everyone’s attention, like Chat-GPT or Bard. Last quarter, we discussed Amazon CodeWhisperer, an AI-powered coding companion for individual developers, competing with Microsoft’s GitHub Copilot. It supports various languages and integrated development environments and offers security scanning. And Amazon plans many generative AI apps for AWS customers.
Jassy believes AWS has a data advantage here:
“While we will build a number of these applications ourselves, most will be built by other companies, and we're optimistic that the largest number of these will be built on AWS. Remember, the core of AI is data. People want to bring generative AI models to the data, not the other way around.”
The data advantage is a recurring theme that compels many analysts to believe incumbents (like AWS) are well-positioned to succeed in this new AI wave.
3. Key quotes from the earnings call
CEO Andy Jassy touched on key priorities such as lowering costs in the stores business, improving customer experiences, and building new experiences.
On efficiency and cost-saving measures:
“Central to our efforts has been the decision to transition our stores' fulfillment and transportation network from one national network in the United States to a series of eight separate regions serving smaller geographic areas. […] Regionalization is working and has delivered a 20% reduction in number of touches for our delivered package, a 19% reduction in miles traveled to deliver packages to customers and more than 1,000 basis point increase in deliveries fulfilled within region, which is now at 76%.”
He added that faster delivery is a key component in a customer’s decision to order meaningfully more through Amazon. In addition, regionalization costs less in transportation and is better for the environment. A win-win-win.
On same-day facilities:
“Our same-day facilities are located in the largest metro areas around the U.S. […] The experience has been so positive for customers in our business that we're planning to double the number of these facilities. We believe that we are far from the law of diminishing returns and improving speed for customers.”
On delivery speed:
“In this last quarter, across the top 60 largest U.S. metro areas, more than half of Prime members' orders arrived at the same day or next day. So far this year, we've delivered more than 1.8 billion units to U.S. Prime members the same or next day, nearly 4x what we delivered at those speeds by this point in 2019.”
As Amazon doubles down on same-day delivery, it will become increasingly difficult for other networks to compete.
“Merchants in early trials who use Buy with Prime saw their shopper conversion increased by 25% on average. […] Merchants who participate in Prime Day activities, in aggregate, experienced a 10x increase in daily Buy with Prime orders during the sales event period versus the month before we announced Prime Day.”
The allure of entering Amazon’s ecosystem is increasingly compelling for merchants, and the numbers show.
On Amazon Business:
“Amazon Business is one of our fastest-growing offerings with a $35 billion annual gross sales run rate. And the team is working hard to further build out the selection, value, convenience and features that business customers need. […] The team is working hard to build $100 billion-plus business over time.”
On Fresh stores:
“We're not going to expand the number of fresh stores in a very significant way until we believe we have something that is resonant with customers and that we're going to like the return on invested capital. So that to me, I'm hopeful we're going to find that but we won't until we do.”
Incubating ideas and expanding in a disciplined way is a critical part of Amazon’s strategy. Don’t expect a Fresh store near you until the formula is proven.
SVP and CFO Brian Olsavsky on AWS and its potential to rebound:
“We are encouraged by the strength of our customer pipeline and believe having a large diverse customer base that is mostly cost optimized sets us up well for future growth. […] What we're seeing in the quarter is that those cost optimizations, while still going on, are moderating and many maybe behind us in some of our large customers. And now we're seeing more progression into new workloads, new business. So those balanced out in Q2.”
He didn’t provide guidance for Q3 but said July saw a continuation of the stabilization trend seen in Q2. Let’s look closer at AWS and what to expect.
4. What to watch looking forward
AWS market share and margins
AWS added $0.7 billion sequentially, indicating a return to healthy sequential growth.
According to Synergy Research Group, cloud infrastructure services market spending reached $65 billion in Q2 2023, growing +18% Y/Y and +3% Q/Q (compared to +20% Y/Y and +4% Q/Q in Q1). So AWS sightly trailed the rest of the market.
Amazon maintained a 32%-34% market share in the past five years, and while Microsoft and Google gained market share, the overall pie is growing for all participants.
In the past few quarters, existing AWS customers have focused on cost-cutting initiatives. One of the benefits of outsourcing cloud infrastructure is precisely to scale up or down based on the current needs. These challenges also affected Azure and Google Cloud Platform.
While this has created short-term headwinds, it’s critical to keep the cyclicality of this business in mind. Once workload optimizations subside, AWS could see growth re-acceleration.
Wall Street has been anxiously wondering how much optimization still lies ahead. And it appears clear after this earnings call that “peak optimization” may be behind us.
Andy Jassy had this to say on the trend for AWS:
“As the economy has been uncertain over the last year, AWS customers have needed assistance cost optimizing to withstand this challenging time and reallocate spend to newer initiatives that better drive growth. We've proactively helped customers do this. And while customers have continued to optimize during the second quarter, we've started seeing more customers shift their focus towards driving innovation and bringing new workloads to the cloud. As a result, we've seen AWS' revenue growth rate stabilize during Q2 where we reported 12% year-over-year growth.“
This is the most important quote of the call. Remember, AWS makes up the vast majority of Amazon’s profits. The idea that the slowdown in AWS growth may have stabilized was not as bad as feared by Wall Street and was well received.
With easier comps ahead, AWS could see a healthy recovery.
Amazon's advertising services reached $10.7 billion, representing:
25% of Alphabet's Search advertising revenue (+3% pp Y/Y).
34% of Meta's advertising revenue (+3% pp Y/Y).
While Amazon remains a distant third, it’s catching up.
Brian Olsavsky touched on the advertising segment:
“Our performance-based advertising offerings continue to be the largest contributor to our growth. Our teams worked to increase the relevancy of the ads we show to our customers by leveraging machine learning and improve our ability to measure the return on advertising spend for brands.”
As discussed in our review of Meta’s earnings, AI is a critical aspect that can boost ad relevance, performance, and overall measurement.
I have suggested in previous articles the sustainable nature of the moat around Amazon’s ad business. In short, given the underlying investments needed to match its operations network, the business could sustain its growth for a long time. The most glaring risk comes from regulators more than competitors.
There was no update on Project Kuiper this quarter, but it remains something to watch.
Amazon plans to build a network of over 3,000 satellites in low-Earth orbit to provide affordable broadband internet service to underserved areas. The company expects its first beta testing with commercial customers in 2024.
Last month, Amazon announced a $120 million investment into a satellite processing facility at NASA’s Kennedy Space Center in Florida.
Kuiper presents a considerable opportunity, sharing similarities with AWS in terms of capital intensity, customer base, and revenue potential.
Amazon Clinic launched last November, and the company just expanded its virtual health clinic nationwide. It’s a virtual platform for common conditions like sinus, acne, or migraines. Amazon connects patients with telemedicine partners, including Curai Health, Hello Alpha, and SteadyMD.
Amazon Pharmacy launched in 2020, which led to RxPass, which enables Prime members to receive generic medications for $5 a month.
Customer demand for improved healthcare experiences led Amazon to venture into primary care, acquiring One Medical in July 2022. It’s too early to drive any conclusion from this recent acquisition.
AWS is poised for a rebound as the challenges of workload optimization wane.
Advertising continues its robust growth trajectory, solidifying Amazon's competitive edge.
While new ventures come with significant costs, they infuse diverse opportunities into Amazon's ecosystem.
AI capabilities are emerging, targeting all layers of the tech stack.
It's worth noting this emphasis on AI isn't just an Amazon trend. The entire tech industry is echoing this sentiment. As Andy Jassy highlighted during the Q&A:
“Every single one of our businesses inside of Amazon, every single one has multiple generative AI initiatives going right now.”
From the stores to AWS, from advertising to entertainment, even down to Alexa — Generative AI isn't just an add-on; it's set to become Amazon's backbone in the upcoming years.
The looming question: In the AI supercycle, can industry incumbents like Amazon maintain or even expand their commanding lead?
We are about to find out.
That’s it for today!
Stay healthy and invest on!
Subscribe to How They Make Money so you don’t miss any updates.
Apply to Sponsor Us
We're offering new sponsorship opportunities for B2B and B2C brands to get in front of our audience of investors and business leaders. Click here to learn more.
Get Your Business a Custom Chart
Interested in custom charts for your organization or brand? Complete the form here, and we'll get in touch.
Author's Note (Bertrand here 👋🏼): The views and opinions expressed in this newsletter are solely my own and should not be considered financial advice or any other organization's views.