The push to speed up its delivery not only led Amazon to miss analysts' estimates, but also caused Amazon's first quarterly profit decline in more than two years.

While Amazon.com Inc.’s sales rose 24% in the third quarter, the retail giant’s transformation of its Prime loyalty program into a one-day free shipping offer put a dent in its bottom line as its net income fell 26%.

The push to speed up its delivery not only led Amazon to miss analysts’ estimates, it also caused Amazon’s first quarterly profit decline in more than two years. Amazon’s shipping costs rose roughly 46% during the quarter to $9.608 billion. Brian Olsavsky, the retailer’s chief financial officer, acknowledged that the costs associated with the shift to one-day delivery have been higher than anticipated. He noted that Amazon expects the effort to cost roughly $1.5 billion during the fourth quarter.

“Back in Q2, I said that we were estimating an $800 million expense tied to one-day [shipping] in Q2, and we actually were just above that in Q2,” he said. “In Q3, we expected that to grow, we factored that into our guidance and we hit essentially where we expected on the guidance. So as we head into Q4, we’ve added what’s just nearly a $1.5 billion penalty in Q4 year-over-year [expenses] for the cost of shipping, which is essentially transportation costs, the cost of expanding our transportation capacity, things like adding additional poles and shifts in our warehouses, the cost for deploying inventory closer to customers. There are a lot of tangential costs but the biggest expense is the actual transportation cost.”

Jeff Bezos, Amazon founder and CEO, acknowledged the expense in a statement that accompanied the retailer’s earnings release, noting that “it’s a big investment, and it’s the right long-term decision for customers.” He added that “customers love the transition of Prime from two days to one day.”

In addition to faster deliveries, Amazon’s sales growth was bolstered by its ever-growing marketing spending. Amazon’s marketing costs rose nearly 44% year over year to $4.752 billion in the third quarter ended Sept. 30. For the sake of comparison, that’s more than Nordstrom, No. 18 in Internet Retailer 2019 Top 1000, generated in online revenue in all of last year. Amazon is No. 1 in the Top 1000.

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At the same time that Amazon is boosting its marketing spending, it is also rapidly growing its own advertising business. The retailer reported $3.586 billion in revenue in its “other” revenue category, which is largely made up of Amazon Advertising. That’s nearly a 44% increase from the same period a year earlier.

“We are very happy with the progress in the advertising business and continue to focus on advancing advertising experiences there to provide advertising options that are helpful for customers, that help them to see new products,” Olsavsky said.

However, he noted that Amazon’s advertising business is still in its early days. “What we’re focused on really at this point is relevancy, making sure that the ads are relevant to our customers, helpful to our customers, and to do that, we use machine learning and that’s helping us to drive better, better and better relevancy,” he said.

While the growth of Amazon’s advertising business was one of a few positive notes during the quarter, the retailer is facing increasing regulatory scrutiny, as the Department of Justice and Federal Trade Commission is examining Amazon and other large U.S. technology companies’ business practices. And President Donald Trump and Democratic presidential hopefuls such as Elizabeth Warren have publicly criticized Amazon.

In part, that’s because it appears as though its retail business was not profitable during the quarter. While Amazon does not break down its net income, it does offer details about its operating income, a key component of net income. The $3.157 billion in operating income Amazon reported came from two main sources: its Amazon Web Services (AWS) cloud computing unit and Amazon Advertising. That suggests that Amazon is using its profits from AWS and Amazon Advertising to sell below its costs to drive its competitors out of business, or at the very least, hurt their bottom lines.

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Amazon’s key Q3 2019 retail and business developments 

During the third quarter, Amazon:

  • Introduced a new lineup of Echo devices, including a next generation Echo, Echo Dot with clock, Echo Show 8, Echo Buds, Echo Flex and Echo Studio. Echo is Amazon’s smart speaker devices that connect consumers to the internet.
  • Launched Amazon Prime in Brazil.
  • Expanded AmazonFresh to Indianapolis, Houston, Minneapolis and Phoenix.
  • Rolled out Personal Shopper by Prime Wardrobe, a Stitch Fix-like styling service that’s only available to U.S. members of Amazon’s Prime loyalty program and costs $4.99 for one styling per month.
  • Launched a number of tools and services for small and midsized sellers, including: Target Inventory Levels, which looks to help sellers better manage their Fulfillment by Amazon inventory; Appstore and third-party tools, which seek to help sellers identify trusted third-party applications that complement Amazon’s free tools; and Sold by Amazon, an opt-in service that automates sellers’ prices.

For the third quarter ended Sept. 30, Amazon reported:

  • Net sales of $69.981 billion, a 23.7% increase from $56.576 billion in the same quarter in 2018. Of that revenue, $39.726 billion stemmed from merchandise Amazon itself sold to consumers—what the retailer terms “net product sales”—up 17.7% from $33.746 billion year over year. The rest, $30.255 billion, came from commissions from outside merchants that sell on Amazon marketplaces, the Amazon Web Services cloud computing service and other smaller revenue sources. Those “net service sales,” as Amazon calls them, were up 32.5% from last year’s $22.830 billion.
  • North American net sales of $42.638 billion, up 24.1% from $34.348 billion for the third quarter of 2018. North America accounted for about 60.9% of sales in the third quarter of 2019.
  • International net sales totaling $18.348 billion, up 18.0% from $15.549 billion in 2018. International accounted for about 39.1% of sales in the second quarter.
  • Amazon Web Services revenue was $8.995 billion during the quarter, up 34.7% from $6.679 billion a year earlier.
  • Other income–largely coming from Amazon’s growing advertising business–totaled $3.586 billion, up 43.7% from $2.495 billion.
  • Revenue from subscriptions, including Prime fees, were $4.957 billion, up 34.0% from $3.698 billion.
  • Net income of $2.134 billion, down 26.0% from $2.883 billion in the same period in 2018.
  • Spending on marketing increased 43.9% to about $4.752 billion from $3.303 billion.
  • Spending on technology and content, including fees for licensing content for its Amazon Video service, increased 25.1% to $9.065 billion from $7.247 billion.
  • Spending on fulfillment increased 28.5% to $9.200 billion from $7.162 billion.
  • General and administrative spending increased to $1.348 billion from $1.041 billion.