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Ad-renaline rush

AN AWARD-WINNING series, “The Marvellous Mrs Maisel”, follows the fortunes of a woman in the 1950s who undergoes an unlikely transformation from a typical housewife of the day into a talented standup comedian. It is produced by Amazon and can be viewed on Prime Video, the e-commerce giant’s on-demand service. Since its birth in 1994, Amazon has starred in several dramatic metamorphoses of its own. It has pushed beyond retailing into fields as varied as electronic books, private-label goods and cloud computing, as well as online video. Now it is intent on becoming a force in digital advertising.

Amazon has a long way to go before it catches up with the giants of the industry. It has 4% of an American market worth $111bn, compared with Google’s 37% and Facebook’s 21% (see chart). But Amazon started experimenting with ads only six years ago, and its young business is growing fast in a rapidly expanding market. By the end of the year it will overtake Microsoft, a software giant, and Verizon, a big telecoms firm, to rank third in America, according to eMarketer, a research firm.

Despite trailing far behind the leaders, Amazon’s ads are having an outsize effect on the company itself. Its revenues from ad sales worldwide in 2018 could hit $8bn, contributing perhaps $3bn in operating profit—over a quarter of the total. Michael Olson of Piper Jaffray, a brokerage, says that by 2021, it is “highly likely” that profits from Amazon’s ad business will exceed those from its lucrative cloud-computing unit, Amazon Web Services. Amazon loses money on its core e-commerce business, but can use the fat profits from advertising in the same way as it has used the cash from cloud computing—to push into new businesses and countries, says Brian Nowak of Morgan Stanley, an investment bank.

Closing the gap between Facebook and Google will be difficult but not impossible. Like those two, Amazon has a rich pool of data about users which it can use to aim its ads, including information about past purchases, which product reviews consumers have read, where they are and their online browsing behaviour. Amazon has a unique advantage, because consumers who are using the site usually intend to buy things right away. Some 56% of Americans start the search for any product on Amazon.

That will help it to grow as brands shift marketing dollars away from physical retailers. “Trade spending”—payments to retailers by makers of soap, mouthwash, canned food and other household basics for prime shelf space and promotional offers—adds up to around $200bn in America alone. Amazon is especially attractive to makers of such consumer packaged goods. Brand loyalty is weak and buyers are more likely to be swayed by prominent ads.

Amazon’s ads will not appeal to all businesses. Firms that do not sell goods through the site, such as fashion brands, carmakers and travel companies, will not advertise there. But online video is one potential opportunity to attract more business. Amazon allows video ads on Twitch, its online-gaming site, but it could also put adverts onto Amazon Prime to win some of the advertising spending aimed at conventional television channels.

Allowing advertising on Alexa, its voice-assistant, and Echo, its smart speakers, is another possibility. In the future, when people ask questions of Alexa or order something by voice, Amazon could incorporate advertising. Earlier this year it was reported that Amazon was in discussions with Procter & Gamble and Clorox about voice ads for their wares.

As it chases growth, Amazon will face three obstacles. First, it must consider whether its advertising will put off customers. Voice ads butting in to conversations, even ones with inanimate objects such as smart speakers, are potentially irritating. And subscribers who have paid to watch online videos are unlikely to enjoy sitting through commercial breaks. Amazon must take care to avoid alienating the people it spends so much trying to please.

Second, Amazon will have to balance its relationship with vendors and address potential conflicts of interest. Advertisers can buy space at the top of product searches or pay to sponsor products. In addition, some search results are labelled “Amazon’s choice”, which favour important vendors and advertisers, says Matti Littunen of Enders Analysis, a research firm. (Amazon does not disclose how products get this designation.) And as Amazon becomes a manufacturer and seller of more of its own private-label items, it will have to decide how much prominence to give paying advertisers and how much to its own goods.

According to research by RBC Capital, an investment bank, of 100 product searches on Amazon’s app, in only three instances was the top ranking result not a sponsored ad. Those were for three Amazon devices: two smart speakers and a Kindle e-reader. Makers of competing products will be unhappy if it appears that Amazon is favouring its own products on its site or discouraging competition by driving up the cost of ad space on products that directly challenge its private-label goods.

Amazon will also have to contend with a more active regulatory environment. In September the European Commission announced a probe into its use of data and whether it could use information about third-party retailers on its site, which are also competitors, to boost its profits. As the inquiry progresses, advertising practices could become an area of interest.

Amazon has so far avoided a privacy backlash from customers. “Facebook uses your personal life and friend graph to target ads. Amazon has a more clearly commercial relationship” with users, says Jonathan Nelson, the head of digital at Omnicom, a large advertising agency. But as its ad business grows, so will scrutiny. Amazon gives users little control over how much information they share for advertising purposes, which could violate new data-collection and privacy rules in Europe, says Mr Littunen.

As it gathers more information about people in the physical world, including their spending habits at Whole Foods, the grocer it bought last year for $13.7bn, its dossier of data on consumers will become larger and more personal. That will propel Amazon’s rise. Just as Mrs Maisel discovers she has a new talent for cracking jokes, Amazon has a chance to thrive in a new venture. Before long it could make the digital-ad duopoly a three-way affair.

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