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Amazon and Walmart: Price War on the Margins

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Earnings will tell how much longer the retail giants can keep books so cheap.

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If you're going to take on Amazon.com (AMZN) in discounting retail goods online -- a game that it not only defined in the 1990s but then went on to improve on throughout the 2000s -- you're either suicidal, or you're Walmart (WMT).

That's what Walmart tried during the fourth quarter of 2009 -- the most important quarter for retailers because of the busy holiday season. And that's why the financial results for the fourth quarter, which Amazon will report on Jan. 28, will be one to watch closely for investors.

In October, Walmart launched the opening salvo in a price war for bestselling books by discounting top titles to $10 apiece, and then, after Amazon matched it, to $8.99. Within days, Amazon started selling at $8.99 as did Target (TGT). Just how much these discounts are hitting margins -- books make up a bigger portion of Amazon's total sales than they do for Walmart or Target -- will suggest how much longer, and deeper, the price war might last.

In the near term, both Amazon and Walmart will benefit from higher market share because, as they battle each other with lower prices, the first losers will be other retailers who can't afford such steep discounts. Earlier this week, Amazon and Walmart were offering bestselling books at discounts of 50% or more. Online discounts of Barnes and Noble (BKS) and Borders (BGP) were averaging around 40%.

This is already evident in electronics, where Best Buy (BBY) has long been the leading brand among gadget consumers but hasn't been able to match Amazon's deep discounts. When consumer site Retrevo recently asked consumers which brand comes to mind first when they think about buying electronics, 40% said Best Buy. That was down from 44% a year ago. Amazon was mentioned 15% of the time, up from 11%. Asked which retailer had the lowest prices, 33% said Amazon, 42% said Walmart, and only 25% said Best Buy.

But who will benefit longer term from a price war? Walmart may be betting that Amazon's 4.6% pretax profit margin is as low as Amazon is willing to go. But Amazon has other small but growing lines of business that can shore up margins longer term. Kindle books are a lot easier and cheaper to ship to consumers than printed books, and Amazon is already shipping more of many titles in Kindle format than printed versions.

Similarly, Amazon's web services are a growing force in the emerging world of cloud computing. While still a tiny portion of overall sales -- Amazon won't break out figures but it's believed to be a few percent of total sales -- web services are a higher-margin business that can contribute to overall profits. Amazon's relationships with third-party retailers who use its fulfillment infrastructure are another way the company can leverage margins higher.
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No positions in stocks mentioned.

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