Walmart’s Latest Moves Could Be a Dagger to Amazon’s Most Profitable Business Segment

While Amazon‘s (AMZN -1.11%) Competitors were busy catching up on their e-commerce skills as the online retail giant expanded its most profitable business of all time: advertising.

But now that competitors like Walmart (WMT -0.28%) are seeing growth in online sales, they have started tracking the e-commerce giant’s new profit center. Walmart brought its advertising business in-house in 2019, but it’s remained a tiny source of revenue and profit for the retailer compared to Amazon, which generated nearly $34 billion in advertising revenue last year.

But two recent changes in Walmart’s advertising business are resonating with advertisers, urging more marketers to consider rival Amazon.

Revised advertising on Walmart.com

Walmart took some of the best practices from digital advertising giants and implemented them on its own website earlier this year.

First, it removed some requirements for search keyword advertising, while ensuring that ads that showed up were more relevant to the products consumers were searching for. It did this by making it cheaper to promote products that show up organically for certain keywords. This step is designed to increase the likelihood that Walmart.com shoppers will actually click on the ads they see.

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The other major change concerns the way advertisers bid on inventory. Walmart introduced a second price auction. In this auction, an advertiser bids the maximum amount they are willing to pay, but the highest bidder only pays the second-highest bidder’s price. The mechanism is standard practice among large digital advertising companies. It allows advertisers to bid based on what they think is worth the ad placement, rather than the price they think others will appreciate.

Both of these changes make advertising on Walmart more valuable and attractive to advertisers.

And the results speak for themselves

Walmart has seen strong results in the short time since implementing these changes.

According to data from PacVue, Helium10, and Assembly, ad spend for Walmart grew 26.7% year over year last quarter. This compares to Amazon’s 13.5 percent increase in sponsored product ads and just a 0.2 percent increase in sponsored brands ads.

The changes in ad relevance are also noticeable. CTR on Walmart’s ads increased from 0.32% in the first quarter to 0.51% in the third quarter. At the same time, the click-through rate on Amazon’s Sponsored Products ads fell from 0.37% to 0.31%. (However, sponsored brand ads improved click-through rates.)

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Additionally, Walmart has done a great job of attracting advertisers to its platform over the past few years. The total number of advertisers on its site has increased six-fold compared to two years ago at the end of the second quarter. With more advertisers and a more attractive bidding system, Walmart is poised for strong ad revenue growth in the coming quarters.

Amazon will feel the pain

While Walmart is showing strong growth in its advertising business, Amazon’s advertising business isn’t growing nearly as fast as it used to.

As marketers shift ad spend to Walmart, Amazon is struggling to attract new ad dollars. Excluding the impact of Amazon’s Prime Day in July, adspend was almost flat year over year. A second Prime Day earlier this month could similarly boost adspend for Q4.

Walmart will continue to improve its advertising platform and attract new advertisers, hurting Amazon’s growth. But the pain could be more short-term for Amazon investors looking to avoid a long-term race to the bottom with Walmart and other online retail rivals.

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Improving profitability of advertising spend at Walmart will return to normal rates once the market has fully digested the changes. That should happen by the middle of next year. Additionally, growth in retail media ad spend is expected to outpace growth in the overall digital advertising market in the coming years. That gives Amazon, Walmart, and many other retailers plenty of room to expand their advertising business over the long term.

In the near term, Walmart’s changes could eat into Amazon’s bottom line, as even a small shortfall in its highly profitable advertising segment could have a significant impact on Amazon’s razor-thin operating margin. But if everything else in the business looks healthy and as expected, operating profits, which are falling a bit short due to a slight underperformance in advertising, could be a buying opportunity for Amazon investors.

John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Adam Levy has positions at Amazon. The Motley Fool has positions in and recommends Amazon and Walmart Inc. The Motley Fool has a disclosure policy.

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