A star Amazon analyst thinks it will make up to $4 billion from advertising in 2018 (AMZN)

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Baird analyst Colin Sebastian predicted Amazon would make between $3 billion to $4 billion in 2018 from advertising.
This would be more than Snapchat made from ads in 2017.
Amazon's ad business is relatively new and the company doesn't disclose how much revenue it makes.
Sebastian said there's "pent-up demand" from merchants on Amazon who want to gain higher rankings on its site.

An analyst with a track record of making correct calls about Amazon has estimated it will make between $3 billion and $4 billion (£2.1 billion to £2.8 billion) from advertising in 2018.

To put this in context, that's more than Snapchat's entire 2017 revenue of $825 million (£586 million), but about 10% of Facebook's $40 billion (£28 billion) ad revenue for the year.

R.W. Baird analyst Colin Sebastian told Business Insider during a press briefing that Amazon had realised there was a "pent-up demand by merchants selling on Amazon to spend on Amazon" and said there was "a lot of upside to that business."

He likened Amazon's strategy to Alibaba, the Chinese ecommerce giant which has quietly built up an advertising giant on top of its core retail business.

Sebastian has a history of making the right calls on Amazon. He notably called in October that Amazon would probably offer a delivery service to compete with US postal services such as FedEx and UPS. The rumours became a lot more concrete after The Wall Street Journal reported this month that Amazon would launch such a service in Los Angeles in the coming weeks. He also suggested Washington DC would play home to Amazon's second US headquarters. The firm hasn't decided yet, but it's widely thought to be considering DC.

Sebastian's valuation of Amazon's ad business is one of the most bullish to date. JP Morgan analyst Doug Anmuth pegged Amazon's ad revenue in 2017 at $2.8 billion (£2 billion). The chief executive of agency holding giant WPP, Martin Sorrell, gave the same estimation in August. All the valuations suggest Amazon made more revenue from ads than Snapchat and Twitter, both of which reported less than $1 billion (£710 million) in revenue for the full year 2017.

It's hard to work out how much Amazon might be earning from ads on its site and app because the firm doesn't disclose that revenue, instead lumping its ad business into its "other" category.

Sebastian said the growth of Amazon's advertising business would partly depend on how much of its online real estate it's willing to give up to ads. "An unknown variable is how much space Amazon will provide on the search results page," he said. "That's hard to know, but it's been increasing."

Here's an example of what Sebastian means: If you type in "Brita water filter" into Amazon search, almost the first half of the page is taken up by ads. Amazon may decide not to devote any more of that space to sponsored posts and ads. "If I'm wrong, it's because Amazon will constrain available supply," said Sebastian.

Amazon sponsored

One "more visible" variable is pricing, he added. It's easier for analysts to estimate how much Amazon might be charging advertisers by looking at rivals such as Facebook and Google.

Advertising could become a profit powerhouse for Amazon, alongside its other big profit engine: Amazon Web Services (AWS). Sebastian estimated gross margins of around 70%. The two combined could subsidise Amazon's core retail business.

aws profit

"If you do the math on [ads] and AWS, Amazon is running its first-party retail business at breakeven margin," said Sebastian. That's by design. They're not losing money. They're incentivised to growing advertising and feed that back into the core business, to subsidise the retail business."

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