The Motley Fool

Trademe’s Amazonian challenge

Imagine joining eBay  (NASDAQ: EBAY), Seek (ASX: SEK), Carsales  (ASX: CRZ), and REA Group (ASX: REA) together and you can picture the huge dominance that classifieds-cum-marketplace website Trademe (ASX: TME) has achieved in New Zealand.

Trademe was founded in 1999 by Kiwi entrepreneur Sam Morgan as an eBay-style online marketplace. After establishing a leading position in general goods auctions, Trademe quickly added car sales, property listings, and finally employment classifieds.

This rapid progress allowed Trademe to capture dominant market share in general merchandise, car sales and property, while also establishing itself a solid second place position in employment classifieds (behind our own Seek).

The fattest margins in all the land

Trademe’s dominance makes it one of the most profitable companies in Australasia. In its most recent annual results, Trademe reported operating profit margins of a jaw-dropping 65% and net profit margins of an astounding 44%. The company’s balance sheet is in great shape too, with debt to equity at a low 25%.

On top of that immense profitability, Trademe has had a long history of growing sales, compounding annual sales over the past 5 years at a strong 13%. This revenue growth has been fuelled in large part by the long-term tailwind of increased online shopping, and advertising shifting from print to digital.

The company has also boosted revenues by flexing its muscles on pricing. Trademe has used its strong market position to raise the fees that it charges to sellers in its various marketplaces.

The real estate revolt

But Trademe could be losing some of that pricing power muscle.

In November 2013 Trademe pushed through significant pricing changes for its property listing business. Real estate agents would be migrated from a flat bulk-pricing model, to a per-listing fee. Trademe hoped to capture more revenue from high volume agencies by charging for each individual listing. The move was intended to set the stage for Trademe to gradually raise those per listing fees over time, as it has done elsewhere.

But many real estate agents revolted against the move, switching thousands of their listings to an industry-owned rival, Realestate.co.nz. Trademe finally buckled in July of this year, allowing some agents to remain on a bulk-pricing model.

Trademe will be able to recover from the short term damage caused by lower property traffic. But the failure raises questions over how much pricing power Trademe really has, and whether the company could face a similar backlash in other business units such as car sales.

Amazon: King of the jungle

Trademe may be the 800-pound gorilla in New Zealand, but on a global scale it is just a minnow.

There are rumours that Amazon (Nasdaq: AMZN) could soon enter Australia directly. Amazon already operates an Australian website, but has not built out its warehousing infrastructure here yet. Once it does, online delivery times will fall substantially, removing a key barrier that has protected Australian retailers thus far.

The same threat applies to Trademe. Once Amazon sets up camp in Australia, the shipping time for goods to cross the Tasman will plummet, and the range of relevant products will expand. After securing Australia, Amazon may even decide to jump the final hurdle and put boots on the ground in New Zealand.

Trademe could pre-empt this threat by imitating Amazon’s model and investing in warehousing and fulfilment centres of its own. But to do so would mean slashing those fat profit margins that the company has come to love.

It is a classic innovator’s dilemma. Trademe must face lower short term profitability if it wants to protect its business in the long run. If there is one global hyper-competitor that has proven time and again that it is willing to make that trade-off, it is Amazon.

Foolish takeaway

Trademe’s rapid expansion in the early days of the New Zealand internet has left it with dominant market positions that any company in the world would envy. But there are signs that growth is slowing as the company reaches market saturation and that its pricing power is weakening.

With the threat of Amazon entering Australasia on the horizon investors should be careful not to project the Trademe’s past growth in to the future. Trademe is a giant in New Zealand, but that may not count for much when it is staring down a global juggernaut.

Don’t miss this! If you love dividend-paying shares, simply click here to claim your free copy of this brand-new investing report, “The Motley Fool’s Top Dividend Stock for 2014-2015.”

Matt Joass is a Motley Fool analyst. You can follow Matt on Twitter @TMFMattJoass. The Motley Fool's purpose is to educate, amuse and enrich investors. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

5 ASX Stocks for Building Wealth After 50

I just read that Warren Buffett, the world’s best investor, made over 99% of his massive fortune after his 50th birthday.

It just goes to show you… it’s never too late to start securing your financial future.

And Motley Fool Chief Investment Advisor Scott Phillips just released a brand-new report that reveals five of our favourite ASX stocks for building wealth after 50.

– Each company boasts strong growth prospects over the next 3 to 5 years…

– Most importantly each pays a generous dividend, fully franked.

Simply click here to find out how you can claim your FREE copy of “5 ASX Stocks for Building Wealth After 50.”

See the stocks now