…I believe Amazon is anything but irrational when it comes to how they think about margins. I believe it’s a calculated strategy on their part, and anyone competing with them had best understand it.
Low margins, per se, isn’t a strategy. Amazon is pursuing a cost advantage, and it’s choosing to keep its prices very low, hence the low margins.  With a cost advantage and low prices, Amazon gives away a lot of value to customers, instead of capturing a lot of value for itself in the form of profits. Its primary objective is to gain market share (i.e., both new customers and a greater portion of existing customers’ everyday shopping). With an increase in market share, Amazon can further reduce its costs through economies of scale (i.e., spreading its fixed costs, such as infrastructure and R&D, over a greater number of customers served and products sold).
Amazon’s cost advantage and its low prices explain why most other online retailers have been unable to gain significant market share and why Amazon is now posing a serious threat to companies like Costco and Walmart. In 2011, Amazon’s total operating expenses as a percentage of revenue were about 91.3%, or about 6% less than Costco’s and 3% less than Walmart’s.  
 I’d argue that Amazon is actually pursuing a dual advantage, both a cost and value advantage (at least for customers that favor convenience over impulse buying). This value advantage stems from features such as home delivery, extensive product reviews, excellent customer service, broad selection, etc.
 Looking at Amazon’s 10-K for the year ending December 31, 2011 and Google Finance (Financials, Annual Data), I found the following. Amazon’s total operating expenses as a percentage of revenue was 98.2%; Costco’s was 97.2%; and Wal-mart’s was 94.1%. Since Amazon also has the Kindle and AWS businesses we have to back-out revenue and operating expenses for these non-retail business. By reviewing Amazon’s 10-K and drawing on published data, I determined the following: Amazon’s total revenue was $48.077b, AWS revenue was about $1.586b, and Kindle revenue was about $2.404b. This yields $44.087b in revenue for Amazon’s retail business. For operating expenses, I allocated the following to Amazon retail business. 95% of “cost of sales,” assuming 5% of Amazon’s sales can be attributed to the Kindle, two-third’s of “fulfillment” costs, and one-third of the remaining line items (technology and content, marketing, G&A, and other operating expenses). Based on reading Amazon’s SEC filings, I’m assuming the bulk of fulfillment costs are for its retail business. I’m splitting the remaining line items equally across the three businesses (retail, Kindle, and AWS).
 Given Amazon is still scaling aggressively, I anticipate this cost advantage to increase overtime. Looking at the latest four years of financial data in Google Finance, Amazon’s revenues are growing at a 25.85% CAGR. This contrasts with 8.54% for Costco and 2.54% for Wal-Mart.