It's true that their profit margins can be vanishingly thin, but that doesn't mean they don't make money.
For some classes of items, they can sell at cost and still make money, because their operations are allegedly so good that they can turn over the inventory before their own payment to the supplier is due.
For example, say Amazon buys a book today and payment is due to the publisher in 30 days. They sell the book tomorrow at cost. Now they get to sit on the full price of the book for the rest of the month. In fact, take that money and buy another book, and sell it right away too. Keep that up, and you have a very big pool of money always sitting in your bank account. Money that can be profitably invested in other activities.
Why would a publisher give them 30 days to pay? Because they're Amazon. It's good to be big.
They are optimizing for market share and innovation rather than profits. It's a world domination thing.
I think it's awesome. Imagine if Google had run a bunch of low-rent punch-the-monkey display ads early on. It would have killed them. Facebook vs MySpace is another good example of what happens when you focus on long-term value creation versus short-term profit taking.
With its low profit margin amazon leaves virtually no room for a small size competitor to dislodge them from their share of the market.
Say you want a bite of the tablet market dominated by apple, it's easy, make a somewhat decent tablet for cheap and there you have it.
If you want a bite of an amazon dominated market, well good luck with that, and while at it hope that amazon is not planning to get into the market you're in.
It seems their strategy relies on tiny margins, maybe with a different set or circumstances amazon would change their stance, but I don't think it's currently part of their plans to ramp up prices.
From Amazon's perspective, it's the only way to exist in the long term. If they keep costs and margins low, they don't give their competitors much breathing room to challenge them on price.
