Amazon Prime Was Too Good to Be True After All

Amazon Prime Was Too Good to Be True After All

Jeff Bezos, introducing the Amazon Fire, in 2011. Victor J. Blue/WIRED
Jeff Bezos, introducing the Amazon Fire, in 2011. Victor J. Blue/WIRED
The price of “free” two-day shipping is about to go up. That was the message from Amazon executives last week, who said that shipping costs would probably force them to raise the price of the company’s popular Amazon Prime program. Now $79 per year, the cost could go up $20 to $40 more.
Judging from Amazon’s balance sheet — and Wall Street’s negative reaction to those balances after its most recent earnings report — the company really has no choice. The irony is that Amazon Prime has worked out just like Amazon wanted it to.
Judging from Amazon’s balance sheet — and Wall Street’s negative reaction to those balances — the company really has no choice.
Amazon Prime launched in 2005 as a premium variation on its “Super Saver Shipping” program, which until a few months ago offered free but slower shipping in exchange for a $25 minimum order (the minimum rose to $35 in October). Super Saver stoked sales in two ways. The minimum order requirement meant that customers might buy more than they planned just to hit the free-shipping mark. Cutting shipping from the final price of an order also eliminated one of the main reasons people still prefer shopping in physical stores.
As recounted in Brad Stone’s The Everything Store, if Super Saver was coach, Prime was first class. For $79 per year, Prime members savored the service’s speed and reliability, and, Stone writes, they were inclined to spend more based on the “faintly irrational human impulse to maximize the benefits of a membership club one has already joined.” Though Amazon does not say how many Prime members it has beyond a general figure of “tens of millions”, the company did claim more than one million new Prime sign-ups during the third week of December alone.
Researchers have come up with various methods for gauging Prime’s influence, and they estimate the average Prime member spends more than twice as much on Amazon annually than non-Prime members. All of this feeds what Stone calls Amazon’s “virtuous cycle” masterminded by founder and CEO Jeff Bezos. “When customers spent more, Amazon’s volumes increased, so it could lower shipping costs and negotiate new deals with vendors.” Stone writes. “That saved the company money, which would help pay for Prime and lead back to lower prices.”

Amazon’s Growth Engine Needs a Tune-Up

But now that cycle appears to be breaking down.
The first sign may have been the Christmas 2013 shipping debacle that led Amazon to offer $20 gift cards to customers whose orders came late. Amazon itself denied culpability, blaming the carriers. But it’s hard not to see the specter of overpromising in those million pre-Christmas Prime sign-ups. Shipping rates can’t get any lower once the system is maxed out.
Even though there’s no other indication that Prime’s fabled reliability has otherwise been compromised, the price of keeping its two-day promise has apparently become too much for Amazon to bear. On last week’s earnings call, Amazon CFO Tom Szkutak said that Prime’s popularity has risen dramatically during the nine years of its existence and that Prime members are ordering more per customer than ever before. And yet, he said, “even as fuel and transportation cost have increased, the $79 price has remained the same.”
Even if Amazon does raise Prime’s price to cover those increased costs, it may still lose money. Shipping losses are growing by a rate of nearly one-quarter year-over-year, and Amazon is spending almost twice as much on shipping as it charges, writes Colin W. Gillis, director of research at BGC Financial. The proposed Prime price hike won’t cover that deficit, Gillis predicts. “While raising Prime pricing and pitching ‘drone delivery‘ solutions make good headlines, shipping losses remain a burden on profits.”

Profits Aren’t Even the Problem

Unlike most companies, Amazon hasn’t had to worry much about its near-total absence of profits. While Apple’s share price wavers despite pocketing tens of billions annually, Amazon’s stock jumped by nearly two-thirds last year after ending its fiscal 2012 in the red.
What investors do care about, however, are sales. As long as Amazon keeps growing into the world-dominating retail giant that Bezos aspires to become, Wall Street has seemed content. But its $25.6 billion in fourth-quarter sales reported last week missed analyst expectations by about $400 million. Worse, sales aren’t growing as fast as shareholders would like. After reporting its results Thursday, investors finally spanked Amazon shares with an 11 percent loss.
‘Amazon Prime members who joined in the past year represent a different risk to Amazon.’
— Mike Levin
As late as June 2011, Amazon sales were doubling compared to the same time a year earlier. Compared to that kind of growth, any losses related to the too-good-to-be true Prime were easy to justify. Now sales growth stands at around 20 percent, and Prime has started to look like it’s not holding up its end of the deal.
Last year, we speculated that Amazon might even considercutting the price of Prime because it was such an invaluable source of sales for Amazon. If that momentum is flagging, however, Amazon will have a much harder time justifying the shipping losses Prime inflicts.
Along with bringing in more money to cut those losses, perhaps a Prime price increase would serve as a kind of litmus test. According to one survey, customers in the first year of their Prime memberships are much less likely to renew than those who have been members for more than a year.
“Amazon Prime members who joined in the past year represent a different risk to Amazon,” says Mike Levin, co-founder of Consumer Intelligence Research Partners, which tracks the costs and benefits of Prime to Amazon.
For those loyal customers who have gotten addicted to two-day shipping, an additional $20 is a small price to pay in order to feed that need. On the other hand, a spike in the Prime rate might have newbies shaking their heads. “Too good to be true,” they’ll say. “We knew it all along.”

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