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Prime Factors: Should Amazon Really Mess With The Best Loyalty Program In Retail?

Feb 2 2014, 8:28am CST | by

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Prime Factors: Should Amazon Really Mess With The Best Loyalty Program
 
 

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Prime Factors: Should Amazon Really Mess With The Best Loyalty Program In Retail?

Amazon has never been one to mind the contradictions. It’s a consumer e-commerce giant and a leader in cloud computing. The two don’t really have anything to do with one another, yet together they’ve made Amazon a smash hit on Wall Street . Similarly, Amazon Prime mashes together a Netflix-like video service and unlimited free 2-day shipping, all in a $79-a-year bundle that has proved similarly boffo with consumers. Amazon says “tens of millions” have signed up for Prime. But during the most recent earnings announcement, the company surprised everyone not just with some disappointing financials but also with news that it was considering hiking the fee for Prime by up to $40 per year. It’s hard to imagine a bigger misstep for the company, which has made remarkably few. So what’s going on here?

 

Prime itself is almost certainly a money loser, but only when viewed through a narrow lens. It was first conceived of late in 2004; the $79 price was apparently chosen because it was a prime number , according to a San Francisco Chronicle story. Back then, the video service and free e-books for Kindles (also part of Prime today) weren’t yet included along with the free shipping. Various reports have suggested Amazon spent more than $1 billion on video content alone last year. If you divide the streaming expense over 20 million customers it works out to perhaps $50 per person, leaving just $29 for shipping.

When you consider that the average Prime customer is likely to order more and more as time passes — we hit 40 deliveries last year for the first time — you can see that the fee for Prime isn’t how Amazon makes money. Although Amazon is fantastically efficient at logistics and obtains greater discounts from UPS and FedEx than anyone, it can’t magically deliver dozens of orders for $29 per household. And it said during earnings that increased transportation costs were why it was mulling the Prime hike. But Prime isn’t just an exchange of money for services; it’s a commitment by the consumer to shop with Amazon — and prepay for the privilege.

What happens is that once you sign up for Prime, you end up using Amazon like a utility. If you need something, you nearly always check there first and end up clicking buy, secure in the knowledge that, most often, the item will arrive before you’d even get around to picking it up at a local store. With Saturday deliveries a reality and most retail shopping occurring on weekends, typically anything we order from Amazon between Sunday night and Thursday morning gets to our door before we’d get in a car to go buy it. It is perhaps the best loyalty program in the world. Like a Costco membership, you end up paying for the right to use it. But thanks to the ease of purchasing and the giant selection, you find yourself shopping there more and more with the passage of time– even though Amazon doesn’t hand out rewards points or discounts for doing so.

According to Consumer Intelligence Research Partners, the average Prime customer spent about $1,340 last year. Multiple that by the 26.5% gross margin Amazon generated last quarter, and you arrive at $355. Suddenly, the shipping losses don’t seem very important. And this is even more true when you consider that for years now, Amazon hasn’t been worried about turning a short-term profit. It has been about building a long-term play to take an ever-larger chunk of retail spending from customers worldwide.

If the price of Prime is raised now, in a best-case scenario Amazon will pick up around $500 million per year — less than 1% of total revenues. (The assumption is that a $40 hike would cost the company a substantial number of customers while a $20 price bump would result in fewer cancellations.) But realistically, it could be much worse. As with any price increase, some will drop Prime entirely. Netflix saw this when it increased prices a few years back and while the direct losses were small on the streaming side (about 800,000), the effect was to hurt the perception of the company overall.

In Amazon’s case, that would likely manifest itself in much slower Prime growth going forward. One strange artifact of the company’s long-term focus is that it has built a vast distribution network across the U.S. that puts many customers within 2-day reach of one of its centers even without Prime. Many might just figure they can skip signing up and wait until they have $35 worth of stuff to trigger Amazon’s standard free shipping before placing an order. The problem for Amazon is that only Prime customers have that “Amazon first” mentality like we do, where it becomes not just the default e-commerce option, but the default shopping option.

A friend who recently signed up posted on Facebook , “In the course of two months, Amazon Prime has completely changed the way I shop.” She was skeptical and needed reassurance from a bunch of folks to join in the first place. While loyalty is fickle, there is little doubt that Amazon’s “memory” of what you’ve ordered before, it’s “subscribe and save” program that automatically re-ships items to you on a regular schedule and its strong customer service make it easy to stay hooked. But it only works if you get hooked in the first place.

So what possible motivation could there be to keep us from doing that? It seems counterproductive on every level. If it’s to justify the unexpected freight costs of people who end up ordering 2-3 times per week, then perhaps Amazon is missing the forest for the trees. Those folks are pulling their weight in margins from sales. If it’s to cover the cost of streaming, perhaps Amazon should consider pulling back on its quixotic quest to compete with Netflix. Most Prime customers aren’t in it for the streaming anyway. If Amazon wants to build a true Netflix fighter, it will need better content anyway. And maybe it needs to charge for that separately and leave Prime as it was originally conceived: a free-shipping program.

Either way, the whole episode is bizarre for Jeff Bezos and company. They have managed Wall Street so expertly that even with a disappointing quarter like this one, the stock only took a small hit. It still remains valued at hundreds of times trailing earnings as investors’ willingness to believe in Bezos long-term vision remains intact. If anything could shake that confidence it would be evidence that Prime is losing ground. And perhaps the only way to pull that off would be to raise its price. Is there any scenario that risk is worth a few hundred million in the short run? It doesn’t seem so.

Follow me on Twitter  and on Facebook . Find the rest of my Forbes posts here .

Source: Forbes

 

 

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