No Longer Competing On Price Alone

How Amazon Prime can help the company grow its membership base and help absorb its famously thin margins.

 
 

It will have been more than 28 months since I graduated college, but in August I will move out of my parents’ house and into the real world. I say that because I, like many, was eagerly awaiting Prime Day to furnish my new place.

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Prime Day is Amazon’s attempt to build a summer sales holiday to rival Black Friday and Cyber Monday. Only available to Amazon Prime members, and held on July 15 this year to celebrate the online retailer’s 20th anniversary, the verdict was mixed. Amazon reported sales larger than Black Friday but that consumer sentiment was largely negative.

Along with the deals, the real linchpin of the sale was the ability for consumers to sign up for a 30-day free trial of the Prime service, the benefits of which include free two-day shipping, video, music, cloud storage, and books, among others. Normally priced at $99 a year, the free trial allows interested consumers to give it a whirl before committing a Ben Franklin.

The Genius Of Prime

If Amazon is known for anything, it’s certainly not profit. In fiscal year 2014, Amazon had $89 billion in revenue. Operating income, however, was $178 million, which resulted in a $241 million net loss. This lack of concern for profit allowed it to sell its wares at lower prices than its competitors and attract consumers.

Prime is a kind of extension of that. The service is meant to make Amazon a first choice for providers, not simply a place where consumers come to shop on price. And based on the spending differences between Prime and non-Prime customers that strategy looks successful.

In the fourth quarter of 2014, Consumer Intelligence Research Partners estimates that Prime has 40 million members in the United States, spending about $1,500 per year each. Compare that to $625 in average spend per year for non-Prime customers.

The initial benefit of Prime was free two-day shipping. Of course, to justify the $99 yearly cost, customers had to consider if they would make enough purchases — and save enough on shipping. Therefore, this service was limited to those individuals who purchased a lot.

But those Prime individuals would become Amazon’s best customers. Not only did they spend $99 a year, but they would use Amazon as a first-choice retailer for even the smallest purchase. And if these consumers spent enough to cause Amazon to lose money on shipping, the loss can easily be justified — it’s a big-spending customer.

No Longer Competing On Price Alone

Now, Prime membership provides access to streaming video, music, and cloud storage, not as a way to provide greater benefit to big-spending customers, but to attract those who spend in smaller volumes. Potential Prime members who can’t justify the costs based on purchase volume can see a benefit in other areas. Netflix, for instance, costs $108 annually; Spotify, Apple Music, and Tidal all cost about $10 a month. Prime costs less than each but provides a similar service with the added benefit of free two-day shipping.

In the first quarter of 2015, according to Consumer Intelligence Research Partners, Prime had 41 million members with members spending $1,100 versus non-members' $700. More people are signing up for Prime, but the average member spend dropped compared to the previous quarter, indicative of Amazon’s greater focus toward lower-volume spenders.

With Prime, Amazon moves away from competing on price to competing on value. Amazon wants to give its customers as much as it can for the lowest possible cost, betting that a suite of affordable products — of varying quality and utility — allows it to compete with retailers and content producers from Wal-Mart to Netflix.

Amazon’s margins are thin, and Forrester Research estimates that Amazon loses $1 billion to $2 billion annually on Prime shipping costs. To continue to justify these losses, Amazon must grow its consumer base through Prime, hoping that shipping costs can be offset by membership dues.

Will it work? I’m not sure. I didn’t buy anything on Prime Day.

 
 

July 23, 2015


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