Amazon Prime: Bigger, More Powerful, More Profitable than Anyone Imagined

Amazon Prime: Bigger, More Powerful, More Profitable than Anyone Imagined

Andrew Harrer / Bloomberg / Getty Images

Amazon’s competitors — a group that basically includes every retailer under the sun nowadays — have more reasons than ever to fear the world’s largest e-retailer. Membership in Amazon Prime, the service that includes unlimited free two-day shipping and tends to boost customer spending at Amazon dramatically, has doubled in less than two years. Analysts predict it’ll easily double again by 2017.

Last week, a report from Morningstar and Consumer Intelligence Research Partners (CIRP) estimated that there are now 10 million subscribers to Amazon Prime, which offers free streaming of thousands of movies and TV shows and, most important, free two-day shipping on most Amazon purchases. The service usually costs $79 annually, though it’s cheaper for college students ($39 annually, after six months free).

It’s unclear exactly how many Prime subscribers there are at any given time (Amazon doesn’t make this info public), but it sure looks like membership soared. It’s been estimated that there were fewer than 7 million subscribers at the start of 2012 and about 4 million members in the fall of 2011. The numbers have likely been boosted by Amazon including free Prime trials with sales of the Kindle tablet, but even so, the increases are impressive — and are presumed to keep occurring with regularity. The Morningstar report predicted that there could be 25 million Prime members by 2017.

Even more interesting than the growing Prime ranks is what Prime seems to do to subscribers. A 2010 Businessweek story stated that Amazon Prime broke even within three months of launching, not the two years predicted by its creators. That’s because customers spent as much as 150% more at Amazon after they became Prime members. Subscribers not only ordered more often, but after paying the $79 fee, they started buying things at Amazon that they probably wouldn’t have in the past. Since shipping was always speedy and free, members saved themselves a trip to the store for things like batteries and coffee beans. “In all my years here, I don’t remember anything that has been as successful at getting customers to shop in new product lines,” Robbie Schwietzer, vice president of Amazon Prime, told Businessweek.

The net result of Prime membership — and the thing that has to scare the bejesus out of Amazon’s competition — is that it tends to cause subscribers to stop shopping anywhere else. It’s assumed that Amazon’s prices are competitive. With Prime, shipping costs become a total nonissue. Subscribers automatically defer to shopping at Amazon first because they know shipping is free. And when they spot something they like at another retailer’s site or in a store (yes, it still happens), Prime members are likely to see if Amazon also sells the item. Chances are, Amazon does, the price is about the same or better, and two-day shipping is, of course, thrown in for free.

Sure, Amazon “pays” for all the shipping on Prime orders. A 2011 investigation estimated that the average Prime member used $55 worth of shipping and $35 in digital content annually. That’s $90 total, so Amazon was “losing” $11 annually by collecting its $79 membership fee.

Regardless of what might seem like a net loss, Amazon Prime has been and continues to be a hugely profitable enterprise for the e-retail giant. A Prime member now makes $1,224 in Amazon purchases each year, on average, compared with $505 for non-Prime customers. After factoring in costs incurred for shipping and streaming, the average Prime member yields Amazon $78 more in profits than other customers, according to Morningstar. Yep, it’s nearly equal to that $79 membership fee.

Wired notes that “Amazon could cut the price by $50 and still make far more than what the company makes off non-Prime customers.” Such a decreased price would probably boost Prime membership through the roof, as more shoppers would find it worthwhile to pay the fee in exchange for a year’s worth of unlimited two-day shipping. “They should be able to give Prime away for free,” says CIRP partner Michael Levin.

An extreme Prime price cut could wreak havoc throughout the retail world. Just imagine if, suddenly, tens of millions of consumers doubled their annual spending at Amazon.com like previous Prime customers have done. Such a change would hammer Amazon’s online and brick-and-mortar competition, and probably also hurt the chances of emerging same-day-shipping services, whose fees fewer would be willing to pay. When two-day shipping is always free, after all, it’s much harder to justify forking over $10 or more to get an item a little quicker. (Amazon also offers same-day shipping in several major cities, and it gives a discount on the expedited service for Prime members.)

That said, there are reasons why Amazon is likely to maintain the Prime fee structure as is. Sure, there are all those millions of $79 yearly fees to consider. That’s easy money for Amazon. And based on expanding Prime-membership numbers, the world’s largest e-retailer doesn’t appear to need help growing its subscriber base.

But there’s more to it than that. From the get-go, many Prime members have been motivated to spend more at Amazon not just because prices were good and shipping was free, but because they want to get their money’s worth out of their $79. If a customer is not ordering all that much, the subscription fee isn’t worth paying. If Prime fees go away, the compulsion to “get your money back” goes away too. When something is free, consumers tend to think it’s not particularly valuable.

Of course, there are many options in between $0 and $79. Amazon is famous for aggressive pricing tactics, and it has always seemed willing to accept smaller transaction profits so long as it wins the sale. “Your margin is my opportunity,” is a favorite quote from Amazon CEO Jeff Bezos. His company is driven to make more sales and attract more customers, and a cheaper Prime-membership fee would help with both.