The Value Proposition For Amazon Prime – No Need to Worry

Last week Amazon announced it would increase the Prime Membership annual fee from $99 to $119 in the U.S. Customers in other markets such as the UK or Germany are wondering if they are next.

Amazon did not elaborate if they would increase Prime Membership prices in other markets and one cannot rule out the possibility, but the increase seems to address cost realities that are specific to the U.S. market.

The U.S. still accounts for about 2/3 of all eCommerce revenue on Amazon and except for Australia which launched late last year and does not offer Prime Membership right now, it is the largest geography the company has to service.

While countries such as the UK and Germany can easily service every address overnight by ground transportation, that is just not possible in the U.S.

In 2005, when Amazon launched Prime in the U.S., it also launched free two-day shipping on eligible purchases.

Initially, the eligible product mix was small, and the two-day promise was a two business day promise and shoppers mostly had to commit very early in the day to receive two-day service.

Over time, as more warehouses were built, more products Prime-eligible products were added, the deadline to place an order and receive two-day delivery also moved further into the day.

And while Amazon still officially calls it a two-business-day delivery commitment, the vast majority of Prime-eligible items are now delivered in 2 days, including Saturdays, Sundays, and holidays.

For about ten years, Prime’s two-day delivery promise was improved by adding more eligible products and reducing the actual delivery time from two business days to two days.

In February 2011, Amazon added Prime Video, bringing over 5,000 ad-free movies and TV shows to the membership. This was the first significant non-delivery benefit addition to Prime membership.

And for most of this period (until March 2014), the company maintained the same $79 Prime Membership fee. In March of 2014, the Prime Membership was raised from $79 to $99.

Amazon Prime – 2014 and On

2014 became a major expansion year for Prime. During this year, the company launched Prime Pantry, Prime Music, the first Amazon Studio shows, Prime Photos, and Prime Now in select New York City Neighborhoods.

Over the last three years, Amazon expanded free same-day and one-day delivery services, launched Amazon Prime Day, Prime Reading, Prime Wardrobe, Amazon Key (including new delivery service to car trunks), A Prime Rewards Visa Signature Credit Card from Chase that offers 5 percent discount on Amazon, acquired Whole Foods Market and now offers free two-hour delivery from stores in select cities, and other Prime only benefits.

Some of these services do require additional fees or have minimum order requirements but are only available to Prime members.

The most significant benefit for most Prime members is the free fast delivery service.

But two-day delivery is no longer unique. Walmart now offers it to many eligible items without belonging to a membership program, the company tried a $49 ShippingPass which failed to gain traction. Best Buy, Target, and other physical retailers are following Walmart by offering free two-day delivery on many online orders.

For Amazon to continue on its growth path, it needs to offer more free same-day and next-day delivery eligible products in more places. In the U.S., this requires more fulfillment warehouses, more inter-warehouse shipments (ground and air), and expanded local logistics delivery networks.

While the company will continue to rely on USPS, UPS, FedEx to handle a lot of packages, it is also building out a comprehensive logistics network for its fulfillment operations, including a new program called Shipping with Amazon (SWA).

In Europe Amazon already delivers most Prime orders within the next day. In the UK, the company delivers about half of its Prime orders using their couriers.

Most logistics expansion in Europe is about warehouse capacity, not really delivery speed. In some markets, the company is expanding grocery offerings with Amazon Fresh, as there is no Whole Foods Market tie-in.

In comparison to the U.S., European logistics operations are much simpler and it was easier for Amazon to scale to free next-day delivery and in some areas even offer free same-day delivery.

To accomplish the same here in the U.S. will require an expansive logistics and delivery network. It is in the process of building its own air hub and expand Prime Air to handle faster product movement all while adding more fulfillment warehouses and ground transportation services.

In addition to increases in logistics expenditures, Amazon also expanded a lot of other Prime features, especially Prime Video by adding more shows and movies and live NFL games.

Logistics, expansion of video content, and improvements of other Prime services come with a cost. The time that Amazon could just shrug off these costs by promising future profits is over.

Amazon is a profitable company now and it needs to stay that way. Especially since Amazon AWS is the main source of its profits and there is investor pressure (and maybe a little concern) to ensure that eCommerce stays profitable as well.

With a U.S. economy generally in good shape, it was the right time to try to recoup more of the expenditures associated with Prime.

How May The Increase Impact Third-Party Marketplace Sellers?

Anytime there is a fee increase two things happen. Some people that were on the fence about joining will join before the May deadline and get in before the price increases.

Others, who will renew later in the year, may decide they don’t use the service as much and it is not worth it to them.

These two factions are likely going to cancel each other out!

Costco last year increased its standard membership from $55 to $60 and Executive Membership from $110 to $120. Also, with the increase, Costco is now higher than rival Sam’s club ($45 standard / $100 Sam’s Plus).

How has Costco fared since increasing its membership fee? Let’s take a look at their last earnings call (Q2 2018):

“… membership income is the next line item. I reported in Q2 $716 million, up $80 million from the $636 million last year second quarter and up about 4 basis points or 12.6% in dollars.

Now FX, the benefit of strong foreign currencies benefit the number by about $12 million. Of the $80 million increase in membership fees increased year-over-year about $37 million related to membership fee increases.

The majority of the $37 million came from fee increases taken last year in first U.S. and Canada with the smaller balances from the fee increases taken in our other international operations starting back in September of 2016. So all told, if you take out both of those, we would on a normalize basis membership fees were up $31 million or about 5%.”

“In terms of renewal rates, our renewal rates improved in Q2 to 90.1% in the U.S. and Canada, up from 90% a quarter earlier and worldwide improved to 87.3% as of Q2 end, up 20% from the 87.2% at Q1 end.”

Richard Galanti, CFO Costco

In simple terms, one year later, Costco increased revenue from membership fees, increased memberships, and even had a very slight increase in membership renewals.

Unfortunately, Amazon is not that open about its Prime membership revenue. So we have to go to the next best option, which is a study by CIRP (Consumer Intelligence Research Partners, LLC).

This study shows that Amazon has a 91 percent renewal rate after the first year and a staggering 96 percent renewal rate after year two. The company also estimated that about 73 percent of free trial Prime memberships converted to paid Prime memberships.

Even being a study based on sample data, not actual financial records, it does provide enough evidence that Amazon’s membership churn rate is similar to Costco.

Also, unlike Costco, Amazon does offer discounted memberships to students and other groups, thereby expanding the affordability of the program.

Yes, both programs mostly benefit from affluent shoppers, but Amazon is actually trying to change that a little.

Given the value of Prime Membership today and additional benefits coming such as Whole Foods Market discounts, and an expanded inventory of same-day and next-day eligible products, there is no reason to believe there will be a mass exodus from the Amazon Prime program.

It didn’t happen at Costco, a similar affluent consumer base. And looking at Costco, it appears the membership revenue can actually raise revenues that help build the logistics network Amazon needs to service U.S. consumers with more products and speedier delivery.

For marketplace sellers, the most important metric is that Prime members spend twice as much as non-Prime members on Amazon. Therefore, having products Prime eligible, either with Amazon FBA or Amazon SFP is key to growing sales.

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