[E12.1] Amazon Prime: monetizing customer acquisition
$14.99 per month or $139 per year per Household
Dear Readers,
In this Profile for Product | Strategy | Innovation I will start a 3-Part Series on Amazon with each part covering one of its 3 Pillars. These include the Amazon Marketplace, Amazon Prime and Amazon Web Services. Jeff Bezos, Founder, Chair and CEO of Amazon at the time, mentions the 3 Pillars for Amazon during a 2016 Code Conference interview with Walt Mossberg.
Amazon’s total revenue including both product and service sales in 2022 were US$514.0 billion. Amazon also reported a gross profit of US$67.7 billion and operating income of US$12.2 billion to provide some context regarding Amazon’s scale. Amazon’s market cap as of the close of business on January 27, 2023 was US$1.04 trillion. This also ranks Amazon 3rd in the S&P 500 behind Apple and Microsoft based on their market caps.
One of Amazon’s key attributes is its ambition and ability to transform an expense on their income statement NOW into a profitable revenue stream LATER. This has materialized at scale through its 3 Pillars. And through a flywheel effect, these 3 Pillars integrate key features to build a moat around the products and services Amazon continuously innovates, tests, and brings to market. In this Profile, I will provide a brief background covering each of these 3 Pillars. Then, I will go into more detail regarding Amazon Prime and what its future could enable.
Background
Amazon.com, Inc. (Nasdaq: AMZN) was founded on July 5, 1994 as Cadabra, Inc. in Bellevue, Washington by Jeff Bezos who chose the Seattle area to access the technical talent there. It’s initial focus was an online marketplace for books, but Amazon has continuously expanded the scope of eCommerce with multiple product categories and services. Amazon went public in May 1997 and began selling music and videos in 1998.
Amazon launched its third-party Marketplace in 2000. This allowed everyone from small businesses to established brands to sell new and used products on the Amazon.com website alongside Amazon’s regular offerings. This is a win-win-win for these third-party sellers, Amazon and its end-user customers. Third-party sellers gain access to Amazon’s customer base, Amazon expands it offerings without having to invest working capital in additional inventory and customers also gain easy access to more products through one access point to Amazon’s eCommerce website.
Amazon’s Retail Marketplace Pillar is a key driver for demand
The Retail Marketplace makes up Amazon’s first Pillar and is a key driver for demand. And the innovation is monetizing the expanded selection of products for Amazon’s customers with a referral fee as a percentage of the sales price. Sellers that use Fulfillment by Amazon (FBA) pay additional fees that include a pick, pack and weight charge. So, Amazon literally drives revenue by expanding the selection of products available to customers to drive more searches for products on its eCommerce website.
A9, a subsidiary of Amazon.com, was founded in 2003 by Udi Manber in Palo Alto, California. A9 focused on the A9.com destination website (redirects now to Amazon.com), product search and a search advertising platform. The A9 search engine powered product search for Amazon.com and several other eCommerce retailers. Amazon implemented a new search algorithm called A10 in December 2018. The A10 algorithm is a neural network that helps Amazon’s search engine determine what products are most relevant to a customer’s search terms. A10 was released in December 2020 as an update to the A9 algorithm.
Amazon Prime is a key driver to acquire customers and build loyalty to the Brand
Amazon launched their Prime subscription in 2005 for $79 per year. Amazon Prime is a key driver to acquire customers and build loyalty to the Brand. This started as a basic service with unlimited 2-day delivery on over 1 million in-stock items. The initial adoption was relatively slow, but in 2011, Prime started to take off as more products were supported and additional benefits were added. Today, Amazon has over 200 million Prime members worldwide. The most interesting outcome of Amazon Prime is that it increases sales for Amazon. Not only do members pay for the subscription, they often spend more on Amazon to take advantage of the 2-day delivery benefit associated with membership.
Amazon Prime takes customer acquisition and loyalty and monetizes them by driving additional revenue. Amazon still spends money to market its brand, but this is essentially an investment of Prime membership revenue back into the Brand vs. taking gross profit from Marketplace sales to fund customer acquisition and loyalty as line item expenses on the income statement. We will cover more on Amazon Prime later in this Profile. Amazon Prime makes up Amazon’s second Pillar.
Amazon Web Services (AWS) is a key driver for profitable growth
Amazon was incurring significant expenses maintaining its information technology infrastructure to support the rapid growth of its eCommerce business. Agile teams were also asking to spin up servers and core infrastructure to launch new projects. But these were early ideas that could fail. This created a need within Amazon for on-demand computing resources that were easy to turn on, scale and turn off. Cloud computing and cloud services were an innovation within Amazon to address their own needs. But as Amazon built out what eventually became Amazon Web Services (AWS), they realized agile teams outside of Amazon driving innovation within other corporations and new ventures would eagerly adopt these cloud services.
The actual genesis of AWS came in the early 2000s after Amazon built its eCommerce-as-a-service platform Merchant.com to offer third-party retailers a way to build their own web-stores. Amazon pursued service-oriented architecture to scale its engineering operations. AWS launched the first web service in 2002. This opened up the Amazon.com platform to all developers. Andy Jassy who is the current CEO for Amazon took over AWS in July 2002 and mapped out the vision for an “Internet Operating System (or OS)”. AWS is a key driver of profitable growth and makes up the third Pillar for Amazon.
Amazon Prime
Amazon launched Prime in February 2005 for $79 per year to scale its core eCommerce platform using unlimited 2-day delivery for many of its in-stock items. As Prime members add more products to an active order and return more frequently to place new orders to take advantage of Prime membership services, the demand for products bought on Amazon increases.
This increasing customer demand on the buyer-side drives more adoption of the eCommerce platform on the seller-side. That includes adding more products to the Marketplace by existing third-party resellers and acquiring new sellers who are attracted to Amazon’s growing buyer-side demand. This creates a flywheel effect to scale the Marketplace as the value proposition continuously improves for both buyers and sellers.
But shipping costs become a constraint for buyers for ongoing eCommerce use. That is the problem Amazon Prime was launched to tackle. But not for Amazon, but to scale the eCommerce business for its third-party sellers by reducing the friction for its retail customers. As Amazon Prime gained adoption with more members, Amazon started iterating on the value proposition for Prime membership by adding even more services. Maybe they learned from Costco or other membership based models, but some services could be added cost-effectively to test the impact on both buyers and sellers.
Amazon generated $31.8 billion from memberships and subscriptions in 2021. These are primarily from Amazon Prime and Prime Video. In 2022, Amazon Prime Day revenue was $12.1 billion, up 8% from 2021. Prime Day helps drive revenue growth through Amazon’s Prime Pillar by leveraging its Members. And when Prime Video releases a new show like “The Man in the High Castle”, it acquires new Members for less than the subscription fees they pay using Hollywood buzz. That means Amazon’s cost to acquire a new customer is often negative when they can leverage a Prime Membership. And Prime Members also spend more on the Amazon platform annually than non-Members.
Amazon Prime Membership
Amazon Prime Membership is for an Amazon Household and can contain the following Members: 2 adults (age 18 or over), each with their own Amazon account, up to 4 teens (age 13 through 17) and up to 4 children under the age of 13 (children can’t shop on Amazon). Teens can have their own Amazon login to shop and stream content while keeping their parents informed of their activity.
New Members can try Prime free for the 1st 30 days with a 30-day trial. At the end of the trial, a new Member would have to pay either $14.99 per month or $139 for a full year of access to Amazon Prime benefits. Amazon Prime Video has a subscription for $8.99 per month with no additional Prime benefits. Students have a discounted Prime Membership option for $7.49 per month or $69 for a full year.
Two adult accounts can be linked to share eBooks, audiobooks, apps and games. Adults can share digital content (free Prime Video, Amazon Music, Twitch Prime) with teens in their Amazon Household. Adults can also set viewing restrictions for shared digital content. Adults can also share digital content (eBooks, apps and games) with children. Adults can personalize each child’s experience by selecting what content they can see, and setting educational goals and time limits.
40% of Amazon Prime Members visit the platform daily and 93% stay with the service after one year. 81% of Americans aged 18 to 34 are Amazon Prime Members. Amazon Prime Video had a 19% market share for streaming video on-demand services in 2022 compared 21% for Netflix who led the category. Disney+ and HBO Max tied for third in market share with 15% each. One-third of Prime Members spend $50-100 a month on the Amazon platform.
Amazon Prime has over 172 million Members just in the U.S. with over 200 million worldwide in 2022. And 76.6 million, representing 59% of American households, had at least one Prime membership in 2022. As of October 2021, Amazon Prime was available in 23 countries.
Prime Day
Amazon Prime Day is a special day of deals exclusive to Prime Members. This usually takes place in the summer or fall. Black Friday on the day after Thanksgiving also provides shopping benefits to Prime Members. Amazon Prime Day generated over $12 billion in revenue worldwide in 2022 through its Prime Members. Prime Day also provides Amazon an opportunity to test new processes, technology, pricing and services for their peak season later in the year. Planning for Prime Day often starts early in the new year.
Unlimited one-day and same-day delivery
Prime was originally designed to offer free two-day delivery for millions of eligible in-stock items across all categories of Amazon’s eCommerce store. As Amazon has increased the number of its fulfillment centers to process Prime orders, one-day and even same-day delivery have become more feasible. Prime Members who order an item tagged as Prime usually get it the next day, even on Sundays. One-day and two-shipping are free when available. Same-day delivery is free on qualifying orders over $25 in certain cities or $2.99 per order. Standard shipping is 4-5 business days and is free.
Prime Video
Amazon first launched a video service in September 2006 as Amazon Unbox and was the company’s alternative to Netflix. Amazon renamed the service as Amazon Video on Demand in September 2008. And then Amazon offers the free access to thousands of TV shows, documentaries, and movies to stream to multiple devices as a key benefit to Prime Membership in February 2011. You can also subscribe to an option for Prime Video for $8.99 a month with no additional Prime benefits.
Prime Video is now a division of Amazon with headquarters in Seattle, WA and serves markets worldwide excluding mainland China, Cuba, Iran, North Korea, Russia and Syria. Services include film production, film distribution, television production, and television distribution. As of September 3, 2022 Amazon Video had 200 million users with 25 million watching the release of The Lord of the Rings: The Rings of Power on its first day. Some movies and exclusive TV content have to be rented or purchased in addition to the base Amazon Prime subscription.
Amazon pushed into sports streaming with NFL Thursday Night Football to add more exclusive content on top of original TV series and movies. Amazon purchased MGM in March 2022 including the rights to more then 4,000 films and 17,000 TV shows including the “James Bond: and “Rocky” series. Amazon Studios is the home for talent, creating and producing original films and TV series for a global audience. Original series all premiere exclusively on Amazon Prime Video.
Amazon Music
Amazon Prime members can access 100 million songs and an assortment of podcasts ad-free at no additional cost through Amazon Music. There is a paid tier of the service called Amazon Music Unlimited, which is $8.99 a month for Prime Members and $9.99 for non-Prime Members. Amazon Music Unlimited provides on-demand and offline listening in HD and Ultra HD quality. Non-Prime Members can listen to a free, ad-supported Amazon Music.
Amazon Prime Photos and Amazon Drive
Amazon offers up to 5 GB of storage through Amazon Drive and storage for an unlimited number of original resolution photos to Prime Members through Amazon Prime Photos. Video storage falls under the 5 GB storage limit even for Prime Members. Additional file storage is available with tiered pricing.
Aside from backing up your photos with Amazon Prime Photos, you can search for elements in your photos. Amazon offers a mobile app for Android and iOS devices, a web app and a desktop app for Amazon Photos. You can also print photos with Amazon Prime Photos with a range of options like canvas prints, metal prints, photo books and calendars. Prime members get free shipping.
Prime Gaming
Amazon Games develops games that harness the power of AWS and Amazon’s Twitch service. Amazon operates Relentless Studios and other assets to develop and publish games. Some top games include: Star Wars: Jedi Fallen Order, World War Z: Aftermath, Guild of Ascension and Elder Scrolls IV: Oblivion. Amazon also offers a cloud gaming service called Luna. Prime Members can access free games through Luna, but can also subscribe to game libraries from partners like Ubisoft, JackBox, and others.
Amazon Reading
Amazon Reading offers a range of features for unlimited reading and listening through Audible Narration for Prime Members with thousands of books, magazines, comics, Kindle singles and more. Amazon Reading supports Kindle devices, but Amazon’s free Kindle app makes content available on any device to support reading anytime, anywhere.
Amazon Fresh
Amazon Fresh is a grocery delivery service available to Amazon Prime Members in major cities throughout the U.S. and certain cities worldwide. Prime Members receive free two-hour grocery delivery on Amazon Fresh and Whole Foods Market orders that meet the minimum purchase threshold. Grocery Lists can be used for recurring purchases. And Alexa is integrated with Amazon Fresh to learn about a Prime Members grocery preferences to act as a virtual assistant.
On February 28, 2023, Amazon will require a $150 minimum Amazon Fresh purchase for free delivery to Prime Members. Amazon will charge a $3.95 delivery fee on orders between $100-$150, a $6.95 deliver fee on orders between $50-$100, and a $9.95 delivery fee on orders less than $50. Amazon Fresh includes local, organic and seasonal groceries with a large selection of over 500,000 products to choose from, including household items. Amazon Fresh grocery prices are comparable to Whole Foods Market prices, but may be a bit more expensive than a more typical grocery store chain. And deliveries can include lots of packaging, some of which isn’t recyclable.
Amazon Prime Rx Savings
Prime Members can save up to 80% on prescription medications when they do not have health insurance. This is a benefit that can be used at over 60,000 pharmacies including CVS, Walgreens, and Costco Wholesale. This service complements health insurance plans when certain prescriptions are not covered by the plan or can be purchased cheaper through Amazon. Prime Members can also use Amazon’s Pharmacy to place online orders with free 2-day shipping.
Amazon is turning into a logistics as a service provider through Prime Logistics
Amazon continues to vertically integrate and scale its supply chain logistics operations between suppliers who are often located in Asia and stocking inventory in its fulfillment centers. This includes purchasing planes, shipping containers, trucks and delivery vans. Last mile delivery to customers also provides a business opportunity for small businesses to create or expand into the logistics business as a partner with Amazon.
Amazon’s Prime Logistics business is aligned with the Retail Marketplace, but the business was launched under the Amazon Prime Pillar to help fund its startup costs and scaling through investment of Prime Membership gross profit back into the Prime Logistics business. As the business becomes cash flow positive, it will become more feasible for Amazon to reposition it Prime Logistics business under the Retail Marketplace as a growth and profit driver.
Amazon can accelerate its market share growth in health care through the One Medical acquisition (if approved) and future alignment under Amazon Prime for direct-to-consumer opportunities rather than employer-based health care
Amazon made a large acquisition to expand into healthcare when it purchased PillPack in 2018 for about $750 million. This acquisition allowed Amazon to enter the pharmacy benefits program business using it online experience and systems to fulfill orders. PillPack allows Amazon to fulfill multiple prescriptions for the same individual into sealed packs with each medication for a specific time packaged into the same pack.
Amazon shut down a health care joint-venture with JP Morgan Chase and Berkshire Hathaway called Haven after a few years and shuttered an employer-based, virtual care business called Amazon Care. But both projects appeared to have not met the anticipated outcomes that Amazon was pursuing. One Medical is different with network of primary care providers and offices around the US while providing both in-person and virtual care options.
Amazon also launched Amazon Clinic to enhance cost-effective virtual care. This will likely overlap with One Medical to enable in-person care as needed, but scale with more virtual care. Amazon Prime could eventually offer a tier of membership that includes a health insurance benefit as Amazon Prime Health. That will radically change Amazon’s approach to health care. And Amazon would have the scale and working capital to insure the health claims exposure while also boosting Amazon Prime revenue.
Conclusion
Amazon is one of the most successful companies in the world and is ranked 3rd on the S&P 500 behind Apple and Microsoft based on market cap. Amazon leverages 3 Pillars to drive profitable revenue growth generated by both Amazon Prime and AWS. But Amazon Prime and all of its services like Prime Video have demonstrated they can be very effective at acquiring new customers at a negative cost to Amazon in many cases. That means customers are generating positive cash flow for Amazon by being acquired. Amazon converted an expense to acquire customers for most companies into revenue with Amazon Prime. And once acquired, these customers spend more on Amazon’s platform as a Prime Member.
Amazon Fresh is almost a new vertical built on top of Amazon Prime and expands Amazon’s strategy for groceries beyond its acquisition of Whole Foods Markets. Food services will become important if Amazon continues to expand into health care. Amazon Studios is another vertical built on top of Amazon Prime to drive original movie and TV series content. Creating Hollywood buzz over a new release can have a big impact on Amazon’s downstream revenue when new Prime Members start shopping more online with Amazon.
And Amazon Prime shares many of the same characteristics as insurance where subscription revenue can be modelled and costs can be managed to generate a float from the positive cash flow that results. This float can be used to fund investments back into strategic businesses. But this also puts Amazon in a strong position to continue to expand into health care. Imagine the future when Amazon Prime includes a premium tier for Prime Health with insured health benefits. Few companies have the scale and systems to do what Amazon could do in health care.
Best,
Stephen
I’m long AMZN mentioned in this Profile. Nothing in this Profile is intended to serve as financial advice. Do your own research. The opinions and views expressed in this newsletter are those of the author. They do not purport to reflect the opinions, views or policies of any other organization, company or employer.