The Hidden Strategy Of Amazon Prime

Amazon.com has arguably built one of the best online shopping experiences of any e-commerce company in existence today.  According to Fortune Magazine, as of November 2015 Amazon has online revenue of $71.8 billion which is 5.4 times larger than the #2 U.S. company Wal-Mart.  Despite this success, Amazon had a vexxing problem:  How do we monetize a great customer experience in an industry where many people shop based on price?  In most industries, if you offer a better product or service, you can charge more.  The Four Seasons and Holiday Inn are both hotels that offer rooms with beds, but they differ significantly on service and thus price.  Generally, if your product is better you should get paid more for it.

 Amazon displays the same price to all users of the site so they can’t segment their customers and charge different prices depending on their perceived ideas of your particular price sensitivity.  This pricing policy leaves margin dollars on the table since some customers are not primarily price shoppers and would pay more for an item because of the superior shopping experience offered by Amazon.  So, how could Amazon get those price insensitive customers to pay more?  Enter Amazon Prime.

 Amazon Prime accomplishes many things including building an online content ecosystem, standardizing shipping experiences and driving increased loyalty from it’s members.  However, I think more importantly Prime allows Amazon to extract incremental revenue and margin from customers who are not price concious but value service.  These customers want to know their order will actually be there in two days and if there is a problem, returns will be an easy no-questions asked experience.  Early adopters of Amazon Prime were mostly attracted by the free two-day shipping benefit rather than the video and music content.  Knowing your package would be delivered in two-days says more about how you value customer service than it does about shipping cost. 

 Amazon does not disclose the total number of Prime memberships but analysts estimate there are approximately 60 to 80 million members and that 40% of all Amazon customers have joined Prime.  In just a 7 day period this past Christmas season, Amazon announced it added 3 million new Prime members.  Consider this, at the low estimate of 60 million members, Prime would generate almost $6 billion in annual revenue for Amazon.   Amazon gets more revenue just from Prime membership fees than Macy’s, Home Depot, Best Buy and Target have in total e-commerce sales.

 Amazon Prime has been a tremendous success in allowing Amazon a way to reap the rewards of developing a superior customer experience.  I would not be surprised if you see a new higher priced higher benefits tier of Prime in the near future.