Amazon Prime's price hike: Crunching the numbers
The time has finally come: The price of Amazon Prime, the company's two-day shipping / streaming video service will go up $20 from $79.99 to $99.99 a year.
Customers never like price hikes, but they should be pleased that it's only gone up $20. Analysts predicted it to go up by as much as $40, and even then Prime is a pretty amazing deal. At the new price, it's only around $0.30 more than Netflix per month, and in addition to having a comparable streaming library (no "House of Cards" but, significantly, it does have "Justified" which Netflix does not) customers get an amazing deal on shipping. The price hike also won't go into effect until 2015, giving members a whole year to decide. I know 47 percent say they wouldn't pay more for Prime, but with the modest hike and long grace period, I don't expect a mass exodus from the service.
Neither do analysts. Gene Munster, an analyst with Piper Jaffray, told the New York Times he does not expect customers to flee the service. Other analysts said at the time the price hike would add $500 million in annual revenue. (Amazon's total revenue last year was $17.09 billion). But is that enough? Amazon has famously small margins (I think the term "razor-thin" is mandatory for journalists to use when describing them). Last year, the company lost $41 million. So all other things being equal, an Amazon Prime price hike could have brought the company into the black last year.
But think about the efficiency of the Prime model on its own: Forrester Research estimates that Prime costs the company between $1 billion and $2 billion a year. Netflix CEO Reed Hastings, based on his own experience with scoring content deals, estimates that Amazon loses up to a $1 billion on streaming alone. In other words, the $20 price hike still may not make Prime profitable on its own.
Then again, if Amazon wants to become the place you go to buy literally everything, Prime is a crucial component to its success. According to Consumer Research Intelligence Partners, the average Prime customer spend $1,340 a year, compared to the $529 a regular Amazon customer spends.
So Amazon Prime gets people to spend vastly more cash on Amazon, but even with the price hike the service will probably still lose the company money overall. What's Amazon to do?
Harvard Business Review's Rafi Mohammed has an idea: "Unbundle" Amazon Prime. In other words, set different pricing tiers for customers who only want the free two-day shipping, those who only want Amazon Instant Video, and those who want both. That may work, but it could backfire, causing streaming video customers to bolt. Only 2 percent of video streamers in the US use Amazon Prime exclusively. That means many Prime customers will happily jettison this option in favor of Netflix or Hulu, which they probably already have anyway.
There are no easy answers for Amazon, with its massive content, shipping, and inventory costs. Raising prices is both inevitable and probably insufficient for solving the company's "razor-thin margins" problem. Not that it hasn't been here before: For Amazon, a company that's always grown ambitiously but earned modestly, it's business-as-usual.
[Image courtesy Shutterstock]