Amazon.com, Inc. unveiled the Prime membership program more than a decade ago. Investors initially thought the retail giant’s plan was doomed to fail. How could a retailer offer a full year’s worth of free and prompt shipping for just $79 per year?
The skepticism seemed logical. It wouldn’t take many orders for a Prime member to save that much in shipping costs. Even after last year’s increase to $99, Amazon Prime continues to confuse the average investor. How can a firm offer so much of free shipping to so many of its customers, and still expect to earn a profit?
Amazon Prime members are a happy bunch
The answer lies in the massive popularity of the plan. Amazon.com, Inc. Prime is in all likelihood the best loyalty program on the planet. An RBC Capital survey of over 4,000 US Amazon customers revealed that close to 37 percent were Prime subscribers. Analysts peg the total number of U.S. Prime subscribers at around 50M. Add to that the roughly 20M from around the globe.
The survey further showed that 74 percent of Amazon Prime members spent more after they took out their subscription. And of those, close to 50 percent spent over $800 a year. And Prime is addictive too, the survey disclosed, with members increasing their spending with each passing year
So why is Prime so popular? Amazon.com, Inc. is forever giving stuff away for free or at very low costs to its Prime subscribers. Besides free and fast delivery, also included in the subscription, are videos, Kindle books, music, photo storage and early entry to sales events.
How does Amazon sustain shipping?
The flip side to this equation is that Amazon’s shipping costs keep on mounting year after year. Have you ever pondered on how the online retailer pays for all that free Prime shipping?
The key to the economics behind the Prime model is the “Fulfilled by Amazon” program. Amazon Prime is not just fueled by the $99 annual charge, but also the fees that merchants pay to participate in FBA.
Merchants are charged a whole host of fees. These include for things like order handling and packing. However, the most meaningful of all those charges is what merchants pay for monthly inventory storage. Amazon.com, Inc. calculates that based on cubic feet occupied.
As of 2014, Amazon had close to 103M square feet of total fulfillment and storage space that it either directly owned or leased globally.
Thus, in simple words, Amazon rents out its ware house space and charges merchants for managing their inventory and fulfilling orders. This is likely the most important source of revenue that sustains the Prime shipping program.
Shares of Amazon.com, Inc. ended Wednesday at $617.10.