Is Amazon Making a Mistake?

Just ahead of the holiday season, Amazon.com (NASDAQ: AMZN  ) announced that it was raising the minimum order size for Free Super Saver Shipping from $25 to $35. The announcement comes at a time when most retailers are bending over backwards to bring in more customers for the typically strong shopping season. Is Amazon making a mistake by upping its minimum order threshold?


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Fundamental to Amazon's success
In every 10-K and 10-Q, Amazon includes a statement on its shipping practices: "We believe that offering low prices to our customers is fundamental to our future success, and one way we offer lower prices is through shipping offers."

At first glance, it may seem Amazon is moving away from this fundamental tenet. The price increase may cause customers to gripe, but with shipping costs rising significantly over the last decade, the same 10-K statement indicates Amazon has seen an increase in the number of people taking advantage of its shipping offers (Super Saver and Prime).

The fundamental tenet is offering customers low prices, not free shipping. If Amazon continues to foot the shipping bill, it may have no other choice but to raise its prices across the board. That would certainly cause more customer complaints than a $10 increase on the threshold for free shipping.

After all, the average order value on Amazon is estimated to be between $45 and $50, which means the average order still qualifies for free shipping. That said, with the minimum order size increase, we might see the average order size increase as shoppers try to meet the minimum on their orders. At the same time, the total number of orders could take a hit as shoppers buying low-priced items may find a better deal on eBay (NASDAQ: EBAY  ) or another store.

Prime opportunity
It seems like the minimum threshold is a move to increase Amazon's number of Prime subscribers. For $79 a year, Prime subscribers get free two-day shipping on most orders without a minimum order size requirement. Therefore, I expect the move by Amazon will increase the company's conversion on Prime as it targets customers who make smaller (no longer qualified for free shipping) purchases throughout the year.

Amazon Prime is extremely valuable to the company. In 2012, Prime members spent more than twice as much as non-Prime members according to a report from Morningstar. As a result, the company makes, on average, more profit on these customers by providing them with free shipping, video streaming, and book borrowing, then it does on its non-Prime customers. Converting more people to Prime subscribers will only increase the service's profitability as it has a good amount of operating leverage.

Potential to take on Netflix
Adding subscribers also helps Amazon's Prime Instant Video better compete with Netflix (NASDAQ: NFLX  ) . Much like Netflix is fueling its content spend through its subscriber growth, Amazon could start to do the same if Prime starts to gain subscribers at a rate anywhere near Netflix's subscriber growth.

With 41,000 titles in its content library and growing fast, Amazon is poised to overtake Netflix's 60,000 titles in the near future. The biggest advantage Netflix has over Amazon Prime is its interface, but that's not the hardest competitive advantage to overcome. All it takes is a design team and a recommendation engine. Amazon already knows how to do both of those pretty well.

eBay fights back
eBay has encouraged its sellers to offer free shipping to winning bidders for some time now. There's no minimum threshold to meet, but it's up to the seller's discretion. Of course, this rarely impacts the total price buyers pay for similar items, but it does give eBay a good marketing tool.

More recently, however, the company has been making moves to compete with Amazon's Prime service by offering same-day delivery in conjunction with big-name retailers. It bought the U.K. start-up Shutl, and plans to extend the business to 25 cities in the U.S. in 2014.

I think this a great move for eBay as it moves away from independent sellers to facilitating big-name stores. I don't think it will have any material impact on Amazon, however, as it's still the primary destination for online shopping.

Pricing power
Amazon's decision to increase its minimum for free shipping is an indication that the company believes it has the pricing power to do so. I'm inclined to agree. Amazon has no equal. People are going to shop there no matter what. I think the benefits of this minimum order increase will outweigh any negative effects of the move.

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