The Future of Amazon May Soon Be Put to the Test

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Even though goodwill is not a big part of Amazon's (NASDAQ: AMZN  ) balance sheet, it explains a big part of Amazon's capitalization. Amazon's market capitalization is around $160 billion, while it carries goodwill of only $2.6 billion. 

For decades, Amazon has been forgoing profits to "get big fast" and build customer loyalty. Customer loyalty is theoretically worth a lot. Studies show a totally satisfied customer generates 17 times more revenue than a dissatisfied customer and 2.6 times a more revenue than a somewhat satisfied customer.  

Many Amazon bulls argue that because it has built up significant customer loyalty, Amazon can raise prices and realize higher margins in the future. This thought may soon be put to the test. 

Rising costs may lead to rising Prime prices
In a recent conference call, Amazon said it was considering raising the price of an Amazon Prime membership by $20 to $40 because of higher costs. The price hike is significant because the $79-a-year, free two-day shipping service has not had a price raise in almost nine years. If implemented, the price hike will be one of the first instances that test how loyal customers are to Amazon.

Some investors worry that Amazon could go through the Netflix (NASDAQ: NFLX  ) experience. Back in 2011, many investors thought Netflix had great customer loyalty. Netflix had a killer product that everyone loved. Then the company raised fees by 60%, and its growth slowed dramatically. The online video streamer lost more than 800,000 subscribers in a single quarter, and its stock tanked before eventually recovering.

Long-term thinking
Mr. Bezos is the ultimate long-term thinker. He has positioned Amazon to be long-term greedy rather optimizing profits for the short term, like many other companies. The long-term thinking has helped Amazon gain market share and become a seemingly unstoppable revenue-growing machine. Wall Street has played along, valuing Amazon stock based on its revenue growth rather than on profit metrics. 

With Amazon's new plan, it seems that Bezos is acknowledging that Amazon will no longer grow as fast as it did before. To satisfy investors, Bezos is beginning to better monetize Amazon, starting with raising the cost of Amazon Prime memberships. 

Whether Amazon succeeds in raising profits without ostracizing its customers will offer a crucial tell on Amazon's ability to monetize its entire base. 

Smooth operations
If Amazon succeeds, the future is still bright.  It is still the early innings. Retail accounted for around $4 trillion in revenue in 2013  with E-commerce accounting for only $260 billion. Unlike Wal-Mart (NYSE: WMT  ) , Amazon can sell/launch new products by simply adding new links on its website. Amazon can take its low-margin, hyper-efficient model and grab market share in new, tangential marketplaces. It has the right corporate DNA to innovate and create total game changers, such as the crown jewel, Amazon Web Services. 

Whereas Wal-Mart mainly targets the price-conscious market segment, Amazon targets everyone. Because it targets everyone, Amazon has more customers with significant disposable income. The average household income of an Amazon customer is around $89,000, versus the $71,000 for the U.S. as a whole. Because it has more customers who are not as price-sensitive, Amazon has a higher margin ceiling than Wal-Mart or other discount stores. 

The Foolish bottom line
Nothing is easy. Discount retail is a cutthroat business where profit margins are often in the low single digits. So far, though, Amazon has done very well growing a large user base. How well it does monetizing that user base will soon be put to the test. 

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Read/Post Comments (3) | Recommend This Article (0)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On February 12, 2014, at 11:26 AM, ZephyrGumby wrote:

    I already question the value of Amazon Prime and Amazon in general...increasing Prime's cost will drive me away. Amazon's streaming catalog gets dated fast and they hold too much good content outside of Prime so you have to pay additional for it.

    Their pricing has also been on the rise for goods. They have built in shipping costs in the price of merchandise so the only benefit to Prime is the limited streaming service.

    If they are going to increase the price, they had better add some value to the program.

  • Report this Comment On February 12, 2014, at 3:09 PM, gto5830 wrote:

    I agree. I will also leave and just order when I can get the $35. 00 total free shipping. Amazon has seen my amount of items increase since I have been a member and I have other ways of watching video on the internet other than through Amazon.

  • Report this Comment On February 13, 2014, at 12:09 AM, erich69 wrote:

    It's refreshing to see some great insights pointed out that challenge a lot of the group think psychology I see on TMF. When deciding on an investment I am more interested to the bear's case against it before moving forward. I like Amazon as a customer, but as an investor I like companies that make profit and grow it. Revenue growth is a joke...what good is selling a trillion dollars of merchandise if your expenses are a trillion! If Amazon's market cap was significantly less it would be worth investing in, but that ship has already sailed so kudos to the people who got in early...the future upside potential is more risky than the downside. Loyal customers? It's the retail industry...the only loyalty is to the company who offers the lowest long as Amazon continues to do so consumers will win and their profits will continue to stink.

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Jay Yao

Jay is an energy and materials writer. He reports on oil and gas fundamentals and macro trends in the industry.

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