Long-Term Considerations for Amazon

Recent survey results show Amazon's pricing power may be limited. This, in conjunction with increasing competition, could spell trouble for the company in the long-term.

Feb 20, 2014 at 2:06PM

Amazon's (NASDAQ:AMZN) stock fell the other day after UBS and Consumer Intelligence Research Partners (CIRP) released the results of a survey asking participants to respond to potential Prime price increases. Results showed that, were Amazon to increase its Prime prices from $79 a year to $99 a year, only 58% of existing customers would renew their subscription. It also indicated that if Amazon were to raise prices to $119 a year, only 24% would renew . In other words, such price increases would yield 27% and 64% Prime revenue losses, respectively. These results, in conjunction with increased push-back from competition, could be problematic for Amazon in the long term.

Static pricing power
Many analysts liken Amazon Prime's membership fees to Costco's (NASDAQ:COST). They argue the online retailer will continue to grow rapidly, build up a large following of loyal Prime users, and then incrementally pass on price increases without seeing substantial decreases in membership.

The issue with this comparison is that Costco and Amazon have rather different value propositions. Costco offers unique and high-quality bulk products for very low prices. Because such products at such prices cannot be found elsewhere, members are willing to pay an increasing premium. Conversely, it now appears that Amazon is more like Wal-Mart (NYSE:WMT): a broad-based distribution channel with little proprietary product outside of the Kindle. While this model offers value in terms of price and convenience, survey results seem to indicate that the value is not worth an increasing membership fee.

Given the fact it can't pass price increases on to its most loyal customers, Amazon will likely be unable to raise prices on regular products. As such, the company will be forced to continue operating on narrow margins and decelerating revenue growth. UBS analyst Eric Sheridan commented "Based on both Amazon's recent Q4 13 results and the results of a proprietary Amazon Prime price survey, we are downgrading Amazon (to neutral)."

Another concern for Amazon's long term prospects centers around competition. In recent years, Wal-Mart has gone to great lengths to increase its online presence. The company is already the fourth largest online retailer and is constantly working to enhance its interface. Furthermore, it has increased its infrastructure substantially to match that of Amazon's, offering same-day in-store pickup and a potential locker system where customers could get the items they ordered online without having to wait in lines . Similarly, prominent retailers like Macy's and Best Buy have begun to combat Amazon by embracing Omni-channel commerce strategies.

As other retailers begin matching Amazon's convenience and selection, a price war may ultimately ensue. Because Amazon already operates on very low margins, such a war could prove troubling.

Despite these concerns, one recent announcement indicates that Amazon is innovating in a major way. Recently, a Wall Street Journal article stated that Amazon "plans to offer brick-and-mortar retailers a check out system that uses Kindle tablets as soon as this summer." In other words, the technology would operate similarly to Square's, allowing retailers to plug a device into a Kindle and take payments from anywhere in a store. What is especially exciting about this announcement is that Amazon plans to incorporate very powerful data analysis tools into the system. This could allow both Amazon and retailers using its payment processing technology to get an even better understanding of customer wants and habits. This information could then very easily be monetized in a variety of ways. Nonetheless, the company stated its "plans remain fluid and the project might be delayed."

The takeaway
Ultimately, Amazon faces some very real long-term concerns. If competition continues to grow and pricing power continues to remain static, the company could face revenue problems in the years to come. However, its latest innovation could prove a quite profitable additional revenue stream. My suggestion? Closely follow Amazon's plans for this potential project over the next few months. If it gets delayed, that may be a good time to sell.

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Scott Inderbitzen has no position in any stocks mentioned. The Motley Fool recommends Amazon.com and Costco Wholesale. The Motley Fool owns shares of Amazon.com and Costco Wholesale. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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