Is Amazon Prime Worth $99 a Year?

If you haven't checked your email inbox this week (or opened a newspaper or turned on a television), you're probably going to be in for a shock: Amazon.com (NASDAQ: AMZN  ) is raising the price of Amazon Prime.

So it would appear Jeff Bezos wasn't bluffing. As you may recall, the Amazon CEO warned investors last month that, in order to keep up with the rising costs of "fuel and transportation," plus the continuous building out of Amazon's digital libraries for Kindle e-book sharing and video viewing, the company was probably going to have to raise the cost of Prime.

For nine long years, Amazon has held the price of its two-day free delivery service at a steady $79 per year, even as time, and inflation, marched merrily along. The popularity of Prime has helped grow Amazon's sales strongly, but its cost has been a big contributor to the fact that, with a net profit margin of less than 0.4%, Amazon is about nine times less profitable than Wal-Mart -- and makes even less profit per dollar of goods sold than does Bezos' supposedly beleaguered rivals at Best Buy.

Raising the annual cost of Prime by $20 to $99 might not change that. Or it might. It all depends on how customers react.

$99? It's a bargain!
The way I look at it, you can think of Amazon Prime in one of two ways:

  • As an all-you-can-eat two-day free delivery subscription, with Kindle lending and video streaming fringe benefits, or
  • As an alternative to Netflix for video streaming, with book borrowing and free shipping on the side.

Either way, Prime passes muster. According to a widget set up by our friends at Slate.com, your average Amazon shopper saves money on deliveries with Prime (at the new price) so long as he or she makes at least 25 orders from Amazon a year. This is assuming that the orders you place would cost only the minimum charge of $3.99 per delivery, though. In truth, one single delivery of a bulky, heavy item, needed quickly, can cost enough to justify a Prime subscription all on its own.

Meanwhile, viewed as a video streaming service, Prime's new price of $99 a year is almost identical to the yearly cost of a $7.99-per-month subscription to Netflix. It only takes one order for free delivery of an actual, physical product from Amazon to make Prime a better bargain than Netflix.

That's the view from a customer's perspective. From an investor's point of view, though, Amazon's in a stickier wicket. 

$99? Never!
According to the company, "tens of millions" of customers now subscribe to Prime. Taking a conservative view of that boast, let's assume that there are 20 million paying Prime customers out there today, paying Amazon $1.58 billion for Prime service annually.

Were all 20 million to stick around and pay the $20 price hike on Prime, Amazon would receive a $400 million boost in revenue -- which would presumably drop straight to the bottom line, more than doubling the company's annual profit. This is almost certainly what investors, who have bid up Amazon shares by about 2% since the Prime price hike was announced, are hoping will happen.

But here's the thing: According to a recent survey of Amazon Prime customers that was commissioned by investment bank UBS, 42% of members will likely cancel their Prime memberships in response to the service's $20 price hike. Again, applying this percentage to a presumed 20 million Prime members, this means it's at least possible Amazon could see revenue decline as a result of the price hike, rather than rise.

Remove those 42% of Prime members from the revenue stream and, even with the price hike, Amazon could end up taking in as little as $1.15 billion in Prime revenue -- a 28% decline.

(In case you're curious, I've run similar calculations assuming that Amazon Prime actually has 30 million or even 40 million members; the conclusion is the same. In fact, the more Prime members Amazon has, the bigger the risk of lost revenue if those customers follow through on their threat and drop their Prime subscriptions).

Foolish takeaway
There are of course caveats to these calculations. For example, Amazon often boasts that Prime members spend more on its website than do non-Prime members. Accordingly, each Prime member lost could have an even bigger impact on Amazon's annual sales numbers than the calculations above suggest, focusing as they do solely on the effect on Prime revenue.

Conversely, if Prime members drop the service but keep on shopping -- and paying more for shipping -- Amazon's revenue loss could be much smaller than we fear.

All I can say for certain at this point is that the investors who have been bidding up Amazon shares steadily following the Prime price hike announcement may not be seeing the whole picture. Even if Prime is still a good deal for Amazon's customers, the risks for shareholders may be greater than they seem.

Ready to throw in the towel on your Amazon stock?
Before you do, get the lowdown on what else is happening with Amazon.com lately, and with America's retail industry in general. To learn about two retailers with especially good prospects, take a look at The Motley Fool's special free report: "The Death of Wal-Mart: The Real Cash Kings Changing the Face of Retail." In it, you'll see how these two cash kings are able to consistently outperform and how they're planning to ride the waves of retail's changing tide. You can access it by clicking here.


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