Amazon Prime’s Fee Hike Will Stimulate Growth

Many Amazon shareholders fear that the company's decision to hike the price of its Amazon Prime service will lead to many members leaving. However, the extra fee will provide a nice boost to Amazon's bottom line.

Mar 17, 2014 at 1:15PM

Amazon (NASDAQ:AMZN) has already hiked its Amazon Prime fees in the U.K. and Germany, and it might do likewise on its home turf in the US. The price in the U.K. rose from £49 to £79 for a 61% increase, while in Germany the price rose from €29 to €49 for a 69% increase. The giant online retailer might also increase its fee in U.S. from the current $79 to between $99-$119, which would be a 25%-51% hike.

Investors were quick to see red after Amazon made the announcement, which led to a huge sell-off of the shares.

Learning from Costco
If the experience of Costco (NASDAQ:COST) with its membership fee hike is anything to go by, then Amazon investors might have overreacted. Although the leading warehouse retailer has repeatedly hiked its membership fee -- by 13% in 2000, 12% in 2006, and 10% in 2011 -- there is no evidence yet that these price hikes have interfered with its membership program in any way. Its membership count has been increasing 9% per annum, while it has seen same-store revenue growth of 8%.

Mind you, Costco relies heavily on its membership fee to boost its bottom line. It makes close to $3 billion from membership fees every year. Executive members pay $110 in membership fees while regular members pay $55. In return for the higher fees, executive members receive a 2% rebate on their purchases. Executive membership count has been increasing at a faster pace than the growth of regular members. In 2009, executive members made up 33% of Costco's total membership, but that figure had risen to 38% in 2013. In the first quarter of fiscal 2014, 250,000 new executive members joined Costco, which represents 1.4% growth compared to the 1% growth of regular members. Executive members buy considerably more products than regular members do, and they contribute roughly half of Costco's revenue.

Amazon Prime members, on the other hand, get two-day shipping on most of the items they purchase, which amounts to a large discount. They also get access to free streaming media. Even with the considerable fee hike, the benefits of Amazon Prime still outweigh its cost and it's quite unlikely that many members will jump ship when it's finally implemented.

Slowing growth at Amazon
Amazon is still growing much faster than any other large retailer. However, its revenue growth rate has started to slow down. In the third quarter of fiscal 2013, the rate stood at 25%. In the fourth quarter, the rate ticked down 500 basis points to just 20%. 

The company's international markets are mainly to blame for this trend. While its North American market grew revenue 26%, its international markets grew revenue just 13%, which was primarily due to lackluster growth in media revenues. As Amazon expands in emerging economies its revenue growth in those markets is likely to be lower since digital sales and e-commerce are still in their early stages there, unlike the situation in America where these platforms are well-established.

Amazon's Achilles' heel for a long time has been its low EBITDA margin. A low margin makes the company more vulnerable to supply chain disruptions, price fluctuations, and competition. However, the company has seen its margins expand as it continues to aggressively push its high-margin web and cloud businesses.

The Amazon Prime price hike is good but not absolutely necessary
According to Amazon, its decision to increase the price of its Prime service has mainly been precipitated by increasing fuel and shipping costs. However, shipping costs as a percentage of the company's revenue over the last six years, after Amazon introduced the service, peaked in 2011 but fell in 2012 and stabilized in 2013. The decision was smart on Amazon's part, but it was not absolutely necessary.

Prime customers are a lucrative segment for Amazon, and they purchase about 2.5 times as much as regular members. The service has become increasingly popular over the years since customers can purchase in bulk and make substantial savings. Customers should be willing to pay an extra $10 to continue enjoying the service.

Amazon recently added 7,000 titles to its streaming library, thereby taking the total selection to roughly 40,000. Admittedly, that might not be on an equal footing with the library of Netflix, but it still makes for a pretty decent and compelling service. The price hike will be directly additive to Amazon's revenue and it will also provide another much-needed boost to its bottom line.

Foolish takeaway
Contrary to what many investors fear, Amazon Prime customers are unlikely to jump ship due to the price hike. For many, the benefits of the membership still outweigh its costs. The segment contributes 10% of the company's overall revenue, and it is likely to see more growth as Amazon adds more attractive perks to the service.

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Joseph Gacinga has no position in any stocks mentioned. The Motley Fool recommends, Costco Wholesale, and Netflix. The Motley Fool owns shares of, Costco Wholesale, and Netflix. 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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