After a few quarters of producing big earnings results, Amazon (NASDAQ:AMZN) has returned to another phase of investing back into the company. Earnings fell 26% in the third quarter, coming in below expectations, and analysts expect an even bigger drop in earnings for the fourth quarter.
The decline in earnings come from Amazon's investments in one-day delivery as well as its pursuit of the grocery market. CFO Brian Olsavsky warned investors that the one-day delivery plans will create a $1.5 billion "penalty" in the fourth quarter.
But Amazon's move to invest in its customers is necessary for its continued growth. Both one-day delivery and Amazon's groceries business invite customers to make more repeat purchases, which is increasingly necessary as Prime membership growth stagnates.
Slowing Prime membership growth
Amazon has seen growth in its Prime membership program, which turns 15 years old this year, slow considerably over the last couple years. About 112 million Americans had access to an Amazon Prime membership at the end of last year, according to estimates from the Consumer Intelligence Research Partners. That's an 11% increase from 2018, the same rate it grew last year, but it's a marked slowdown from the 35% growth rate it was experiencing in mid-2017.
Amazon has also seen a slowdown in subscription services revenue over the last couple years, falling from 52% growth in the third quarter of 2018 to 35% growth in the third quarter of 2019. That said, there are several factors that go into Amazon's subscription services revenue and it enacted an accounting change in 2018 that skews the results.
Not only is Prime membership saturating, there's been a considerable shift in how customers are paying for their memberships. Over half of Prime members pay month-to-month instead of opting for Amazon's annual subscription. That gives them the option to cancel or pause the service, which makes them potentially less valuable to Amazon than annual subscribers.
Increasing engagement to grow revenue
The best way for Amazon to combat stagnating growth and the shift to month-to-month payment plans is to increase subscriber engagement. More engaged subscribers spend more and are more likely to stay subscribed month after month.
Amazon's two areas of focus to increase engagement are one-day shipping and grocery delivery.
After pushing Prime's shipping benefits to one-day delivery, Amazon saw a notable acceleration in retail sales. During the company's third-quarter earnings call, Olsavsky noted the acceleration in unit growth the company saw was actually higher for Amazon-fulfilled units than sales fulfilled by a third-party merchant. That suggests the acceleration is being driven by Amazon's push into one-day shipping.
One area of particular note is Amazon's ability to deliver more convenience items to customers in one day without the need to add those smaller items to bigger orders to qualify for the shipping benefits. The ability to buy those items on Amazon has led Prime members to opt for the online retailer over its brick-and-mortar competitors where they wouldn't have before.
Meanwhile, Amazon continues to make a bigger push into the grocery industry. After acquiring Whole Foods in 2017, the company went to work integrating the upscale grocer with its Prime Now delivery service. Prime members started receiving greater incentives to shop at Whole Foods in 2018, and regular Whole Foods shoppers were likewise incentivized to join Prime. Amazon only recently started promoting Whole Foods grocery delivery on its main website; it was previously relegated to the less-popular Prime Now app.
Most recently, Amazon removed the subscription fee for AmazonFresh, a program that delivers groceries from special fulfillment centers. The move could lead to a growth in the number of Prime members taking advantage of Amazon's grocery delivery options, and thus increase how frequently they use their Prime membership benefits.
Additionally, Amazon is launching a new grocery chain, starting in southern California. The move could expand the appeal of its grocery business beyond the high-end shoppers Whole Foods attracts. And it's likely going to build the stores with Prime membership and online ordering in mind.
In order to keep growing Prime membership and revenue, Amazon needs to get its members shopping on its various platforms and stores more often. The push to offer faster shipping and more options in its grocery business are promising, and Amazon is smartly making big investments. While it'll negatively impact the company's bottom line in the near term, it's maximizing the long-term potential for the retail business.