Amazon's (AMZN 2.94%) core strategy has long been to go after market share and deliver profits later, once it's accumulated a critical mass of customers.
In e-commerce, for example, the company made itself the leading online retailer in the U.S. with a focus on competitive prices, wide selection, and fast delivery. The e-commerce segment was further enhanced by its Prime membership program.
While that focus on being competitive has been a winning strategy with customers, allowing it to capture roughly 40% of the e-commerce market in the U.S., it's often failed to turn a profit. As recently as last year, Amazon lost $2.8 billion in its North America segment, which is mostly made up of e-commerce, a business it's been running for nearly 30 years.
Its Prime Video initiative has been similar. The company historically used its video-streaming service as something of a loss leader, helping to add new Prime members and increase retention to its loyalty program. As Founder Jeff Bezos once said, describing the company's unique strategy, "When we win a Golden Globe, it helps us sell more shoes." In other words, Prime Video has long been an ancillary business in service of driving the larger e-commerce operation.
However, it's gotten expensive for Amazon to stock its online video store with the content it offers. The company said its total video and music expense for last year was $16.6 billion, and the vast majority of that is video.
Amazon has made little effort to monetize that video spend, instead including it as part of the Prime bundle, though most Prime members sign up primarily for the free shipping benefits. In 2022, the company brought in $33 billion in subscription revenue, primarily from Prime, though it spent about $80 billion in shipping costs.
Taking those numbers into account, it's clear that Amazon sees the Prime membership offer itself as a loss leader, making up for the net loss from shipping and video with profits from its e-commerce marketplace and direct sales.
Image source: Getty Images.
Here come the ads
New CEO Andy Jassy has been taking a scalpel to Amazon's business model, cutting costs in a wide range of businesses and leveraging the company's scale in others where available.
Now, it seems Jassy sees an opportunity in Prime Video.
The company announced last week that it will begin showing ads on Prime Video, saying in a blog post that it would include "limited advertisements" starting in early 2024.
Amazon promised it would have "meaningfully fewer" ads than linear TV or other streaming platforms. The company will launch ads in Prime Video in the U.S. and eight other countries next year, and will also offer an ad-free option for $2.99 per month in the U.S. and for an undetermined price in other countries.
The move seems well-timed as streaming rivals like Netflix and Walt Disney have also recently launched ad tiers and are pushing their own members to sign up for them, seeing a significant growth opportunity in ads.
What about that $8 billion?
One of Amazon's biggest bulls on Wall Street, Wedbush, said a global ad rollout for Prime Video could deliver in the range of $6.6 billion to $8 billion in incremental annual revenue for Amazon, and the firm expects it to materially improve operating margins as well.
That range might be a stretch for Amazon. The company has more than 200 million Prime members, and the $2.99 per month charge to skip ads shows it's valuing the ads at about $3 per month per member. If you assume every Prime member watched the equivalent of $3 per month in ads or paid for the ad-free version, Amazon would bring in $7.2 billion a year in Prime Video ads. If you assume it has 220 million members, you would get nearly $8 billion in revenue.
That's a best-case scenario (and it's unlikely to reach that level), but it shows that Amazon has a significant opportunity to add what's essentially straight profit to the bottom line by finally monetizing its video content. It's already a robust advertising business on its e-commerce site, so extending that to Prime Video should be a natural fit. The best part about Prime Video ads is that the revenue is very high margin. It doesn't require new content, and it's not cannibalizing any existing paying subscribers, since most Prime members view the video content as a free add-on with the expedited shipping benefit.
Look for Amazon to take advantage of more such opportunities where it sees an opening. Similarly, the company expanded its Prime shipping benefits to websites outside of Amazon with Buy with Prime, forming a surprising partnership with Shopify recently, and it has more opportunities to leverage Prime along with advertising, shipping capabilities, and other strengths.
As it does so, shifting its focus from market share to profitability, Amazon's profit margin could expand significantly. If it executes this strategy well, the stock could still have significant upside from here as investors are likely to reward it for these kinds of profit-unleashing moves.
