The past few years have been challenging for Amazon (AMZN 2.61%). A decline in consumer spending caused by near-record-high inflation and exacerbated by tough pandemic-era comparisons caused e-commerce growth to slow to a crawl.
An uncertain economy caused businesses to slow cloud spending, taking a toll on Amazon Web Services (AWS), the company's cloud infrastructure business. And marketers scaled back on advertising spending, stunting growth in the third leg of Amazon's trifecta of businesses.
In recent months, however, the dark economic clouds have begun to lift, signaling brighter days ahead. Now, Amazon is taking a page from a few of its streaming rivals, which could add billions of high-margin revenue to its coffers, but some of its customers won't like the strategy -- not one bit.
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Prime real estate
Late last month, Amazon announced plans to roll out advertising to its Prime Video service beginning early next year. In a blog post on its website, the company said, "To continue investing in compelling content and keep increasing that investment over a long period of time, starting in early 2024, Prime Video shows and movies will include limited advertisements."
Amazon noted it was shooting for "meaningfully fewer ads" than broadcast TV and other streaming services. But it will offer an ad-free option for viewers who want to continue watching Prime without commercials, charging an extra $2.99 per month for the privilege.
As a consolation prize, the company noted it wouldn't be raising the price of Prime membership this year, which currently clocks in at $139 annually or $14.99 per month in the U.S. Amazon plans to introduce ads to Prime Video in the U.S. first, eventually rolling it out across its worldwide markets.
It's likely the move will incense some Prime members. Still, management has probably already done the math and knows the additional revenue will more than make up for the minority of subscribers who will cancel.
NASDAQ: AMZN
Key Data Points
It all "ads" up
Amazon keeps its Prime subscriber numbers close to the vest. The last official update came in April 2021, when then-CEO Jeff Bezos wrote in the company's annual shareholder letter that Amazon had surpassed 200 million Prime members.
By adding advertising to its streaming video service, Amazon has two ways to profit. First, the company will collect added revenue from the targeted advertising shown. Second, the company will collect $2.99 per month for viewers who don't want to see advertising.
Assuming the advertising is at least as valuable as the extra charge for the ad-free version of its service, we can estimate the value of this move. At roughly $36 per customer per year ($2.99 per month for 12 months), that works out to as much as $7.2 billion in high-margin revenue each year.
A more conservative estimate comes courtesy of UBS analyst Lloyd Walmsley, who suggests Amazon can generate $6 billion in incremental revenue. He says an operating margin of about 80% would result in $5 billion in incremental operating profit.
Walmsley says that even if Amazon adds just three minutes of advertising each hour, that would result in $3 billion in incremental revenue. Pushing that to six minutes per hour would double that. Given that Amazon already has all the content and systems in place, there shouldn't be much in the way of incremental expenses, which means most of that additional revenue -- however much it is -- will drop to the bottom line.
Over the past few years, advertising has become a growth business for Amazon. In 2022, the company generated $37.7 billion in ad revenue, up 21% -- enviable growth during the worst of the downturn. As a result, Amazon has become the world's third-largest digital advertiser, behind Alphabet and Meta Platforms.
Advertising still represented only 7% of Amazon's total revenue of $514 billion last year, so this move won't move the needle -- at least not very much.
Does Prime deliver?
In a completely unscientific poll posted on X (formerly Twitter), the majority of respondents cited free shipping as the most valuable benefit included in Amazon Prime. After an all-too-brief discussion, my family and I decided that we wouldn't pay the extra $36 per year on top of the $139 we already pay for Prime.
It isn't particularly surprising that Amazon eventually decided to institute an ad-supported tier, since rivals Netflix, Disney, and Hulu already have them. Plus, Amazon-owned Freevee (formerly IMDb TV) has long been its free, ad-supported video-on-demand service, so the systems to deliver ads are already in place.
As an Amazon investor, I'm delighted the company has found another way to boost its bottom line. As an Amazon Prime viewer, not so much.
