It's been nine years since Amazon.com (AMZN +3.51%) rolled out its Prime offering. And through all that time, the price has remained $79 per year for what's arguably one of the greater values today in the U.S. With free two-day shipping, video streaming, and access to the Kindle Owners' Lending Library as the main selling points of the service, Amazon has been able to build up a membership of about 20 million paying members. So last week when management said it was considering an annual price increase of $20 to $40, the news definitely turned some heads.
It's been done before
But would a price increase be that bad? It definitely could be. It wasn't all that long ago that Netflix (NFLX +3.32%) tried to implement a price hike, while at the same time separating its DVD segment from the video streaming service. To say management miscommunicated that move is an understatement. Netflix's stock price plummeted, and it took a while for the company to repair the damage.
There are similarities between Amazon and Netflix. Above all, both companies have passionate leaders who are dead-focused on their customers. On one earnings call last year, CEO Reed Hastings said Netflix is "fundamentally in the membership-happiness business." And Amazon's business is driven by its mission of wanting "to be Earth's most customer-centric company." As Bezos himself has said, "If you're competitor-focused, you have to wait until there is a competitor doing something. Being customer-focused allows you to be more pioneering." To be sure, CEOs driven to please their customers are not necessarily a dime a dozen and have a unique perspective.
The power of free
One of the biggest drivers to get consumers to shop online is the offer of free shipping. Free two-day shipping, video streaming and access to the Kindle Owner's Lending Library make up the current value proposition of Prime. And while I know this is a long shot, Amazon CEO Jeff Bezos' recent acquisition of The Washington Post could actually serve as a potential value addition down the road. Bezos acquired the Post more or less as a favor to Post CEO and Chairman Don Graham, which explains why he bought it himself and not on behalf of Amazon. But there's nothing that says somewhere down the road he can't consider mixing it into the Prime offering.
According to Macquarie Equities Research, Amazon has confirmed it has at least 20 million Prime members today. While some Prime members are students who pay half the cost of the regular subscription, let's assume today that a price increase only affects regular Prime members. With 20 million members at $79 per subscriber, Amazon would be bringing in about $1.58 billion in membership fees on an annual basis today. Again, think rough estimates here.
If Amazon bumps the cost of Prime to $99 and experiences zero attrition, subscription revenue would clock in at $1.98 billion annually. But this isn't a reasonable assumption; members will drop off. The question is: How many? It's difficult to say, but let's assume 10% quit. This would leave the company with 18 million members at $99 per subscriber, which equals about $1.782 billion.
It's about options
The biggest challenge Amazon is likely to face in raising the cost of Prime is the acquisition of new members. While Bezos' biggest priority is the customer, I have to believe he is at least thinking that "choice" is a key word in regard to this plan. A price increase on its own doesn't necessarily offer the consumer more choices. And that could be a big problem. So what adds more choices? Well, there is certainly at least one option: more price points.
What would happen if Amazon raised the price of Prime to $99 per year, and then offered another price point at $59? A less-expensive price point could give Prime members most of what they already get with at least one major difference, say instead of free two-day shipping you just get free shipping without the time component. After all, two-day shipping is more expensive to provide than shipping sans a time limit.
Prime the pump
Again, if Amazon keeps 18 million members at $99 per subscriber, that equals about $1.782 billion, which is 10% less than the price increase with no attrition but 13% more than no price increase at all. Members would still get the same services, and who knows? Maybe he tacks on a free subscription to The Washington Post via the Kindle. It may not sound like much, but it is a nationally known newspaper, and it's one more thing to offer subscribers. Or maybe it's something else altogether.
But should this lower price point offer everything a $99 subscriber gets minus the two-day shipping? Maybe not. Maybe it needs to be more distinct. Perhaps this $59 membership doesn't offer the lending library and free subscription to the Post. I don't profess to know all of the answers, but it frames up the notion that one gets more with the new higher price point. Then it becomes, "Upgrade to the $99 'Prime Plus' and get guaranteed two-day shipping, access to the lending library, and a free annual subscription to The Washington Post, along with everything else."
A new, lower price point could also serve as a powerful acquisition tool. Think about it from the video perspective alone: Twelve months at $59 implies $4.92 per month for what is becoming a pretty robust library of streaming content. No, it's not Netflix, but it doesn't have to be. It's simply one more option to complement the other options consumers already have. And if it brings in another 5 million members in the short run, well, that's another $295 million added to the $1.782 billion it gets with the new price point and 10% attrition, which gives Amazon a total of $2.077 billion in membership revenue to go with 23 million total Prime members. And I think the subscriber base continues to grow from there.
The big goal
More members is the big goal here -- more members means more people buying more stuff -- and we already know that Prime members spend more at Amazon. Of course, there would be new acquisitions at either the $59 or $99 level, and there would also be those customers who choose to either upgrade or downgrade from their current level, so differentiating successfully between the two price-point offerings would be crucial. With all of the other "what ifs" Amazon has in the hopper (phone, set-top box, Prime Air, AmazonFresh, etc.) there are plenty of ways to potentially differentiate between memberships at different price points. But the bottom-line number of $2.077 billion in membership fees with the additional, lower price point is:
- 31.5% greater than the $1.58 billion in membership fees today with no price increase;
- 5% greater than the price increase to $99 with no attrition at all; and
- 16.5% greater than the price increase to $99 with 10% attrition.
At the end of the day, this is all speculation, of course. The basic point of this exercise is to examine a potential price increase, how management could approach it, and what it could mean for consumers and investors. The difference between $59 and $99 is significant enough to make one ask if two-day shipping is really enough to warrant a $40 difference in cost. For me as a customer it would, but I also fully understand that it wouldn't for others. The video service could be a powerful tool as part of a $59 offering and could bring in a slew of new members if framed correctly: "For less than $5 per month you get Prime streaming along with free shipping on millions of items every day."
The Foolish takeaway
Price increases are never easy. But they are also pretty much unavoidable when you get right down to it. As long as Jeff Bezos gives this some deliberate thought and keeps the customer's interests as priority No. 1 (as he always does), I think Amazon should be able to pull this off rather nicely. Of course, that's just my opinion as a happy Prime member and even happier Amazon shareholder.
