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Amazon Prime Continues to Grow Despite Price Bump

By Daniel B. Kline - Jul 26, 2014 at 8:13AM

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Despite a price increase, the company said more people signed up in the second quarter of this year than in the previous one.

Amazon ( AMZN -1.38% ) has always been tight-lipped when it comes to releasing the number of customers who subscribe to its Prime service. On its quarterly earnings conference call Thursday, the company maintained that policy, but CFO Tom Szkutak did offer some insight in response to a question.

The online retailer added more Prime subscribers in the second quarter of 2014 than it did in the same quarter of last year, he said. That's impressive because the price of the service increased from $79 to $99 on April 17, 2014.

"We're very pleased, and we continue to get new subscribers," Szkutak said.

Prime offers customers free two-day delivery on millions of items sold by Amazon. It also includes access to the company's streaming video service, Prime Instant Video, and a recently launched Prime Music.

Though free delivery is the key attraction of Prime, the company added the video and music services as a way to sweeten the deal and keep customers on board. Prime Instant Video is a Netflix alternative that produces original programs while offering a slate of previously aired television shows and movies. The service offers much less than Netflix, but as a free add-on for customers who likely purchased Prime for the free shipping, it's a nice addition.

The music offering is similar in that it's free and has a nice selection, but it's by no means as complete as Spotify or the other all-you-can-listen music services. Prime Music has more than a million songs that can be listened to on demand for no extra charge.

Neither Prime Music nor Prime Instant Video would be worth the $8.99 that Netflix charges for a basic monthly subscription or the $9.99 a month Spotify gets, but both are good enough to add real value to Prime. The two services have likely kept some Prime customers on board and helped justify spending the $99.

Why does Prime matter?
Having free shipping makes customers more likely to make a purchase on Amazon. It removes a psychological barrier to buying and stops someone from browsing on Amazon then making the buy at a local brick-and-mortar retailer -- a reverse of the more common "show-rooming." Keeping customers paying for Prime is key to Amazon driving revenue.

Prime subscribers spend almost $538 a year compared to the $320 spent by non-subscribers, according to a study conducted by RBC. The survey, conducted in June 2014, was based on the answers of more than 2,000 shoppers -- 708 Prime members and 1,357 non-Prime customers. 

Once customers have Prime, they use it -- in part to justify the cost of buying it in the first place. And for frequent Amazon buyers, it can be worth it even if you don't use the music or video services.

Slate created a widget that helps people figure out whether Prime makes sense for them purely on the basis of free shipping. The widget uses the assumption that each Prime-eligible shipment costs non-Prime subscribers a minimum of $3.99 (actual costs can vary). To bring your average cost per shipment below $3.99, a customer would have to place 25 eligible orders in a year. That would bring the Prime cost to $3.96 per shipment, according to the widget.

If a customer buys less than that or is right around the 25 purchase numbers, the music and video offerings add enough value to make Prime a good deal. That may become increasingly important as some loyal Amazon customers shift purchases into digital buys that are electronically delivered. That might make Prime a tougher sell, so Amazon must keep improving the non-shipping benefits or risk losing customers. 

How many Prime subscribers are there?
Amazon won't say, but research from Consumer Intelligence Research Partners estimates the number at 27 million. The research company also found that the vast majority of Prime members -- more than 90% -- planned to renew their membership. 

If that 27 million is correct -- along with the RBC estimate of Prime users spending an added $218 a year compared to non-subscribers -- then Prime users bring Amazon an extra $5.8 billion in sales annually. That's a huge number even by Amazon's lofty standards.

This is good news for Amazon
While Amazon has shown tremendous growth, the company has struggled to turn a profit. Net sales increased 22%, to $15.7 billion, in the second quarter, compared with $12.8 billion in second quarter 2012. But the company lost $7 million for the quarter.

Amazon has always poured money back into the business, constantly building new services and technologies that should pay off in the long run. Maintaining its Prime base is key, as those loyal customers are the ones likely to increase their spending even further as Amazon figures out faster delivery or even gets its drones off the ground. 

Prime's growth came despite the price increase and a market where physical delivery is less relevant for some customers, and that should be seen as a very strong positive. For Amazon to continue growing its sales -- and eventually its profits -- it needs to keep the Prime user base growing and happy.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis – even one of our own – helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.

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