A lively debate has sprung up in the last few months here at Fool.com surrounding e-commerce giant Amazon.com (NASDAQ:AMZN). The company's CEO Jeff Bezos is notorious for taking the uber-long view — sacrificing profits over years and even decades in order to maintain dominance over the next 20, 30, or even 40 years.
On one side we've had writers point out that though Amazon isn't terribly profitable, its free cash flow has been impressive. But on the other side, some have taken Amazon to task for using accounting gimmicks to cover up the fact that it's a money pit.
I'm not here today to further this debate (admittedly, I come down firmly on the side of the former, as Amazon.com accounts for over 10% of my real-life holdings). Instead, I want to focus on Amazon Prime.
Over the past few years, it's become increasingly clear that this is the most crucial driver for the company going forward, as the program locks users in for the long-haul and gets them to spend more money on the company's services.
During Amazon's most recent conference call, CFO of the Global Consumer Business Brian Olsavsky stated that, "Worldwide paid Prime members increased 53% year-over-year." For a service that is in its tenth year of existence and working off of a base of tens of millions, that's a ridiculous figure.
It begs the question: has Amazon Prime reached a tipping point?
The fundamentals of Amazon Prime
For those who aren't familiar, Amazon Prime offers members free two-day shipping, along with access to Instant Video, a collection of over 800,000 e-books, and unlimited storage of photos — all for $99 per year.
The package delivery is unquestionably the biggest part of Prime, and many wonder how Amazon could ever turn a profit with such a deal. Over time, I believe that answer lies in the company's network of billion-dollar fulfillment centers. This network is unmatched, and when completed, the closer proximity between fulfillment center and customer's doorstep will undoubtedly slash costs — not to mention the effect that drones might have on raising the bottom line.
The importance of an Amazon Prime member on the company's bottom top line is undeniable. Beyond the $99 that each household pays yearly, the average Prime member spends $1,500 per year on the site, as compared to $625 for those who use Amazon but aren't Prime members — according to Consumer Intelligence Research Partners (CIRP).
Though Amazon does not reveal actual figures for Prime membership, CIRP has been taking surveys over the past couple of years, and their numbers tend to jive with the hints that Amazon drops. Here's what Prime's growth has looked like over a very tiny three-year window.
What's amazing here is not only that Amazon Prime membership in the United States has grown by about 100% per year over the last two years, but that overall U.S. customers to the website have gone from roughly 42 million to 89 million in just 15 months!
Signs of a tipping point
That type of growth is pretty mind-boggling, especially for a company that already occupied so much mind-space — and e-commerce market share — before 2012. To help figure out what exactly is going on here, I consulted one of my favorite reads: Malcolm Gladwell's The Tipping Point.
In it, Gladwell highlights how three key factors help turn an ordinary movement, idea, service, or product into one that is adopted by the masses. I want to focus on two of those factors: the stickiness factor and the power of context.
Stickiness, in the most general sense, is the ability for an idea to stick in the mind of the public, and therefore dictate its behavior. Gladwell contends that at the beginning, these sticky ideas often represent a divergence from conventional wisdom.
When Amazon came out with its Fire tablet, many thought it would be a failure. They thought Amazon likely wouldn't make any money on the product, and would have to contend with entrenched powers that already dominated the scene.
But it now appears that Amazon was content to give its tablet away for cheap because of one tiny add-on feature: those who bought the tablet were automatically enrolled in a one-month free trial of Amazon Prime.
It is no coincidence that Amazon Prime's enrollment numbers shot up markedly after the release of the Fire tablet. It created a stickiness factor to a service that Bezos has been pouring billions of dollars into — all to the delight of new members.
Which brings me to Gladwell's second tipping point factor: the power of context. In the most general sense, this means that even if a product is great, it won't reach a tipping point if the context in which it's introduced isn't conducive.
But with Amazon Prime, I believe that table is set. Consider that one way Prime snags members is by offering a 50% discount to college students. Those that joined Prime after the Fire was released, but were still in college, are now entering the workforce — and likely spending more on Amazon than they did in their college days.
Taking it a step further, there is an important generational shift occurring. Though many Baby Boomers have adopted e-commerce, it is the younger generations that are driving online shopping. According to a Business Intelligence report, the average Millenial spends $2,000 and 1200 hours per year online. That's about 25% more dollars and 35% more hours than older Boomers.
With the economy continuing its steady improvement, and spending by younger users likely to increase as their salaries bump up, the context looks perfect for America's next generation to look for Amazon Prime to fulfill many of its shopping needs.
Though the company will likely continue to be coy when it comes to Amazon Prime numbers, keeping an eye on comments from management — especially when it comes to worldwide membership, which I barely touched on here — as well as reports from the likes of CIRP will give investors a peek into just how popular this service is becoming.
Brian Stoffel is a happy Prime member, who wouldn't know what to do without the monthly delivery of diapers for his one-year old. He owns shares of Amazon.com. The Motley Fool recommends Amazon.com. The Motley Fool owns shares of Amazon.com. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.