In the fall of 2014, Wal-Mart Stores, (NYSE:WMT) promised to beef up its investment in e-commerce, and this week the company took a major step toward that goal.
The world's largest retailer announced plans to launch a membership program to counter Amazon.com's (NASDAQ:AMZN) Prime service.
A Wal-Mart spokeswoman said the company planned to test a program that would give members free three-day delivery on a wide range of items for a $50 annual fee. By comparison Amazon offers free two-day shipping on a host of items for $99 a year, and also gives access to thousands of movies and TV shows on Prime Instant Video as well as privileges like cloud storage and free books from the Kindle Lending Library.
Wal-Mart said the service, which is code-named "Tahoe," will initially be available by invite only in order for the company to test the service. There is no word on when the membership program will be made available for the general public.
The Power of Prime
Amazon and its CEO Jeff Bezos consider Prime to be perhaps its most important innovation along its path to e-commerce dominance. Now ten years old, the fast-growing membership program claims tens of millions of loyal customers. Amazon has never given the public a hard number on Prime membership, but analysts have estimated as many as 40 million members worldwide, and its growth should continue as the company continues to stuff it with more benefits.
According to Amazon, Prime members spend twice as much as non-Prime customers on its website, and with its bundle of perks at a low annual price, Prime delivers what may be Amazon's biggest competitive advantage.
It's clear then why Wal-Mart would seek out its own competitor. With same-store sales having flatlined at its superstores, its core format that generates the majority of its revenue, the company needs to find new ways to grow. E-commerce, whose share of overall retail is growing steadily each year, is an obvious source.
Amazon doesn't have all the advantages
Last year, Wal-Mart notched a surprising win against its Internet-based rival, posting faster online sales growth at 30% compared to Amazon's 20%. Of course, Wal-Mart's $10 billion in e-commerce sales pale in comparison to $68 billion for Amazon, but the brick-and-mortar giant is clearly moving in the right direction.
Much attention in the business world has also been heaped on Amazon for lighting-fast sales growth and innovative products, services, and its business model, but Wal-Mart is still the much larger company with total revenue more than five times that of Amazon.
For instance, Amazon's efforts to expand its fulfillment centers nationwide have made headlines as it's added distribution capabilities in major metropolitan areas to enable same-day delivery. The company now has 65 distribution centers nationwide, which ain't too shabby, but Wal-Mart has more than double that sum, with 134. Warehouses intended to supply retail stores are set up differently than those for e-commerce, but Wal-Mart's distribution centers could be converted to serve online customers as demand through that channel grows.
Similarly, the retailer's stores can also serve as an asset in this regard with ship-from-store and in-store pick-up programs. Wal-Mart's Neighborhood Market stores have been expanding rapidly in recent years, and could be especially valuable in that sense. For instance, the company has eight such stores in Chicago, giving it a proximity to customers that Amazon can't match.
Shipping costs, schmipping costs
Despite Prime's undeniable success in building a customer base and boosting sales, critics have consistently pointed to a key flaw in the model: shipping costs.
Amazon's shipping costs have grown alongside sales, and net shipping costs, which account for revenue brought in by Prime membership and straightforward shipping fees, now total $4.2 billion in expenses as of last year, a large sacrifice to make for loyalty.
Amazon runs its business at breakeven, and CEO Jeff Bezos has made it clear many times that he's playing the long game. He's happy to sacrifice profits or take on expenses in order to build market share or develop competitive advantages.
For Wal-Mart, this means that a Prime-like membership program may not drive profits any higher, and could even be a weight on them, especially since the company is charging just $50 a year, half of Prime's annual fee.
Still, a free-shipping membership program is the right thing to do for Wal-Mart. It has already waited long enough to get into the ecommerce game, and it needs to find a way to compete with Amazon on price and service. A Prime-like offer is also likely to boost Wal-Mart's customer appeal, a break it needs considering its low marks on customer satisfaction surveys. At this point, giving up profits may simply be table stakes for competing on Amazon's turf, but if Wal-Mart builds an e-commerce customer base and leverages its brick-and-mortar footprint, those online sales should eventually trickle down to its bottom line.
Jeremy Bowman owns shares of Apple. The Motley Fool recommends Amazon.com and Apple. The Motley Fool owns shares of Amazon.com and Apple. 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.