The Logic Behind Amazon’s Prime Day – Rafi Mohammed

www.smsvaranasi.com

Amazon has boldly anointed Wednesday, July 15 as Prime Day. Most holidays revolve around religion, historical events, or appreciation for someone special. So what’s Amazon Prime Day?

At root, it’s a self-interested homage to rock bottom prices and free expedited shipping. To celebrate its 20th anniversary, Amazon has pledged more deals than Black Friday, exclusively for Amazon Prime members – as well as complimentary 30-day trials of its Prime membership. Prime, which normally costs $99 annually, includes benefits such as free two-day shipping, same-day delivery in some areas, streaming video, streaming music, Kindle library, photo storage, and early access to sales.

So why do we care? We’re interested because Amazon doesn’t seem particularly concerned about earning profits. In FY14, for example, Amazon had an impressive $89 billion in revenues. However, operating income was $178 million (thus, a measly 0.2% operating margin) which resulted in a $241 million net loss. Partly because of Amazon’s longstanding lack of concern over profitability, consumers have faith that Amazon is going to roll out awesome deals on Wednesday.

Prime is the lynchpin of Amazon’s plan to rub out brick and mortar retailers. With “free” expedited shipping, the goal of Prime is unabashedly clear: make Amazon the first-choice retail product provider for consumers. One click assures home delivery in two days or less. The purchase loyalty engendered by this program is reflected in the big difference between Prime vs. non-Prime customer spending. In the fourth quarter of 2014, Consumer Intelligence Research Partners (CIRP) estimates Prime had 40 million members – with members spending on average $1,500 annually compared to an average of $625 spent by non-members. (Note: this 40 million member figure includes a significant number of consumers who took advantage of free holiday trials.)

The brilliance of Prime is in how the bundle of benefits is constructed. At its inception, Prime’s key benefit was unlimited two-day shipping. This promotional program was targeted at “Whale Buyers,” those who purchase a lot. For Whales, the calculation is straightforward: “Am I going to make enough purchases – and thus save on shipping costs – to justify the cost of Prime?” If the answer is “yes,” this cost savings justification makes Amazon top of mind for all purchases, including small items such as tweezers normally bought at CVS. And if Amazon loses money on shipping (i.e., cumulative shipping costs are greater than the $99 Prime price) for a particular member, the loss can be rationalized as a volume discount to a big-spending customer.

So why add such seemingly unrelated perks such as streaming video and music and photo storage to the Prime program? And what does the company hope to achieve with Amazon Prime Day? Quite simply, Prime has saturated the Whale Buyer market and is now hunting for smaller volume customers to fuel growth. With an increasingly large stable of benefits, potential members who can’t justify Prime on the grounds of shipping savings can now conclude, for instance, “Netflix costs $108 annually, so I’m already ahead of the game by purchasing Prime for streaming video before even considering the additional benefits.”

Indeed, the data confirms that Prime is moving beyond Whale Buyers and has begun to attract large numbers of lower volume customers. CIRP estimates that in the first quarter of 2015, Prime had 41 million members with members spending on average $1,100 annually vs. non-members’ spend of $700. Thus, more people are signing up for Prime, but the average member spend dropped by 27% compared to the previous quarter.

The downside of Prime – to Amazon’s stockholders, that is – lies in its pledge of unlimited shipping. The challenge of “unlimited” is that it attracts over-users. Consider Red Lobster’s 2003 Endless Crab promotion. Offering all-you-can-eat crab leg dinners for $20 – $25 (depending on market), determined diners ate and ate—and unfortunately for the seafood restaurant chain’s bottom line, they ate some more. After announcing disappointing financial results – drained by endless crab servings – the market value of Red Lobster’s then parent company, Darden Restaurants, dropped by $405 million in one day – one of the biggest stock routs in the company’s history.

Amazon could think creatively about minimizing the risks of its “unlimited” shipping offer. For instance, the current $99 program could allot, say, 15 free shipments a year, with any overages charged at a trivial $1 per shipment. If Amazon put a ceiling on the number of free shipments on its $99 Prime membership, it could then offer a $149 unlimited shipping option. These two options would allow Amazon to serve different volume customers – and the beauty is customers self-select which option works best for them based on their shipping needs. Forrester Research estimates Amazon loses $1 billion to $2 billion annually on Prime shipping costs. Given that this loss is up to 11 times as much as Amazon’s $178 million operating profit, small changes to Prime’s pricing can significantly improve Amazon’s financial well-being.

Remember the vicious discounting wars that occurred during the Internet bubble era? Amazon emerged a clear victor in that virtual retail grab. It’s time for brick and mortar retailers to be on the lookout. With an enhanced Prime program, focus on same day delivery, and now its own holiday, Amazon is clearly setting its sights on fully invading land-based retail territories.

Source : Harvard Business Review

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