Amazon tests delivery by drone, says founder Jeff Bezos

Amazon (AMZN) is changing things up on us this morning.  The omni-present online retailer announced that it would be raising its Prime membership fee from $79 to $99 per year, and to $49 from $39 for student Prime.  The market seems to be a fan of this move, with the stock up 2% since it opened.  I’m going to go against the grain today though – I am not a fan of the price increase and think it may actually have negative impacts longer-term.

This price hike marks the first increase in Prime membership costs since its inception in 2004 ($79 originally being chosen in part because it’s a prime number).  Prime membership currently gets you free 2-day shipping, plus unlimited streaming video.  Amazon blamed the price hike on increased fuel and shipping costs.  Plus, I’m sure they were working off expected high demands for Prime membership.  Prime currently has tens of millions of members, and it had to limit  new Prime membership sign-ups during peak periods in December (although many of those December members quit Prime after they were done with their Christmas shopping).  If all works according to plan, the price hike could add a few hundred million dollars to Amazon’s revenues.

The snag though is that this huge estimated increase in revenues assumes Amazon won’t lose a ton of Prime members from the price hike.  And I’m worried churn will be high.  First off, history shows us customers don’t always respond well to sudden price increases for membership.  Look no further than the Netflix price hike debacle of 2011.  Netflix announced subscribers would have to pay two separate fees for streaming and DVD shipments (amounting to about a 60% price increase) and customers just about revolted.  Netflix lost significantly more customers than it expected and the stock price tumbled from $300 the day before the announcement in July 2011 to $64 in November 2011.

Speaking of Netflix, the other issue with the Prime price increase is that it weakens Amazon’s position against its video streaming competitor.  Prime is now slightly more expensive than Netflix, which comes out to about $96 per year.  On top of that, Netflix already offers significantly better content than Amazon (Orange is the New Black, House of Cards).  Even with Amazon’s investments in its original content, I just don’t see it matching the rabid popularity of Netflix’s content anytime soon.  So now that Amazon no longer has cheaper or better video streaming than Netflix, I don’t see many customers justifying a Prime membership on the basis of its video streaming service.

Given Amazon’s decreasing ability to compete with Netflix on video streaming, the free 2-day shipping will have to be a major incentive for Prime.  I don’t see that being enough though.  As it is, most Amazon purchases arrive fairly quickly.  Prime membership may make packages arrive a day or two faster, but a day or two is hardly enough to justify a $99 membership.

The real issue with Amazon losing Prime members though is that Amazon doesn’t just lose out on the Prime membership fee, it also loses out on the extra purchases customers are incentivized to buy when they pay for membership.  Prime membership makes customers loyal because it makes them feel like they need to get 2-day shipping on enough purchases to justify the membership fee.  It means that if they have the choice between buying an item on Amazon or a different website, they’re likely to stick with Amazon to get the most bang out of their Prime buck.  A customer who de-activates Prime will be less loyal to Amazon and will likely make less purchases during the year.  Amazon could easily lose more revenue in purchases than the revenues it gains from higher membership fees.

Time will tell whether this was a good move on Amazon’s part or a mistake.  I’m betting it’s a misstep, and I’m looking forward to seeing how this shakes out in Amazon’s next earnings announcement.

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