Tuesday, February 03, 2015

Could Amazon Become the Costco of the Web?

As many readers know, Amazon has seen its stock price suffer in the past year, as some investors finally are asking the question: Will this company ever make significant profits?   I often ask my customers:  Would it be awesome if Amazon could become the Costco of the web?  Initially, many students are puzzled by the question.  Those who haven't taken a look at Amazon's annual reports initially assume that Amazon is just as successful financially as Costco, if not more so. After all, Amazon is a dominant e-commerce player. Costco is a traditional brick-and-mortar retailer.  When they look more closely, they see that Costco is a very successful, highly profitable retailer.  Amazon would be very successful if it could ever achieve that type of profitability.   

I then ask students:  How is Amazon's business model like Costco's?  An astute student or two notices a key parallel.  Amazon Prime is much like a Costco membership.  I ask:  How much of Costco's profits is accounted for by its membership revenue? Answer: All of it!  The membership revenue is more than the total net income of the firm.  Then, I ask:  How is Amazon Prime different than Costco's membership revenue?  Answer:  Use of Costco does not come with much incremental expense for the firm, beyond the cost of goods sold for the products that are purchased each time a customer visits the store.  However, for Amazon, all that free shipping means significant incremental expense each time a customer orders goods on the site. Hmmm... so Amazon Prime may not ever be the same type of profit driver that Costco's membership fee is.  

With all that in mind, I was intrigued by this recent article on Fortune.com titled "Inside Amazon Prime."  Here's a key excerpt:

Because Amazon does not typically disclose data about Prime, it’s unclear how frequently shoppers use the service. But what is clear is that Prime members spend significantly more than more casual Amazon shoppers, according to RBC Capital Markets. Prime members said they spent an average of $538 annually with Amazon, far more than the $320 by non-Prime members.  Also nearly certain: Prime costs Amazon dearly. Greeley declined to disclose specifics, but he suggested as much in an interview. “When you look back, the program was launched in 2005 at $79,” he said. “You factor in just simple inflation, transportation and fuel costs, the price would be over $100 today, in just 2005 dollars.” Translation: Prime doesn’t pay for itself.  Indeed, Forrester analyst Sucharita Mulpuru estimates that Amazon loses at least $1 billion annually on Prime-related shipping expenses. It’s a staggering cost that pushed Amazon to hike the price for Prime by $20 to $99 in April.  “On the one hand, Prime adds to their bottom line, but it’s like a leech that sucks their blood,” says Mulpuru. “When they throw in things like lending library and streaming, it just gets more and more expensive for them.”

1 comment:

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