Why does Amazon offer free shipping with Prime membership even though it loses them huge money?
The story of one of the greatest retail innovations of the internet age!
Be it our “yeh bhi theek hai” & “yahi tk tha jo tha” responses to everything from Mirzapur or “That’s what she said” references from The Office, we can’t deny the fact that Amazon Prime video content has played a crucial role in our everyday lives.
It all started on 2nd February 2005 when Jeff Bezos has addressed all the customers with a letter on the launch of Amazon Prime:
And it did not end there as no matter how crazy this proposition looked, it just got crazier with time when Prime got extended to free kindle services, free music & streaming services, exclusive discounts, and much more.
The results?
Two-thirds of American households and 16% of the Indian population is having an Amazon prime legit account (and we all know how the rest of us are using prime with our friend’s school friend’s relative’s brother’s prime password xD)
With it, Amazon single-handedly — and permanently — raised the bar for convenience in online shopping. That, in turn, forever changed the types of products shoppers were willing to buy online. But everything in business comes at a price!
Shipping things quickly and freely across the globe isn’t cheap. In 2016 Amazon lost $7.6 billion on shipping, up from $5 billion the year before, largely due to Prime as also mentioned in the reference below.
If free shipping loses them so much money, why does Amazon offer it for Prime members?
Great Question! Let’s figure out
Before getting into details, we need to take a look at Amazon’s business model and philosophy.
As a company, Amazon tends to care more about increasing revenue than increasing profits. That’s because it’s historically reinvested its revenue back into the company instead of giving it to shareholders.
The idea is to grow the business as quickly as possible to maximize long-term growth, and also because retail is a low-margin business in general as also depicted in the graph below.
So, how does the Prime membership with free delivery is helpful to Amazon? Here’s why:
1. Prime is a powerful loyalty program:
A customer loyalty program is a marketing approach that recognizes and rewards customers who purchase or engage with a brand regularly.
In simple words, Amazon has built a moat around its business in the form of an annual subscription for which it charges people money and, in return, they spend even more money.
A Morgan Stanley study shows that the average consumer who isn't a Prime member spends about $600 a year on Amazon. For Prime members, it's $1,400. Also, when a user is committing to Prime subscription fees, they feel the need to buy a lot of stuff (and get a lot of free shipping) to justify that spending.
2. Prime members are shopping by default on Amazon
According to a survey from eMarketer last year, 80% of Amazon Prime members start their search on Amazon when shopping online. Only 12% start on Google.
Prime customers get so accustomed to free shipping that they just start buying everything on Amazon.
“They are trying to get you hooked on the convenience,”
A prime member who starts shopping on Amazon is 12 times less likely to also visit Walmart.com than a non-Prime member. In other words, Prime makes customers even more loyal.
3. Prime has raised customer expectations & hence the competition
Prime has conditioned customers to expect two-day shipping, so Amazon competitors are being forced to offer free two-day shipping just to stay competitive.
The spread of two-day shipping is great for consumers, but it could be a death sentence for retailers without the money or infrastructure to ship that much stuff that fasts. Hence, a market with less competition.
For Amazon, it doesn't matter if customers buy from Amazon or from one of its third-party sellers on Amazon. What matters is that they start (and often end) their search on Amazon.com. What matters is that, because of Amazon Prime, they've become the default. It doesn't get much more successful than that.
It’s pretty much clear that this business model is scalable only when more and more people are joining Prime at the same pace. Hence, they extended their services from just free shipping to free movies, 1.5 million free kindle books, free music, and much more.
The services were too much into the lifestyle that in his 2016 annual letter to shareholders, Bezos said Amazon wants people to believe that the Prime membership is "such a good value, you'd be irresponsible not to be a member.
Even though Prime might look like a losing proposition on the surface, it’s a treasure trove for Amazon. Bloomberg even called it the “most ingenious and effective customer loyalty program in all of e-commerce, if not retail in general.” Hence, Amazon has not just won the battle, it has also won hearts with Prime :)