Amazon Could Keep Prime Low to Hammer Apple

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On the company’s earnings call last week, Amazon.com Inc. (NASDAQ: AMZN) said that it may raise the price on its subscription shipping service, Amazon Prime, from its current level of $79 a year to as much as $119 in the next year or so. The company raised its free-shipping level for non-Prime customers from $25 to $35 just before the recent holiday shopping season, so there is some precedent here.

Free-for-a-fee Prime shipping has forced other retailers to offer free shipping as well. By forcing traditional retailers, and even primarily mail-order houses like L.L. Bean, to adopt some level of free shipping in order to compete, Amazon is threatening to wring more profits from its competitors’ sales. Amazon has proved over and over again that it does not care much about its own profits.

That is what makes the possibility of a price hike on Amazon Prime such an interesting question. In the fourth quarter of 2013, Amazon’s net product sales totaled $21.07 billion. The company’s cost of sales was $18.81 billion and its fulfillment (shipping and handling) costs totaled $2.92 billion, for a total of $21.73 billion. Without services revenue of $4.52 billion, Amazon loses money in the quarter.

If Amazon truly cared about profits, the company could follow the model of Costco Wholesale Corp. (NASDAQ: COST). Costco makes a tiny margin on the goods it sells and posts virtually all its profits as a result of membership fees. Raising Amazon Prime’s cost by $40 a year might have a similar impact on Amazon’s earnings.

Amazon does not reveal how many Prime subscribers it has, but analysts estimate between 10 million and 20 million. A $40 price hike would add $800 million to Amazon’s coffers if no subscribers bailed out. Not all of that would go to the bottom line, of course, but Amazon’s paltry fourth-quarter net income of $239 million on nearly $26 billion in sales would easily have been doubled.

Which path is the more likely for Amazon to follow: continue to eschew profits in favor of market share or boost its fee in a bid to lift profits? As long as the company’s shareholders do not rebel and drive the stock price down to $50 a share, CEO Jeff Bezos and company have always favored the scorched earth policy of taking no prisoners in the battle for market share.

Like competitor Netflix Inc. (NASDAQ: NFLX), Amazon is beginning to produce original content for its streaming video service that is available free to Prime subscribers. Amazon could cause some real headaches for Netflix if it chose to spend some of the $12 billion in its cash and liquidity hoard to force Netflix into a battle the much smaller company could not afford to fight for long.

The only company that Amazon is competing against that could fight back on a more than an equal footing is Apple Inc. (NASDAQ: AAPL), with a cash and short-term investment pile totaling more than $50 billion. Amazon’s Kindle Fire has been a good seller for Amazon, but its much lower price compared to the iPad is probably the main sales driver. In the fourth quarter of 2013, Apple claimed 33% of the global tablet market, compared with 6% for Amazon.

So far Apple has not stooped to play in the low-end of the market for either smartphones or tablets, and that has given Amazon’s Kindle space to ring up third-place in the tablet market, behind only Apple and Samsung. If Amazon wants to add to the pressure it is putting on Apple’s share of the tablet market, the retailer will keep its Prime subscription low and continue to do all it can to lower the cost of the Kindle until it reaches a point that a Kindle has 99% of an iPad’s functionality at less than half the cost. Even Apple would have to pay attention to that.

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