Amazon on the verge of a rare mistake

January 31, 2011 § 5 Comments

Over the weekend, super-blog Engadget revealed screenshots of an apparently new product offering from Amazon.  Based on the screens, which are no longer accessible from Amazon’s site, the ecommerce juggernaut intends to offer unlimited streaming of TV shows and movies, for FREE, to all Prime subscribers.  Prime subs currently pay $79 annually for unlimited shipping, and Amazon has reported a strong correlation between the launch of this delivery service and an uptick in sales activity.

In and of itself, Prime may be a winner, but I think Amazon is on the brink of making a large mistake if it intends to include online media benefits for no additional charge.  Here’s why:

  • It devalues the online media industry.  For the sake of argument, let’s attribute the full price of the Prime service to the media feature.  At $79, it’s already $16 below Neflix’s comparable, streaming-only service.  If it’s successful, as Amazon surely hopes, Netflix will have no choice but to meet or beat the price, and voila!  There go Netflix’s profits, and Amazon’s differentiator.  Listen for the hissing sound of margin escaping the industry, like air from a balloon, as the two race each other to the bottom.
  • It requires heavy subsidization.  Shipping is a money loser for Amazon.  Even with the Prime subscription fees, Amazon spends more on shipping than it takes in, and the stats are worsening.  According to its financial statements, Amazon took in $1.193B in shipping revenue last year, while incurring $2.579 in cost.  Relative to the prior year, shipping revenue grew only 29%, while cost grew 45%.  Yikes.  It may be a perfectly sound strategy for Amazon to increase its appeal by making shipping more affordable, but with shipping being a cost center, the subsidy for the online media business has to be funded by its core ecommerce operation.
  • It smells of the “causality trap”.  Their research may indicate otherwise, but it’s not intuitive that the way to increase memberships to its premium shipping service is to add online media benefits.  And even if their ploy were successful at growing Prime subs, it’s even less likely that the new members will buy more physical goods from Amazon (which is necessary for the subsidy to work).  I think Amazon my be falling for the causality trap, in which company planners observe a beneficial correlation (in this case, Prime subs order more frequently than non subs), assume a causal relationship, and then extrapolate that if they could only drive more of the causal behavior, that the correlation will surely hold, and they’ll make a whole lot more money.  But this is flawed logic.  Existing Prime subs value the service for its shipping benefits and are therefore more likely to be active buyers.  If new subs are lured in by media benefits, they will care less about the shipping features, relatively speaking, and can be expected to behave differently from the installed base, i.e., buy less often.

So what might explain Amazon’s strategy?  It’s media business is large, contributing over 40% of its overall revenue, but while its Electronics and General Merchandise business is growing at an increasing rate (67% last year vs. 48% the year prior),  Media has started to flatten, producing a comparably modest 16% growth over the last two years.  So Amazon is under some pressure to try something new.  It is also likely anticipating a not-too-distant future as Netflix has, where streaming and downloading online content overtakes the sale of physical media, such as DVDs and Blu-ray disks.  Both are good motivations, but I think their strategy is off base.  If they’re willing to invest in subsidies, as they seem to be, they could boost media service subscriptions with a more relevant and targeted offering to electronics buyers, particularly those buying units compatible with its online media services (e.g., free 12-month trial).  Who wouldn’t give that a try?  An offer like that would produce paying subs as they roll off the promotional period, and would help differentiate their electronics business (not to mention, leverage the huge amount of volume generated by that business already).  Similar reasoning underscored Best Buy’s purchase of CinemaNow, Walmart’s acquisition of Vudu, and Sears’ recently announced partnership with Sonic Solutions.

Amazon, if you’re planning to give online media away for free to your Prime subs, you may want to take a step back and rethink that.  Sorry if I’m disappointing all you Prime customers out there.

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§ 5 Responses to Amazon on the verge of a rare mistake

  • Charlie Myers says:

    I think its a brillant strategy – devalue a competitors product, Netflix, by giving it away for free, to your core customers. Put them out of business – then your in control. It may be a war of attrition but they can squeeze Netflix out of the picture – or make them ripe for an aquisition.

    • We’ll see! But that sounds like predatory pricing, which will attract a lawsuit. May also backfire, because while Amazon is well capitalized, it’s online media business isn’t as healthy as Netflix’s. Remember the lesson from gradeschool … when you’re going to pick a fight on the playground, make sure you can win!

  • Depends on how much it costs them to fulfill. Microsoft subsidized the XBOX for years and in recently they went very profitable:

    http://www.engadget.com/2008/01/24/xbox-goes-profitable-almost-like-a-grown-up-business/

    I think Amazon may just be making a bet that they need to be a player in this playground and are leveraging their existing program assets to do so, likely with a long view. They also might be trying to do what Jobs did with iTunes, to get the content assets down in price.

    Frankly I’m one that thinks if they were to lower the price of TV shows down to around $6.99 a season rather than pay the rates they currently charge for a season. So I don’t ever buy a season. But if they made it what I consider “reasonable”, I would.

    I do agree maybe they should have targeted users differently, but who knows, maybe they plan to do A/B testing, or maybe they already even have?

  • kindle 3g says:

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  • Cedric Arnaud-Battandier says:

    They can indeed hit hard on Netflix with that strategy but will probably broaden their losses as content owners will not want to sell their content cheap (and Netflix should see a rise in content acquisition in the next negotiations). On top, I would think that content owners will become unhappy as it diminishes the perceived unit value of their content.
    Then we can ask ourselves if it is not a strategy “à la Walmart” that has been selling DVDs at or below cost to attract people in their stores and purchase other products: for example it will drive purchase of connected devices which generate better margins.
    Another thought could be they noticed that shipment costs of DVD products are a big chunk for them and shifting their consumers to streaming delivery can significantly decrease their total cost.
    Last, it also depends what kind of movies/TV shows are available. If the catalogue is so old that nobody is interested, it might be a good (marketing) pitch for thier Prime offer to have more subscribers at a minimal cost…

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