Belt Tightening On Free Shipping Will Boost Amazon Prime Memberships

  • Amazon has raised the minimum order required for goods to qualify for free shipping.
  • The move appears aimed to lower the company's shipping costs and encourage more people to sign up for Amazon Prime.
  • What does the latest move mean for the online giant's delivery costs?

Amazon (NASDAQ:AMZN) has just made it harder to qualify for free shipping by raising the minimum order requirement for non-Prime members for free shipping from $35 to $49. The last time Amazon raised the minimum order amount was in 2013 when it hiked it from $25 to $35. In staying true to its origin as an online book retailer, Amazon has made an exception for book shipments and the minimum order required for free shipping stays at $25.

The latest move by Amazon appears like a thinly veiled attempt to push non-Prime members to sign up for a Prime membership which goes for $99. After all, a non-Prime member now only has to put up another $50 to subscribe for Amazon Prime and receive perks like free 2-day shipping, and unlimited streaming by Prime video.

For people who choose to pass up on Amazon Prime, there are only two options left: pay for shipping costs or increase the size of your order. It’s win-win for Amazon whichever way you cut it.

Growing Prime Membership vs. Saving on Delivery Costs

Although the company keeps the number of Prime shoppers a closely guarded secret, Consumer Intelligence Research Partners, or CIRP, estimates that Amazon had 54M Prime members by the end of 2015, a 35% Y/Y increase from 40M during the end of 2014. CIRP estimates that 47% of Amazon customers in the U.S. were Prime shoppers.

There is a good reason why Amazon would like to get as many shoppers as possible onboard on Amazon Prime. CIRP estimates that Amazon Prime members spend almost twice as much on Amazon compared to non-Prime members--$1,100 per year vs. $600. Converting non-Prime members to Prime members is therefore an easy way for Amazon to quickly grow its sales.

In fact, judging from these estimates by CIRP, it appears as if nearly all of Amazon’s growth is coming from growth in Prime membership. Amazon’s sales increased 20% to $107B in 2015. Using these figures it appears as if Amazon’s non-Prime segment grew revenue by just 5% in 2015. It’s therefore, clear that Amazon’s growth hinges very strongly on an increase in Prime members.

The second big reason why Amazon increased its minimum order level for non-Prime members is in a bid to control its ballooning shipping costs. Amazon badly missed on earnings estimates during its latest earnings call, and a big part of this can be pinned on a huge 32.8% increase in fulfillment costs. Amazon spent $5B, or 5.1% of revenue, on shipping costs in 2015, up 19% Y/Y. Any move to lower shipping costs therefore comes as a welcome development and could have a tangible impact on the company's bottom line.

Drone delivery could lower shipping costs even further

Amazon has introduced other innovative programs in a bid to lower delivery costs, including Amazon Flex, an Uber-like service that uses everyday people and their own cars to deliver Amazon packages. Using Flex, Amazon can save on the huge capex that goes into purchase of thousands of delivery trucks.

But perhaps the one program that has the biggest potential to lower Amazon’s delivery costs is drone delivery. Amazon aims to start delivering packages to customers using drones as soon as the current year if the company manages to get clearance from the FAA. The program, dubbed Amazon Prime Air, will use drones to deliver packages weighing less than 5 pounds to customers’ doors in as little as 30 minutes. Amazon says that 86% of its deliveries weigh less than 5 pounds, so the program could potentially be rolled out on a large scale basis.

It’s estimated that using drones for delivery services can potentially lower Amazon’s delivery costs from $7.99/package currently to just $1. If Amazon implements drones in as little as 20% of its deliveries, it can save more than $3B in delivery costs per year, and the savings would trickle right to its bottom line.

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