Friday, July 25, 2008

Unlocking the Mysteries of Amazon Prime!

During Amazon's recent Q2 earnings call, the following question was asked and then answered by Jeff Bezos:

Jeffrey Lindsay - Sanford C. Bernstein

What is the impact on your delivery and fulfillment charges particularly with regard to Prime, of increased transportation costs, is this really a 2009 phenomenon for you or is there a possible increase in delivery cost coming through the pipeline? And then could you just give us a comment on how you’re seeing any impact from consumer confidence on sales, product mix, sales frequency, smaller ticket items, are you seeing any difference now that consumer confidence is significantly lower?

Jeffrey Bezos
On the fuel prices we suspect that higher fuel prices may be a relative advantage for us both in terms of relative to physical world stores because of the expense of driving to a store, even just driving 10 miles these days is a few dollars worth of gasoline and consumers we suspect are beginning to take that into account and think about that and try to do trip consolidation and so certainly our free shipping offers and Amazon Prime become very high, a clearly of even more value to customers under that set of circumstances.

And then relative to other online retailers because of our scale we have a distributed fulfillment center network that places products closer to customers that allows us to do fast transportation to customers, fast deliveries to customers but usually using ground transportation instead of air transportation and ground transportation is much more fuel efficient then air transportation. So probably this is a relative advantage for Amazon and its our job to insulate customers since we offer free shipping and Amazon Prime offers fast free shipping, the burden is upon us to make sure that we can do that in a way that is economical for us so that customers can continue to enjoy those free shipping offers and we have clearly no intention of changing those. We’ll keep them in place.

Okay, since Mr. Bezos won't explain the intricacies of Amazon Prime and Super Saver shipping, I will. First a little background on how I know this stuff.

I sold for many years on eBay as Glacier Bay DVD and I am intimately aquainted with the systems in place and the costs associated with shipping product; I currently sell on Amazon using FBA (Fulfillment by Amazon) and I've studied how Amazon Prime works both as a seller and a customer.

I have no inside information and what follows is strictly my analysis of their service based on logic, research, observation and public statements. (No metrics were harmed in the making of this blog post).

How does Amazon make Prime and Super-Saver shipping work?
  • Customers pay $79 a year for a Prime membership which gives them free 2-day shipping and $3.99 next day shipping on eligible items. Super-Saver shipping is free standard shipping for orders of $25 or more.

    Prime customers order more frequently and Super-Saver customers purchase more items per order, both positives for an on-line retailer.
  • Notice that I didn't state "2-day Air" or "Next Day air", that is because, as Mr. Bezos mentions in the quote above; "And then relative to other online retailers because of our scale we have a distributed fulfillment center network that places products closer to customers that allows us to do fast transportation to customers, fast deliveries to customers but usually using ground transportation instead of air transportation and ground transportation is much more fuel efficient then air transportation."
  • The actual cost to deliver is much lower than you would expect. In some cases the $3.99 next day shipping charge may actually make the company money.

    Because of Amazon's scale and sophisticated systems, they can keep the same SKU in multiple warehouses based on historical geographic demand and then ship that item to the customer from the closest warehouse. In most cases they can ship Next Day orders via ground transportation. Occasionally they will have to use Air Transportation, if their inventory is not in the correct warehouse or combining the entire order can be accomplished in another warehouse, but they are smart folks so they've worked out all of these potential challenges.
  • So in theory Amazon can offer the same level of service for every customer, no matter if they are a Prime customer, Super-Saver customer or pay S&H on their purchase. The one caveat to this is the time it takes to put together your order. Super Saver orders may take a couple of days to pull together your orders. From a cost standpoint they are delivering the fastest way possible and the least expensive method. Doing this well isn't rocket science but it is close.

    This is a great experience for the buyer because they almost always get their order ahead of schedule.
  • So Amazon collects a $79 per year subscription that encourages more frequent purchases or they ship orders that generate more revenue ($25 or more) for free with Super Saver shipping and here is the beauty, they are basically the same cost basis (with some differences in pick/pack time)
  • Amazon's scale allows them to get the absolute best shipping prices available in the market and I can attest to the prices because I use Amazon's UPS rates to ship product to their Reno warehouse for FBA -- quite a savings over standard UPS rates.
  • This is why FBA is such a big part of their future plans. With FBA sellers can have their inventory in Amazon's system and get the same speed of service and make their items eligible for Prime and Super-Saver customers. An extra benefit to the system is that Amazon can actually charge the seller for pick, pack and ship helping defray the cost of shipping the item. So for Prime customers Amazon gets the revenue and the seller pays for shipping -- What a country! BTW, I do not mind this at all because I get access to their best customers and it saves me money over shipping it myself.

These guys/gals who run Amazon are brilliant and everything they do is meant to leverage their infrastructure and technology. IMO, this is why they deserve a premium valuation in their share price because everything they do is geared toward reducing costs and increasing non-burdened revenue (3P, FBA, AWS, Digital Delivery, etc.) while positioning their own retail business as the low-cost leader. Their profit margins cannot help but go up as they execute their plan.

IMO, the battle for ecommerce supremacy has been won by Amazon and they are pressing their advantage. Companies like eBay and other less efficient retailers are at a distinct dis-advantage when competing against Amazon. You just better hope they don't start selling in your category or niche.

Just my 12%


Cliff Aliperti said...

Great analysis!

To add, I'm sure they also get their share of folks who sign up for Prime and don't come near $79 in annual shipping fees. Or a fair amount of people who order enough items that they would have qualified as SuperSaver customers anyway, thus they're really only upgrading their free ground shipping to free 2-day.

I bet they hate customers of my ilk. I order constantly basically spending an extra $10-$15 here or there when I have a couple extra bucks and want a DVD or CD.

Of course I take slight issue with your final paragraph. I still feel eBay has a unique presence with their "only a venue" status. They don't have to host and maintain any of those warehouses that Amazon has spread out all over the world. I think the battle is still far from over.

And the thing is, assuming Amazon can clearly win, how long before everyone is bitching about them?

Randy Smythe said...

Cliff, that "they've won" statement was more hyperbole and fun.

Anybody that out-executes Amazon has a chance. eBay hasn't executed well, IMO

BTW, they love customers like you becasue you talk up the program.

Cliff Aliperti said...

Love the program, will always recommend it to anyone when I know they buy a lot of media items.

I do wish this NY Sales Tax would go away though, I see my free shipping but kinda feel like I'm getting screwed when I see that tax amount pop up there.

Randy Smythe said...

I think everybody wants it to go away. If Amazon prevails in court it will be pretty difficult for other states to try this.

Cliff Aliperti said...

Everyone seemingly except indy book sellers in NY. And of course the state itself.

Anonymous said...

For those of you with Prime memberships, here’s a good website for searching for Amazon Prime items:

Anonymous said...

How can a seller get their product into the prime program?