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Summary

  • The announced 25% increase in Amazon Prime price is not expected to increase Amazon’s bottom line but this may assess how successful this critical move turns out to be.
  • Investors waited for a very long time to see Amazon giving consideration to its bottom line that has always been sacrificed for its top line growth.
  • Amazon’s business model is capable of bringing a smile to the faces of its customers but its business model is not expected to generate considerable profits.

Amazon (NASDAQ:AMZN) announced that it will charge $99 for its Amazon Prime service instead of the original $79 that it has charged since 2005 when this service started. A few weeks back AMZN announced that it was considering a price rise in the range of $20-$40. This announced 25% increase in the price lies at the lower end of the range that AMZN had indicated. With an estimated 20 million Prime members, this price rise is expected to translate into an additional sum of $400 million added to its bottom line. For a company making around $74.4 billion in revenues, this increase is just an additional margin of around 0.5% so it would not really change the bottom line.

Some believe that Amazon would grow its revenue to a very high level and at that point a small increase in the margin will create big profits. Now this is a test case for AMZN that will determine how customers react to the price rise.

Initial reaction

The initial reaction of customers was mixed and it's not clear what the actual impact the price rise will have on Prime membership. There are loyal and satisfied customers who think that the Prime package is still a good value even at $99.

Amazon Prime offers free two day shipping, over 40,000 movies and television episodes accessible for streaming through Amazon's Prime Instant online video and access to over 500,000 Kindle titles available at the Kindle Owners' lending library. There are customers who feel that AMZN has made them addicted to its service and that they would take the membership despite the 25% price hike.

And there are others who think that they spend more than non-Prime members and that AMZN should not raise price of Amazon Prime. It is argued that people tend to spend more because of the membership and with this price hike the membership will decrease and with that associated sales volume will also decrease.

Time will tell how customers react to the price rise but presently the market seems to be welcoming it with a frown.

Disappointment in AMZN's Valuation: Great Revenues but where are the Profit Prospects?

The success of a company is measured by how much profit it is earning and the ability to sustain and grow this profit in the future. Startup companies generally go through an initial phase where they have little to no profit and positive cash flows. AMZN started many years ago and they are still not making much profit. There is a question mark on their business model and a very rational question is whether or not it will be profitable enough to produce meaningful dividends in the future so that an investment in AMZN is justified. After all, dividends are the ultimate form of returns that an investment must receive to justify staying invested.

AMZN has posted superb growth in its top line at a CAGR of around 30% per annum over the last nine years. This growth has come from a business model that offers customers the best value for their products at razor thin margins. This strategy is serving their customers well but question looms as to whether or not this strategy will serve their investors in the long run. A logical argument can be made that AMZN's business model will slowly kill itself if it tries to aim for profit growth apart from revenue growth by increasing margins.

Although investors are putting pressure on AMZN for profits, it seems as though AMZN's top-line growth and business model are an amazing phenomenon. It seems that the pleasure of imagining the future growth of this monster retailer is more intense than the concern for profit.

At the moment, the market does not like to believe that AMZN's business model will be unsuccessful in the long run. This is obvious from the price gain that AMZN is enjoying. AMZN's stock gained 39.8% in the last year and gained 431% in the last five years. What would happen if AMZN stops focusing on the growth of its bottom line? If AMZN continues to be a top line growth junkie and keeps its revenue growing further with market support, then the time will come when AMZN will find it even harder to make enough profit to justify its business model.

Conclusion

AMZN knows how to keep its customers happy and this is giving it superb top line growth. The market is also very excited about this. But it's the sustainable and growing bottom line that is the real measure of return for investors to justify investment. AMZN really needs to balance its priorities between its top and bottom line growth without delay. At the moment, AMZN seems to be a good stock that is attracting investors so they should consider investing in the stock since correction does not seem to be near. But investors should also keep a close eye on the stock and should exit immediately when a correction is initiated.

Source: Amazon Prime's Price Rise Is A Test Case