Amazon: How Price Hike Could Drive Prime Conversion

| About: Amazon.com, Inc. (AMZN)

Summary

AMZN increased the minimum order requirement for a free shipping to $49 from $35.

Positive implication to drive Prime adoption and addressing rising logistics cost.

Remain bullish on AMZN for its strength in e-commerce.

Amazon (NASDAQ:AMZN) recently increased its minimum order size for free shipping for its non-Prime customers from $35 to $49, or a +40% increase. This is the second increase in the past three years when the last increase in 2013 was from $25 to $35, also +40%. The current $49 minimum order requirement places AMZN on the same level as that of Wal-Mart (NYSE:WMT) ($50 minimum order).

In my view, AMZN's decision to increase its minimum order price is a move to drive higher Prime subscriber acquisition and addressing its higher fulfillment cost. On the Prime Service, increasing the minimum order to $49 could potentially encourage AMZN visitors to sign up for the $99/year Prime membership that has unlimited two-day shipping along with other value-added services such as video streaming, music and cloud services.

The customers may see a superior value proposition by paying an annual fee to address the minimum purchase requirement while receiving a superior shipping service. As for AMZN, it is worth noting that fulfillment cost has gone up +37% in the most recent quarter and the +40% increase in minimum order is to address a portion of that increase due to non-Prime members.

The conclusion that investors can draw from this price hike is that logistics remains the single biggest cost AMZN faces and the company is doing what it can to address this from both the revenue and the cost side. In the near term, fulfillment cost will continue to creep up as AMZN invests in its logistics network in both the traditional channels (i.e. trucking, cargo plane and cargo ships) as well as unconventional channels (i.e. drones). Near-term profitability is unlikely to be a priority for AMZN so top line growth is what will really matter. I remain bullish on AMZN and continue to believe that the company is well positioned for the rising e-commerce penetration in North America.

When we look at the overall revenue profile of AMZN Prime Services, assuming that the service has 40m-60m subscribers, AMZN can generate $4b-$6b of revenue from annual subscription alone. More importantly, Prime members on average spend $1,500 per year vs. non-Prime members' spending of only $625. So AMZN has an incentive to convert non-Prime members into the Prime ecosystem.

The original $25 minimum order was not enough to incentivize the customers during the early days of Prime. As e-commerce penetration rises, it appears that most non-Prime customers are still content with the $35 threshold. Raising it to $49 could incentivize non-Prime customers to consider signing up for the $99/year Prime membership to receive unlimited two-day shipping.

From a psychological point of view, customers usually prefer to avoid paying for shipping. With the $49 minimum threshold and an estimated shipping cost of another $5-$15, a typical customer could be spending at least $55-$65 for a typical order. On the other hand, signing up for Prime allows the customer to avoid paying a minimum amount and still enjoy superior shipping service. Such a valuation is difficult to pass on in my view.

When we look at AMZN's cost profile, logistics accounts for a material portion of it, and last year, fulfillment costs increased by +37% to $4.17b in the last Q4. Raising the minimum order by +40% partially addresses AMZN's cost inflation but is still not enough given the amount of spending AMZN has on building its full-time logistics fleet that could potentially rival the USPS and FedEx (NYSE:FDX). My view on AMZN's investment in logistics is that the company is moving towards the right path but near-term profitability will be pressured. That said, AMZN will continue to be a revenue-driven story until North America e-commerce hits maturity, which could be in the next 20 years.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.