Is Amazon Prime Profitable?

Is Amazon Prime profitable

Since we have started the blog, we have written quite a few articles regarding the growing e-commerce trends. In fact, our latest addition to the portfolio, ATSG, was a great example to this trend. Additionally, we continue believe that this secular trend is here to stay, rather than a temporary shift driven by the impacts of the coronavirus crisis.

Specifically, Amazon (AMZN) has largely benefited from this emerging secular trend over the past decade. In this article, our goal is to explore one of the businesses that made Amazon the company it is today – Amazon Prime. We address key topics and questions such as how does Amazon Prime Now make money, is Amazon Prime profitable and how do they make money with free shipping.

We conclude with our view on the trajectory of where will Amazon Prime be in the medium term.

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    How does Amazon Prime Now make money?

    Amazon Prime needs no introduction.

    A straightforward subscription-based business model, Amazon Prime Now is an express delivery service exclusive to Amazon Prime members. In particular, Prime Now offers ultra-fast and convenient delivery on various products such as groceries, electronics, essentials etc. For a flat fee, members are not only entitled to enjoy unlimited express delivery services, but also other services such as Prime Videos (Amazon’s video-on-demand product), Amazon Music and many more.

    At the time of writing, Amazon Prime membership costs $12.99/month or $119/year in the US. While in the UK, this is £7.99/month or £79/year.

    Arguably the pioneer in ultra-fast delivery, Amazon Prime has successfully grown its membership subscription base gradually over the years. While the company does not periodically publish this number, Amazon disclosed in January 2020 that it has >150 million Amazon Prime members worldwide.

    Amazon prime members US
    Amazon Prime membership in the United States 2013 to 2019. Source: Statista & own estimates.

    Is Amazon Prime profitable?

    The trillion dollar question among investors’ mind is “Is Amazon Prime profitable?” The short answer is we don’t know, since Amazon does not disclose separately.

    Fortunately, with the information we have at-hand, a back-of-the-envelope calculation can done. The idea is to guesstimate its revenue, cost and hence profitability.

    Let’s go through our assumptions.

    Firstly, from its latest filing, Amazon reported a subscription services revenue of ~$18 billion for the first 9 months of 2020. We assume that bulk of this revenue comes from its Prime membership fees.

    Secondly, we need to estimate its cost base. The total shipping costs for Amazon for the first three-quarters of 2020 amounted to $39.6 billion. However, this figure includes costs allocated to goods shipped throughout the entire company.

    Average annual spend by Amazon Prime and Non-Prime
    Average annual spend by Amazon Prime and Non-Prime members. Source: Statista.

    Finally, we are in the position to appraise its profitability. Our estimates suggest that the profit of Amazon Prime membership today is a loss of ~$9.7 billion, or ~0.6% of its current market cap, at the time of writing. While this is an estimate, it’s worth pointing out that our calculation only includes the subscription services derived from Amazon Prime.

    The estimated loss can be explained by Amazon’s initiatives to continue to beef up in building its warehouse and logistics capabilities (hence why we like ATSG!) aggressively over the years, especially since early 2020.

    How does Amazon make money with free shipping?

    As we highlighted earlier, Prime members spend an average of $1,400/year. With an annual subscription cost of $119, one can argue that this may be just not even cover the variable cost, let alone fixed cost. So, how does Amazon make money with free shipping?

    We believe the answer lies in its strategy. Amazon is famous for taking bold and concentrated bets, from its investment in Pets.com to Amazon Web Services (AWS). This seem to be the case for Amazon Prime as well.

    Specifically, Amazon continue to reinvest into its logistics capabilities with the goal of achieving greater scale. Despite being ahead of the curve, in our view, Amazon continues its quest to build a world-class logistics arm – Amazon Air. In fact, in recent months, Amazon Air has not only significantly increased its leases of aircrafts, but also launched its first Amazon Air regional hub in Europe.

    The fact that these investments are upfront means that any favorably economics will be delayed in the medium term.

    Summary

    In short, we believe that Amazon Prime remains unprofitable today, based on our assumptions. However, there are good reasons to support this.

    Namely, Amazon continues to reinvest in its logistics business. As long term investors, we believe this is a coherent business strategy, as it not only builds upon its competitive edge, but also act as barriers to entry to incumbent and new entrants.

    UPS FedEx operating margin
    UPS & FedEx operating profit margin from 2016-2019. FedEx’s has a financial year ending 31 May. Source: Company reports.

    In the medium term, once Amazon is deemed to achieve its scale, we see no reason why its profit margin would not be in the upper range of its two logistics peers. Some argue it may be even higher!

    All in all, Amazon Prime is a fundamentally sound and consumer-centric business that has continue to build up its competitive edge. E-commerce is not only here to stay, but to grow.

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