Amazon announced on its earnings call last Thursday that it plans to raise the price of its Amazon Prime service by between $20 and $40, or 25-50%, in the near future. The reason given was that the service launched back in February 2005 at $79, and the price hasn’t risen since, despite rising transportation and fuel costs. But I’m skeptical  of that reasoning and I suspect the price hike is really about all the free stuff Amazon gives away with Prime beyond free shipping. Below, I’ll explain why.

Trends in shipping costs

Much of Amazon’s business is a black box – we have no idea how many Prime subscribers it has, how many Kindles it sells, what it makes from or charges for digital vs. physical media and so on. But shipping is actually one of the few things Amazon is pretty transparent about: each quarter, it reports total shipping costs, total shipping revenues (including some of its revenues from Prime), and the difference between the two. As such, we can calculate what percentage of Amazon’s total shipping costs were covered by shipping revenues, as shown below:

In its early history, Amazon made a profit on shipping – just over 20% in 1997 and 1998. But it soon realized that discounting shipping (a) removed one of the biggest competitive disadvantages it suffered against brick and mortar retails and (b) therefore was a very cost-effective form of marketing. Interestingly, over time, the net cost of shipping has come to very closely mirror actual marketing spend, even though it is not reported as such: Continue reading →