David Cummings on Startups

Costco and Amazon Prime are More Similar than you Think

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David Cummings

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What if you were a retailer that operated like a Software-as-a-Service company whereby you barely marked up your products and you made the bulk of your profits off the recurring revenue subscriptions? Costco does it. Amazon Prime is doing it. Think about it for a second: would you rather break-even selling products and make good money off of predictable, high margin recurring revenue or make varying margins off products with less predictability?

Amazon Prime is really Costco delivered to your doorstep.

If Amazon Prime has 5 million subscribers (probably high) that pay $80 per year, and they mark up products barely enough to cover the expedited shipping, inventory, operations, etc, that’s $400 million per year of profit (assume the $80 per year is nearly all profit). $400 million per year of profit is solid. And they’re just getting started. And they’re giving consumers more reasons to sign up, like free streaming movies and TV shows.

Look for more services with an annual fee that sell their product or service near cost and make all their profit off the subscription fee.

What else? Are Costco and Amazon Prime more similar than you thought? What are some more examples of this model?

Comments

4 responses to “Costco and Amazon Prime are More Similar than you Think”

  1. Jamie Bardin Avatar
    Jamie Bardin

    David —

    So normally, I completely agree with your posts. However, I think you might want to look at this a little differently…

    Costco — buys in bulk, essentially by the pallet in larger packages, reducing the cost per unit per package, and passes the value on to you. Yes, you pay a membership fee, but at an average check in the $100s, the value is in the purchases, not the membership fee. And for SMBs, the average purchase in the $100s to $1000s

    Amazon — Prime is not the money maker, but rather an enticement to actually pay MORE for products and services since you get it faster and for free shipping. A huge barrier to online commerce is the shipping cost, which is where many merchants make their profits, sometimes 40-50% gross. Amazon on the other hand works to keep costs low and has reasonable margins, and once you are a Prime member you are locked. It is really a customer acquisition cost, and an opportunity for higher margins. You can actually find the products cheaper often times than Prime FBA, but you have to wait 7-10 days and not have the convenience of Amazon or the points from your Amazon CC.

    I don’t think either of them is really making the money off the membership fees…

    Some — like smugmug.com absolutely do, and the products are a small margin, and the membership fees — huge. I am not so sure the math works the same with Amazon and Costco.

    Cheers,

    J

    Reply
  2. Wei Avatar
    Wei

    Building customer loyalty through the membership is just one of many ways Amazon brings cash home. Amazon can afford to sell stuff at below MSRP and still be profitable mainly because they’ve mastered the art of handling cash flow.

    For example, say Best Buy and Amazon both order 500,000 units of iPads from Apple with a net 30 term. While it may take Best Buy 45 days to sell that stock at retail, Amazon could discount it and sell the same volume in about 2 weeks. The collected cash then sits in the bank collecting interest for Amazon for another 2 weeks before the invoice has to be paid out – making up the difference and more. Spanning this across all their products and channels, the margins ends up being a bit higher than how folks like you and me would figure out our earnings from selling the same stuff.

    I do get what you’re trying to say about buying into a membership so the consumer would feel more obligated to shop there more. Besides fresh produce and some groceries, I now get most of my stuff from those two retailers exclusively.

    Reply
  3. Adam Avatar
    Adam

    Both companies are following membership economics. By securing a sunk cost upfront and providing lower margins, both companies can increase spend of most profitable customers. Not sure that Amazon purely “breaks-even” on merchandise minus free shipping. Smart move.

    Reply
  4. Joe Gallagher (@JoeGallagherIV) Avatar
    Joe Gallagher (@JoeGallagherIV)

    From my time with a Fortune 50 retailer, my take on the Costco membership and Amazon Prime is less on a subscription revenue model and more of a play on the ever illusive retail problem of measuring and capturing customer loyalty.

    Committing to a year long investment in a retailer is one of the “bigger” commitments a customer can make with retailer. As one of my bosses said, customer loyalty is generally based on their LAST shopping experience with you.

    The subscription/membership also gives the retailer a data point to track and monitor, thus allowing them to gain a leading indicator on whether customers plan to spend with them in the future. If they don’t renew their membership/subscription that is a pretty good indicator that their loyalty is eroding with you.

    Keep up the great posts.

    Reply

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