Why learn about pricing strategies?

When Amazon.com was created in 1994, the company sold books online. While many viewed it as a real threat to traditional bookstores, few, other than its founder and CEO, Jeff Bezos, imagined what the company would become. Today the services that Amazon offers are extensive, and many of them center on a quiet service membership called Amazon Prime. The following video shows the impact of this offering on one American family.

Read a transcript of the video here.

What is Amazon Prime? When Amazon launched the product in 2005, it included free two-day shipping for most orders, and it was priced as an annual $79 membership fee. At the time, analysts wondered how Amazon could justify the value to customers (implying that it was too expensive) and, at the same time, how it could afford to keep offering the service if demand should grow (implying that it was too cheap to cover costs).

Greg Greeley, the vice president of Amazon Prime Global, reflected on the company’s decision and told the Washington Post,

We have always thought of it as the best bargain in shopping—Jeff [Bezos] went on record again saying that—in 2005 when we launched it with unlimited two-day shipping on 1 million items. But we did not think of it as a shipping program, but as a convenience program.

Prime introduced three concepts. It had two-day shipping at a time when people expected to pay for shipping and still not get their items for four to seven business days. It was very predictable: We put it on the Web site that if you ordered in the next 3 hours and 20 min., for example, you could have it in two days. And it was an unlimited, single membership fee that made fast delivery an everyday experience instead of an occasional indulgence.^[1]

Was the initial $79 price too low? Too high? Does it really matter that much?

After 2005, Amazon began adding services to the Prime membership without raising the price. Today the service includes unlimited video streaming, unlimited music streaming, $5.99 flat-fee shipping on discounted household items, access to a Kindle lending library and a host of others services. In spite of increased services, Amazon held pricing flat at $79 per year. In 2013, Amazon admitted that by simply adjusting the 2005 price for inflation, transportation, and fuel costs, the price would be more than $100 today.

Finally, in January 2014 Amazon told its customers to expect a price increase of $40 for Amazon Prime memberships, which would make the new price $119. In March 2014, the company announced the actual price increase: a $20 increase, or annual price of $99. While there were some disgruntled customers, the majority accepted the increase without complaint.

While Amazon doesn’t share its usage or financial data for Amazon Prime, analysts have completed customer surveys, analyzed Internet traffic, and reviewed enough detailed financial data to support the following:

• Amazon loses at least $1 billion annually on Prime-related shipping expenses
• Amazon spent $1.3 billion into Prime Instant Video in 2014, over and above the shipping costs
• Amazon Prime has between 40 and 50 million subscribers
• Prime members spend an average of $538 annually with Amazon, far more than the $320 by non-Prime members^[2]

Is it strategic genius or terrible folly for Amazon to lose billions of dollars a year on Amazon Prime on account of its pricing? Is Amazon actually losing money on Prime, or is Prime bringing in enough other sales to cover its costs . . . and more?

Choosing a price is as easy as picking a random number. As you’ll discover in this module, however, finding the right price to achieve company objectives and provide sustained value to customers is much more complicated.