Fresh food could help drive more loyalty for Amazon

March study found Prime members are among online retailer's most profitable customers

Amazon has announced that it will offer a free, 90-day trial of a new same-day delivery service to customers in the Los Angeles area that includes fresh food. The service, Prime Fresh, is being offered to Amazon Prime members, and after 90 days, the company will offer to let them upgrade to Prime Fresh on a permanent basis, for $299 per year, from the current Amazon Prime price of $79 per year. In addition to access to Amazon Fresh deliveries, the upgradeded Prime membership also includes the standard free two-day shipping on all purchases as well as unlimited access to Amazon's streaming video service. The company tested the program for six years in Seattle and plans to expand it to San Francisco later this year.

With the upgrade comes a chance to recoup some dollars that have been leaking from the shipping line of Amazon's balance sheet. The company spent a net $2.9 billion on shipping in 2012, a 17% increase from the year before, according to its 2012 annual report. For that, programs like SuperSaver shipping and Prime have not always been very popular among Wall Streeters. Building in an extra $220 per Prime membership certainly helps offset the impact of rising shipping costs.

Meanwhile, according to one report, Prime customers are already quite profitable to the company, with members among the online retailer's best customers.

The March 2013 report, by investment firm Morningstar and Consumer Intelligence Research Partners, noted that Morningstar's $300 fair-value estimate of Amazon's stock "seemingly requires a leap of faith" given the company's 1.1% operating margins in 2012. But that same report noted that the number of users of Amazon Prime may be much higher than originally estimated.

While coverage of Amazon by Bloomberg indicated that Prime had 3 million to 5 million members in October 2011, the Morningstar report estimated it had reached 10 million by the end of 2012 and would grow to 25 million by the end of 2017. Furthermore, the report found that Prime members show greater loyalty than nonmembers: Excluding the annual fee, members buy about $1,200 worth of merchandise per year, compared with around $600 for nonmembers. And Prime members likely make most of their online purchases through Amazon, making the online retailer something akin to an anchor tenant in a shopping mall, according to the report. Overall, according to eMarketer and ComScore, U.S. online shoppers totaled more than 184 million in 2012 and spent more than $186 billion, not counting travel.

Overall, the report found that by 2017, the company could generate $138 to $415 in operating income per member, or $3.2 billion to $9.6 billion in total, and Prime is already a meaningful contributor to profitability. Nevertheless, Prime members' effects on profitability has been masked by technology, content and fulfillment center investments.

Getting back to Prime Fresh, giving members of the option of spending an extra $220 per year on memberships certainly would add to the revenues it gets from membership fees for the program, but it remains to be seen how big a player Amazon can become in the fresh food business. Clearly, it wouldn't be expanding Prime Fresh to Los Angeles and San Francisco if it didn't hold promise; Los Angelinos may find it helpful in a city notorious for gridlock traffic, where something as simple as a trip to the store can be a major hassle. But the company might find more mixed results if it tries expanding on the East Coast, where it will face competition from existing companies like Fresh Direct and Ahold USA's Peapod.

Still, assuming the estimates by Morningstar and CIRP are on the mark, it means that giving Prime members two more reasons to use it — same-day delivery and access to fresh food without having to make a trip to the supermarket — could make them even more loyal and attract new members as well.

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