A little while ago I was shopping on Amazon’s website and the product I found had two sellers from which to buy. One seller was cheaper, but wasn’t eligible for Amazon Prime’s free shipping. The other seller was Amazon itself – so, free shipping – but the price was more expensive. If I had to pay shipping, the cheaper vendor would have won out.
This got me thinking about a couple of things. First, I had a little bit of pity for the seller who wasn’t Prime, but he probably gets business from non-Prime members, so that’s ok. The other thing I thought of more carefully is the Amazon Prime membership itself.
Let’s forget the other benefits of Prime like the free streaming videos. Let’s just say that when you buy a Prime membership, you are paying shipping costs in advance. That is, you put $80 in a shipping escrow account and you use it up throughout the year as you buy Prime-eligible products. How long will it take to use up that $80? Maybe 10 purchases, give or take a few?
Now, what if all the products you were buying with free shipping were a little more expensive than other sellers, but still cheaper than whatever it would cost with shipping from those other vendors? Even if it was just a couple of dollars, it’s still cheaper, right? A bag of gummy bears for $8 with free shipping or the same bag for $6 plus $4 shipping. It’s $2 more on the product, but $2 less after shipping is considered.
But… you’ve paid for shipping in advance, remember? You are chipping away at your escrow account slower than you might have thought, because you’re contributing a little bit towards shipping by paying a slightly higher price. So, while you may think you’re getting an awesome deal by purchasing Prime, it’s not that awesome. It can still be very good, though. That 10-purchase, break-even point we estimated earlier could easily double.
The more important part is that Prime incentivizes you to buy from Amazon and not from other sellers – even other sellers on Amazon. This means the profit from the sale of the item stays with Amazon. And if Amazon is lucky, you won’t use so much free shipping as to burn through your escrow.
To summarize: You pay more for a product from Amazon than from another seller. The additional profit for Amazon goes to offset the cost of the “free” shipping. You are also paying for some of that shipping from your purchase of Prime.
This is like a wet dream for number-crunchers: to come up with the perfect balance of item pricing that undercuts the competition by the smallest amount and still convinces the buyer to choose Amazon. Can you imagine the computing power that is likely devoted to this formula every single day?