Why Amazon Offers Free Videos For Prime Membership

October 18, 2012

My History using Amazon Prime:

I’ve been an amazon prime member for around 4-5yrs now. I initially joined because it was easier to order things from amazon for our company (printer paper, ink cartridges, medical supplies, etc) than drive to Walmart or Office Depot hoping for the lowest price & good selection.

With prime, you pay $79/year to get free 2 day shipping on most things.

Otherwise, you have to buy at least $25 worth of stuff to get free super saver shipping – which takes 5-8 business days.

In online shopping, amazon figured out one of the most important things a customer cares about is how fast they get the item. Before, sites would take like 2 weeks or longer to send stuff, so amazon was revolutionizing the way online business was done with super fast shipping.

Amazon already has the lowest priced items you can find anywhere (online or at a store). They have more customer reviews than other shopping sites. They also have the largest selection. Icing on the cake, they make return shipping super easy & hassle free.

So even paying $79/yr to get faster shipping, you’re in the bonus while shopping at amazon due to all the other benefits.

I often giggle like a school girl (or boy, let’s be politically correct here!) when buying only one item costing $4.99 – yet they’ll pick, pack & ship it free in 2days! Most other companies have minimum order limits of $50-$75!

Amazon spends tons for shipping costs. The $79/yr we pay doesn’t nearly cover their expenses.

So what are the benefits for Amazon for offering Prime?

1) Charging $79/yr is better than charging $0.

So they’re defraying some of their high shipping costs with incoming revenue. This is just a secondary benefit for them though, compared to the ones below.

2) Once a person commits to paying $79 for prime shipping, their shopping increases exponentially.

Maybe it’s to try to make the most of it?

Like when you pay to eat at a chinese buffet, you try to get your money’s worth – even if it means stuffing yourself, gaining weight & feeling sick.

This is exactly how it started for me (both in chinese buffets & online shopping).

At first, I signed up for prime for our business just so we can get the printer paper delivered faster. Then I tried to shop there more to make up for the $79/yr cost. Now I exclusively shop here for 99% of my things (business & personal). ie: books, soap, shampoo, deodorant, toilet paper, kitchen paper, electronics, games, anything.

And every year, I buy more items than I did the previous year.

Classic example of Cialdini’s commitment/consistency principle being used here (#8).

3) So I was thinking, why don’t they just charge $6.58/month rather than $79/yr?

I have a few theories.

a) They don’t charge per month because they’d rather get money up front. This sunk in as I was reading some Buffett & Munger books recently. It’s always better to charge for a service up front, before you have to deliver it – creates float. In Buffett’s case with their insurance business, their large float allows them to buy other companies. In amazon’s case, their float isn’t that large I would assume but it’s still better to get one year’s worth of shipping costs up front rather than charge per month.

b) This also means customers are only charged by amazon once a year rather than 12x a year. When you pay once, you can forget about the expense for rest of the year. If you are paying every month, even if it’s as low as $6.58, you will be kinda annoyed at that and will cut that expense out during crunch times. Why pay for express shipping when your income is down? Seems like a luxury good.

c) Also, once a person pays for the year’s worth, they will try to get their money’s worth by shopping often. This is great for amazon. If you only paid one month’s worth, your need to get your money’s worth only lasts for 30 days.

d) Lastly, amazon probably figured out that $79 is mathematically perfect in the customer’s mind to pay for fast shipping. If it was, let’s say $300/yr – I doubt anyone would sign up. Even if it cost $150 or $100/yr, we’d second guess that expense.

4) Why offer free instant streaming videos with prime membership?

This I was pondering for a while. Netflix charges $8/month for around 100,000 streamable videos. Content is expensive. Why is amazon giving away this for free?

Compared to netflix, I think amazon only has like 10,000 or 20,000 videos available for streaming.

Reason: this adds to the stickiness of prime shipping = which adds to the stickiness of shopping on amazon = more $$$ for amazon.

In business, “stickiness” is everything. I think I learned that from Eben Pagan & Joe Polish – so thanks guys.

Let’s talk about apple for a second:

Macs:

Stickiness is the whole reason Apple is the biggest company in the world today. Apple started out as a niche computer company in the 70s. Windows/pc kicked their ass for multiple decades because they offered an open system while apple was a closed system.

By that I mean – apple created the hardware & software and sold it as a premium product. No other computer runs the apple operating system.

Bill Gates created only the windows software and licensed it to all the computer makers so that they could use the windows operating system. Windows spread like a virus while apple didn’t get anywhere.

All this changed when apple introduced itunes in january 2001. Somehow Steve Jobs convinced the music industry to sell thru him for a low cost. Pirating was at an all time high and no one believed people would pay for mp3s.

Then he launched the ipod music player in October 2001. It was the first cool mp3 player that hooked up directly to the itunes ecosystem so that you can buy, download & upload your music easily to the ipod.

Itunes is available on macs & pcs, which increased its stickiness. Everyone could buy & download music, not just mac owners. And you didn’t need to own a mac to run an ipod – it worked on pcs just as well.

Not everyone bought mp3s of course. Even if you were pirating music, it was cooler & more useful to have an ipod than other lower end music players. So either way, ipods got into the hands of many people.

Then, apple introduced the iphone in June 2007. iPhone is an ipod combined with a phone combined with a connection to the internet. 3 items in one.

People were already used to downloading music from itunes – the idea of having your music player also be your phone is super useful & cool. No need to carry two devices anymore (a crappy cell phone & an ipod).

People became more used to the way apple does things: itunes, os, etc. Now it makes more sense that the next time you’re going to buy a computer, might as well buy a mac rather than a pc – because a mac works well with iphone + itunes + ipod. Mac sales soar.

Lastly, as the first cool tablet in the market – ipad launched in April 2010 – everything gets kicked into another gear. If you have an iphone & a mac, you want to stick to the same apple ecosystem of apps/itunes & buy the ipad.

Everything started with the stickiness of itunes – which started because somehow Jobs convinced the music industry to sell cheaply thru him.

He was probably able to accomplish that because he was the largest shareholder of Disney (thru the sale of Pixar animation to them in a stock deal) – and disney owns record labels. Once he got disney to join, he was able to persuade other large labels. Plus the music industry was desperate for any solution at that time.

Oh yea, itunes also included podcast listings for free = super-sticky-ickyness.

Podcasts existed before apple thought of this idea but listing podcasts for free on itunes meant more people were going to see your program. This is a boon for podcasters because they can reach a wider audience.

It’s great for listeners to use the same program to buy music & download free podcasts. It’s super easy since it hooks up directly with your mac, ipad, ipod & iphone. This makes itunes super sticky. Even if someone didn’t buy music, they would download itunes to listen to free podcasts.

Like a fungus, itunes spreads!

Back to amazon:

Phew. That was long but interesting, right?

So apple is a giant cash machine due to its stickiness. Once a customer is firmly stuck in your ecosystem, there is tremendous pain & displeasure in switching to a competitor.

Amazon’s stickiness is its selection, price, customer ratings & most importantly – fast shipping. Once you get in, it’s hard to shop anywhere else.

But shipping is replicable. Other companies can set up warehouses and eventually learn to run fast shipping. So amazon has to widen their business moat by making amazon prime more stickier = additional bonuses = free prime streaming videos.

So next time you think of canceling your prime service, not only are you losing fast shipping – you’ll also lose the ability to watch free movies & tv shows on your computer/tv/tablet/phone. It’s not the end of the world, but I suspect amazon will make their prime shipping service even stickier in the future.

Now they’re making their own kindle ereaders & tablets to get people into their amazon digital ecosystem. Like Apple, Amazon also sells digital music, movies & books. And all of that is integrated better with their kindle tablet than any other device.

Other sticky factors:

Amazon also lets you share your prime membership with 4 people. This means once you become hooked & enthused about the service – you can play the hero & give the same fast free shipping to your family/friends – for free! They then get a taste of how cool it is and will buy more products thru amazon + may buy their own membership if the original guy ever cancels his. Genius.

Students also only pay half price of $38/yr (after allowed to try service free for 6 months) = amazon getting them hooked at a young age!

Expected moms can try prime for free for 3 months + 20% off diapers & baby wipes + other mom discounts/deals.

If you buy Kindle Fire = one month free amazon prime (useful for free video streaming).

In business stickiness is everything.

One last example I’ll use (since I’m on a roll here) is my own. I was in the family medical business and there are a few different software companies we can choose to manage our patient database digitally.

All these companies charge a one time software installation fee + monthly “maintenance” fees to run their software. That’s how they make their real money – thru monthly fees.

We originally picked one randomly due to a friend recommending it. Over the years, I noticed the software was super clunky & a hassle to use. Thru research, I found a cheaper, leaner & more popular alternative.

The catch?

We have to somehow transfer all existing patient data from the old software to the new one. This also affects our billing because we have to keep track of which patients to bill thru the old software & which ones thru the new one.

Anyways, I knew it would be a headache for at least 3 months but went ahead with the transfer. If the new software company were smarter, they would have offered to make the transition easier on us – or even free. Instead they charged us for them to transfer the data. I thought that was super dumb but they wouldn’t budge.

Why? Because once someone is in your ecosystem, they will rarely leave. It’s too much of a hassle. This software company should make it super easy for anyone to switch over to them – for free – because that means years & years worth of high monthly software fees!

Lastly, that’s why Warren Buffett spent 10B in buying IBM stock:

His first ever “tech” purchase. Though nowadays, IBM is more service oriented than strictly a tech company.

He had been reading IBM annual reports for over 20 years and never thought of buying the company.

Then last year, he was talking to his many different companies that berkshire owns & asked them who they use for the IT software/system. All of them used IBM and said that once someone picks them – they rarely ever change. Because IBM is sticky & it’s a hassle to change IT services.

And this lasts for a lifetime. Buffett started salivating and threw down 10B to buy IBM!

All because IBM was smart enough to get out of the consumer pc business and go into the super sticky business services industry.

Am I super smart & rich because I figured this out?

Hells no.

I just read other people’s ideas & books & came to this conclusion.

Just because I can learn things in hindsight does not translate into millions for me. I’m not sitting on a pile of cash for figuring this out, yet!

The real genius is in having foresight – figuring this out while no one else is thinking about it = ala the genius of Apple, Amazon & IBM.

Credits: Steve Jobs by Walter Isaacson. Robert Cialdini’s book Influence. Malcolm Gladwell. Wikipedia. And many other smart people I’ve read but can’t quite recall who you are. Rest assured, my “insights” are a combination of my little brain power combined with your large brain & research skills.

Disclosure: I’m an amazon fanatic (if you couldn’t tell by now) and also own their stock. I’m an apple fanboy too but don’t own stock.