It works like magic! That’s what Stephenie Landry, the Amazon VP in charge of Prime Now, intended this service to be. Nicknamed “Amazon Magic” by her team, it indeed does work like magic for customers. Order one of the over 25K products in any of the several cities where it is available, and your order will be delivered in 2-hours for free, and in 1-hour for a flat fee of $5.99. The only caveat – you have to subscribe to the $99/year Amazon Prime membership which offers among others “free” 2-day shipping on hundreds of millions of products, millions of video titles, and several other benefits.
It also works like magic for Amazon shareholders, by pulling a Houdini on them and never returning their invested capital. To learn how, let’s first study Prime Now’s business model.
Prime Now – The Business Model
Like most of Amazon’s other businesses, Prime Now was a bet on scale – if your variable cost per unit is below your revenue per unit (i.e. if you are contribution profit positive), at the right scale, your fixed costs can get allocated well enough for you to turn an overall profit (or more importantly positive free cash flow). And similar to Amazon’s core Ecommerce business (that I described in my Amazon Marketplace Profitability Analysis post earlier) – Prime Now has two business models:
- A Retail model (denoted by store “Amazon” on the Prime Now app) – where Amazon takes ownership of the product from the manufacturer, stocks the product in urban Prime Now fulfillment centers (FC), sets the price to the end consumer, pays for inbound (from manufacturers to Amazon FCs) and outbound (from FCs to customers) shipping, and is the seller of record. As of Jan-2018, customers who place orders worth less than $35 pay $4.99 delivery fee for 2-hour delivery (no 1-hour delivery option), and those who place orders worth $35 and above get free 2-hour delivery (or pay an extra $4.99 to get 1-hour delivery).
- A Marketplace model (denoted by other stores such as “PCC”, “Bartell Drugs”, “New Seasons”, or “Restaurants”) – where Amazon allows third-party stores and restaurants to sell to Amazon customers through the Prime Now App, taking a cut of each sale (aka referral fee/rake that is rumored to be about 20-30% of total sales). Unlike the MFN model of Amazon’s core Ecommerce business (and similar to the FBA model), Amazon pays for outbound (from restaurants’ or sellers’ locations to the customer). As of Jan-2018, customers who place orders worth less than $60 (for some stores $50) pay $5.99 delivery fee for 2-hour delivery (no 1-hour delivery option), and those who place orders worth $60 and above get free 2-hour delivery (or pay an extra $5.99 to get 1-hour delivery).
Let’s forget all the 1-hour and 2-hour fee differences and complications, and perform a quick gut-check to comprehend the unit economics of Prime Now’s business.
Start with the variable costs first. If you’ve ever worked in physical retail, you know that the average contribution profit in the kind of products that Prime Now sells in the Retail model is about 10% of topline without delivery costs. In Prime Now’s case, the physical store still exists (the urban fulfillment centers in case of the Retail model above, and the actual physical store such as Bartell’s in case of the Marketplace model above); yet they incur additional variable costs – from fulfillment to delivery – that eat into this contribution profit. I performed a very scientific study of asking every Prime Now delivery associate I saw how many orders they had delivered in the last hour. Across 25 associates, the average number of orders was only 3. To recover and breakeven on fixed costs (such as software development, or cost of building Prime Now urban FCs), Amazon needs to make substantially higher number of minimum value orders per driver per hour. Simply scaling number of orders don’t help profitability; the orders have to be from the same apartment or neighborhood in order for the drivers to increase the number of deliveries per hour.
To be fair, Prime Now can be sustainable if the only sold profitable items (e.g. if they only sold $1000 smartphones) or if they increase the prices of products sold (e.g. if an apple from Prime Now is suddenly priced at $35), then sure, the contribution profit will not be 10%. Prime Now can also be profitable if they increase the minimum order value from $35 to let’s say $70. That’s exactly what Amazon has done with Prime Now’s Marketplace model. As of Jan-2018, they have increased the minimum order from $35 to $60 for marketplace orders (from Bartell or others).1 Customers who place orders worth less than $60 (for some stores $50) pay $5.99 delivery fee for 2-hour delivery (no 1-hour delivery option), and those who place orders worth $60 and above get free 2-hour delivery (or pay an extra $5.99 to get 1-hour delivery). Arguably some orders are much higher than the minimum orders, bringing down the number of orders needed to breakeven; however, remember, we haven’t even got to fixed costs component yet. Even if they are slightly contribution profit positive, Amazon is looking at a significant time to recover fixed costs.
While using the contractor-model of Amazon Flex delivery drivers has helped offload the fixed salary component of hired drivers to a variable component of on-demand drivers, Amazon still needs to be contribution profit positive for Prime Now to be sustainable. All this would be okay if you could bring down variable costs through economies of scale in the long-term. Yet, for that to happen, you need to make more number of orders per hour per driver – only possible in extremely dense urban locations such as New York or London.
The other important argument (that any Amazonian will definitely put forth) is the impact on the Prime Flywheel, i.e. downstream impact from new Prime customer acquisition and existing Prime customer retention. This is similar to the argument that one should view Prime Now through the CAC and LTV lens. Since Prime member data isn’t publicly available, it is unclear how much impact Prime Now has on the Prime Flywheel; but unless every dollar that Prime Now loses is made up by an additional dollar of profit from spend on the overall Amazon platform by Prime customers, Prime Now will continue to be unsustainable.
+ Prime Fresh
So, what about Amazon Fresh, the $180 per year grocery delivery service, then? Well, tack on the variable costs of specialized delivery bags, Amazon-owned fresh trucks, Amazon-employed delivery drivers, higher produce shrinkage and the additional fixed costs of refrigerated fresh fulfillment centers, and you get the picture. Even with the additional ~$15 per month from each customer and a minimum order of $40, Prime Fresh is unlikely to cover the additional costs incurred (compared to Prime Now). The bottom-line, if Prime Now is unsustainable, Prime Fresh is UNSUSTAINABLE in all caps.
+ Whole Foods
Amazon now has Whole Foods, that should change things for Prime Now right? Amazon has already announced Prime Now deliveries from Whole Foods, and in some ways yes, the fixed cost of Urban FCs and the fulfillment portion of the “nominal fulfillment and delivery” costs will now allocated to the physical store business’s P&L (which in Whole Food’s case is profitable). But that said, the variable costs of Prime Now’s delivery will still make it unsustainable at current prices. Again, unless every dollar that Prime Now loses is made up by an additional dollar of profit from spend by Prime customers on the overall Amazon platform – whether at Whole Foods or elsewhere on the platform, Prime Now will continue to be unsustainable.
The Refresh (Prime Now + Prime Fresh + Whole Foods)
Given that there are rumors of a consolidation between Prime Fresh and Prime now already underway, I wouldn’t be surprised if Amazon announces a complete shutdown of the Amazon Fresh business within the next couple of years or so. As for Prime Now, it will live to fight another day. That other day, though, will not look like today. In the current “delivered to the home” model, Prime Now + Whole Foods will need to make two major changes to their pricing – (1) increase the minimum order to $80 to increase the per order contribution profit, and (2) institute delivery fees of $10 (to cover for admin, sales & marketing, and fulfillment costs) for orders below $80. Increasing prices to these levels, however, will quell customer demand, and while I don’t have any data on price elasticity for Prime now customers, my intuition says that customer demand at these prices will be insufficient to sustain the Prime Now business.
For all these reasons above, in the long-term (perhaps 5 years or so from now), Prime Now will eventually go the way of several other experiments at the World’s Best Place to Fail.
Note: This blog post does not contain confidential Amazon information; these are my personal views and does not represent the views of Amazon or its management.
PS: Unexpectedly, this post briefly trended on the front page of Hacker news and I received some fair criticism and feedback about my analysis. The fair ones: (1) In an earlier version of this post, I used estimates that were are not backed by data. I will not disclose internal confidential Amazon data even if I had access to it. (2) I had incorrectly assumed SG&A as a variable cost; it is actually fixed costs, so per order SG&A should decrease with scale. (3) Prime subscription revenue isn’t baked in to this analysis. I only talked briefly about downstream impact from higher prime member spend because I believe that Prime subscription revenue is offset by higher Prime shipping costs. (4) Future tech and scale. If automated cars, drones, and delivery robots become a thing (and it will eventually, just a question of when), yes, things will look very different for Prime Now. I also agree that scale (more number of orders per hour by the same driver) will improve profitability.
The point of this post wasn’t to get into the details of Prime Now’s financials; rather it was to suggest that Prime Now, like Shyp and other unprofitable on-demand businesses, will struggle to be sustainable in the long run due to their negative unit economics. Thanks for the feedback.
When Prime Now first launched $20 was the minimum order.↩