gas prices

The one price Amazon is willing to raise

March 13, 2014: 1:25 PM ET

Amazon's $20 Prime price hike breaks with the company's low-margin, high-growth strategy. Here's why the move makes complete sense.


FORTUNE -- Amazon Prime customers awoke this morning to something they're not quite used to seeing from the e-commerce giant: a price increase.

The Seattle-based online retailer sent emails to both its regular Prime and student membership program customers announcing a $20 price increase for the regular membership (from $79 to $99) and a $10 increase for students (from $39 to $49). And while that may not sound like a lot of money in absolute terms (just $1.60 more per month for the standard membership), most companies don't take a decision to raise the price of a product by 25% lightly.

Indeed, Amazon (AMZN) has been famously resistant to raising prices in recent years, which has enabled its revenue to soar -- by 20% in 2013 to $74.4 billion -- but it has left its profit margins razor thin:

AMZN Profit Margin (TTM) Chart

AMZN Profit Margin (TTM) data by YCharts

As you can see, this trend hasn't exactly been in the favor of investors, who have been valuing the company at a sky-high price-to-earnings ratio of 636.7. As Morningstar analyst R.J. Hottovy sees it, Amazon's stock market valuation "seemingly requires a leap of faith based on whether the company will be able to monetize its explosive growth."

MORE: Google's plans for a store may be more like a museum

So why is Amazon all of a sudden bucking its aversion to price hikes? There are several reasons, including the fact that it probably can't expect growth in its Prime program to continue at the rapid pace it has seen in recent years. Hottovy estimates that Amazon doubled the number of Prime members from 10 million to 20 million in 2013, and while he still thinks it can add "several million" more members in 2014, it's unlikely it'll hit 100% year-over-year growth again. Like any savvy business, Amazon wants to direct its investments in the areas where it can expect the largest growth.

Now that Amazon has what analysts believe to be roughly 20 million members -- its Prime army -- it wants to invest in making that experience as robust as possible. That means spending money on better content for its video streaming services and continuing to build out its fulfillment-center infrastructure so that it can efficiently ship to every corner of the country in two days or less.

Most of all, Amazon is raising its Prime prices simply because it can. The e-retailer is famous for beating out its rivals on prices for commodity products like electronics and media. But while Prime began as a sort of loyalty program that enticed shoppers to buy ever more from its massive warehouses, Prime has, for many customers, become one of the most unique products that Amazon offers. After all, where else can you go to to pay $100 bucks to get free shipping on such a wide variety of products, with free streaming video and Amazon's e-book lending library thrown in for good measure?

After years of duking it out in the rough-and-tumble world of commodity retailing, Amazon finally has a product no one else can offer -- and it's making a pretty safe bet that it can demand a higher price for it.

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