What's in Amazon's Box? Instant Gratification

Ruth Tinsley made two momentous changes to her life in the last year. In December she had identical twin girls. A few weeks later she signed up for Amazon.com's (AMZN) free shipping service, Amazon Prime, which guarantees delivery of products within two days for an annual fee of $79. The combination of those two events turned the graphic designer from Birmingham, Ala., into an Amazon loyalist who now buys software, jewelry, and birthday gifts on the site. Her 2010 Amazon total heading into the holidays: 150 individual items, up from 82 in all of 2009. "Now if I see or hear about a product somewhere else, I'll always check first to see if Amazon has it," Tinsley says.

Amazon Prime may be the most ingenious and effective customer loyalty program in all of e-commerce, if not retail in general. It converts casual shoppers like Tinsley, who gorge on the gratification of having purchases reliably appear two days after they order, into Amazon addicts. Analysts describe Prime as one of the main factors driving Amazon's stock price—up 296 percent in the last two years—and the main reason Amazon's sales grew 30 percent during the recession while other retailers flailed. At the same time, Prime has proven exceedingly difficult for rivals to copy: It allows Amazon to exploit its wide selection, low prices, network of third-party merchants, and finely tuned distribution system, while also keying off that faintly irrational human need to maximize the benefits of a club you have already paid to join.

Now six years after the program's creation, rivals, both online and off, have sensed the increasing threat posed by Prime and are rushing to try to respond. Wal-Mart Stores (WMT), Best Buy (BBY), Target (TGT), and J.C. Penney (JCP) have recently unveiled free shipping promotions for the holidays, turning the fall shopping season into a race to see who can go furthest in lowering shipping costs. In August, eBay announced its first rewards program, eBay Bucks, which gives shoppers 2 percent back on items purchased on the auction site using PayPal. Last month a consortium of more than 20 retailers, including Barnes & Noble, Sports Authority, and Toys 'R' Us, banded together with their own copycat $79, two-day shipping program, ShopRunner, which applies to products across their Web sites. "As Amazon added more merchandising categories to Prime, retailers started feeling the pain," says Fiona Dias, executive vice-president at GSI Commerce (GSIC), which administers the ShopRunner service. "They have finally come to understand that Amazon is an existential threat and that Prime is the fuel of the engine."

Amazon relentlessly promotes Prime in press releases and on its home page, and this year started offering free Prime trials to students and parents. The company declines to disclose specifics about the program, though analysts estimate it has more than 4 million members in the U.S., a small slice of Amazon's 121 million active buyers worldwide. Analysts say Prime members increase their purchases on the site by about 150 percent after they join and may be responsible for as much as 20 percent of Amazon's overall sales in the U.S. The company's executives acknowledge only that the program gets people to buy more—and more kinds of items—on the site. "In all my years here, I don't remember anything that has been as successful at getting customers to shop in new product lines," says Robbie Schwietzer, vice-president of Amazon Prime and an eight-year veteran of the company.

Prime came to life in late 2004, the result of a years-long search at Amazon for the right loyalty program. An Amazon software engineer named Charlie Ward first suggested the idea of a free shipping service via a suggestion box feature on Amazon's internal Web site, according to Ward's colleagues at the time. Bing Gordon, an Amazon board member and venture capitalist, says he came up with the "Prime" name, while other executives, including Chief Executive Jeffrey P. Bezos himself, devised the free two-day shipping offer, which exploited Amazon's ability to accelerate the handling of individual items in its distribution centers.

According to several former employees who participated in the program's creation, Bezos commissioned Prime in December 2004 at an unusual Saturday meeting in the boathouse behind his home in Medina, Wash. At the meeting, he told the small team of employees they could commandeer other company engineers and resources, and instructed them to ready Prime for a rollout in time for the company's fourth-quarter earnings report in January, less than two months away. The program is a "big idea," Bezos told the group that day in the boathouse, according to people who were there, and one that would help the company further capture the devotion of its best customers.

Bezos met with the group three times a week during that span. When the team members said they could not make the deadline, Bezos, eager to take advantage of the free publicity from earnings announcements, delayed the report by a week. One challenge was selecting the annual fee for the service; there were no clear financial models because no one knew how many customers would join or how it would affect their purchasing habits. The team ultimately went with $79 mainly because it's a prime number. "It was never about the $79 dollars. It was really about changing people's mentality so they wouldn't shop anywhere else," says Vijay Ravindran, who worked on the Prime team and is now chief digital officer for The Washington Post. After the launch, Prime broke even in just three months, not the two years the team had originally forecast. The results "blew us away," says Jeff Holden, who led the team and now runs Pelago, a startup that makes a mobile phone game called Whrll.

Amazon now offers Prime in the continental U.S, Britain, Germany, France, and Japan, and Schwietzer says the company is moving toward guaranteeing Prime shipments within a day instead of two days. Analysts are divided on whether the free shipping offers from Wal-Mart and others will affect Prime. Some point to the fact that these offers will expire after Christmas and do not guarantee two-day delivery, and say consumers will find Prime the better deal. Others, like Gene Munster at Piper Jaffray (PJC), think shoppers will think twice about paying that $79, at least for now. "Free shipping does undermine Prime," Munster says. "Wal-Mart made every person in America a Prime user overnight."

Another debate among Amazon analysts and customers is whether Prime is actually worth the money. Many members swear by the service and evangelize about it—Ruth Tinsley says she has gotten several friends to join. Others question whether Prime is really a good deal, since Amazon usually offers free shipping when customers buy more than $25 worth of items at a single time. The company now reliably ships to certain parts of the country such as New York and San Francisco within a few days and at no extra charge.

"I don't think it's a bargain at all," says Kit Yarrow, a professor of psychology and marketing at Golden Gate University who recently got a free Prime trial and cancelled it after a month. "Really what people are paying for is immediate gratification."

The bottom line: Wal-Mart and others want to replicate the success of Amazon Prime, which has boosted customer loyalty and sales at the e-tailer.

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