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Jun 21, 2023

Amazon's Buy With Prime Is A Game Changer, Here's Why (Part 2) (NASDAQ:AMZN)

Daria Nipot Yesterday, we uploaded the first part of a miniseries on the new

Daria Nipot

Yesterday, we uploaded the first part of a miniseries on the new Amazon.com, Inc. (NASDAQ:AMZN) Buy With Prime offering. In that article, we discussed what Buy With Prime is, its value proposition, and the pain points it solved for 3P sellers. In this article, will go over the topics you can see on the right-hand side in the image below:

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Without further ado, let's get started!

In our first article on Buy With Prime, we discussed how Buy With Prime added value to 3P sellers who were suffering the pain points of selling on Amazon's marketplace and the Prime members who wanted to enjoy the "Amazon experience" elsewhere.

Amazon has always focused on its customers, and Buy With Prime is just another example of this as it improved the value proposition for its Prime members. This said, Amazon has also been widely criticized for only focusing on the customer without any effort to manage costs and profitability. This criticism is now louder than ever, as the stock is down quite a bit from its highs. So, investors are at a point where they want to see how the benefits accrue to Amazon and not only its customers.

We have divided these benefits into monetary and non-monetary. So, let's go over them.

Buy With Prime will generate revenue for Amazon through various sources. The most significant revenue source (which doesn't mean it will be the most profitable) will come from fees (FBA, referral, and payment processing) that Amazon will charge Buy With Prime sellers:

Amazon

We have not found on Amazon's website how much Buy With Prime sellers will have to pay for these services (the company claims in the image above that pricing is explained in detail once enrolled in the program). However, we did come across the following table on Twitter which details the fees and seems to be coherent with what is described in the image above:

Twitter

Note that we have no way of knowing if the table above is correct because it doesn't come from an official source, but we imagine it might come from a seller willing to enroll in Buy With Prime.

If the fees shown in the table are correct, it looks like Buy With Prime sellers will pay a bit less on referral fees but will pay more on FBA fees than 3P sellers on Amazon's marketplace. Amazon currently charges 3P sellers a referral fee between 8% and 15% per product depending on its category (some products carry a higher referral fee). This referral fee will be 3% for Buy With Prime orders, irrespective of the product category, and will have a $1.50 floor.

Note that Amazon will take a 2.4% payment processing fee for Buy With Prime orders that was most likely "included" in the 8% to 15% referral fee on its marketplace. If we add the Buy With Prime referral fee to the payment processing fee, we end up with somewhere around 5.4% in "referral" fees per order. This is still significantly lower than the usual 8% to 15% referral fee that most 3P sellers are currently paying.

This said, it does seem that Amazon will make up for this difference through increased FBA fees. Let's take both extremes to compare them. Sending a special oversized Buy With Prime order would cost the seller a minimum of $189.19 (from the table above). However, if this seller were to sell this product in Amazon's marketplace, it would cost them a minimum of $158.49 in FBA fees. That's 19% higher for the Buy With Prime order.

Amazon

If we go to the other extreme and look at a seller willing to send a small standard package of fewer than 4 ounces through Buy With Prime, that would cost them $5.38 in FBA fees (we are assuming only one unit is sent). This amount would be reduced with every additional unit until reaching a minimum of $2.76 per unit. If this seller were to send this product after selling it through Amazon's marketplace, then it would cost them $3.22 per unit:

Amazon

For comparison reasons, we calculated the average of the four numbers shown in the Buy With Prime table above, reaching an average price per unit of $3.81. In this scenario, a Buy With Prime order would be on average 18% more costly for the seller than selling directly on Amazon's marketplace. We have not calculated this for every size tier, but it seems obvious that Amazon is making the difference in lower referral fees through higher FBA fees. This divergence makes sense, in our opinion. The rationale is that, through Buy With Prime, the traffic will be generated outside of Amazon's marketplace, so it makes sense to take a lower referral fee. However, high conversion is most likely achieved thanks to Amazon's fast delivery, so the FBA service becomes more "valuable."

Let's look at the numbers with a quick example. Imagine a seller sells a set of 4 pillows with a selling price of $25. Assuming a large standard size and somewhere between 8 to 12 ounces (225 grams to 340 grams), the amount the seller would have to pay would vary as follows depending on whether this was a Buy With Prime order or if it was sold directly through Amazon's marketplace. Note that we assumed a 15% referral fee for the second case, that only one unit is shipped, and we ignored the seller fee that sellers selling on Amazon's marketplace would have to pay:

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The seller would incur a total fee of 32% of order value selling directly through Amazon's marketplace. This number would be 37% for a Buy With Prime order. Amazon is making more money in this particular order with Buy With Prime, but it's also true that sellers have benefits that they wouldn't enjoy selling on Amazon's marketplace, for example being able to protect their brand and owning the customer data.

Another direct monetary benefit will come from ads. As discussed in the first article, Buy With Prime sellers will be able to advertise their Buy With Prime products on Amazon. These ads will redirect buyers to an Amazon landing page displaying all the seller's Buy With Prime products. Once the buyer has selected one of these products, they will be redirected to the seller's website to check-out. It's difficult to grasp how much money Amazon will make from these ads, but it's undoubtedly a highly profitable venture for the company.

It's also pretty obvious that Amazon's Total Addressable Market (both in ads and in the myriad of fees it takes from sellers) gets much larger with Buy With Prime as it breaks the barriers of the marketplace for the first time.

There are a couple of non-monetary benefits that we want to discuss. We call them "non-monetary" not because they will not generate revenue for Amazon but because the link between Buy With Prime and where this money will be generated is not as clear as with the monetary benefits discussed above.

The first one is regulation. Regulators have set eyes on Amazon for exerting monopolistic power over 3P sellers. We have already seen that Buy With Prime might even be more expensive for sellers, but we believe that the fact that they can now end the purchase on their own site and "protect" their brand will serve Amazon well when facing future regulatory pressures. Amazon is still supplying the buyer and fulfillment, but its marketplace's barriers have been opened for the first time. Of course, the focal point of the research is that Amazon used the data of its sellers to benefit from and that is still a risk with Buy With Prime.

The second non-monetary benefit is a larger top of the funnel for the Prime membership. The Buy With Prime button that buyers will see on third-party websites will always be visible:

Amazon

Every visitor to the website will see it, and once they push it, Amazon will "find out" through a login or the app if the customer is indeed a Prime member. Having this option always visible regardless of Prime membership status gives the Prime subscription a lot of visibility and might help increase the number of subscribers.

Buy With Prime may allow Amazon to lower its regulatory risk, but also brings other risks that should be considered. The main risk is that the transaction is being taken out of Amazon's marketplace, which might allow 3P sellers to build long-term relationships with Prime members who might stop using Amazon's marketplace as a search venue. Now, we don't think this risk is that significant. Let's see why.

Amazon will still "own" the buyer and that buyer will be there because they can enjoy Amazon's fast and free delivery on a third-party website. This results in a very low probability of a 3P seller building a long-term relationship with a Prime member and cutting Amazon off. The rationale is that to sustain that relationship, the seller would have to offer similar conditions to the Prime member than they get on Amazon. Unless this seller has invested billions into a curated supply chain or is willing to lose quite a bit of money per order in fulfillment, this seems unlikely to us. We have to also consider that one of the strengths of Amazon is the product variety in its marketplace. Not many companies can offer this and if they can, it's unlikely they will enroll in Buy With Prime!

It's also worth noting that Buy With Prime ads offer a significant switch barrier. Everyone knows that Amazon's ads are highly effective in directing high-value traffic (primarily because the user comes in with a purchase in mind), so cutting off Amazon would mean that sellers would have to generate this traffic elsewhere, probably through a less efficient marketing channel.

The risk of Amazon being cut off in the buyer-seller transaction is undoubtedly higher in Buy With Prime than on its marketplace, but this risk is still very low, in our view. We have also seen how Amazon will be more than compensated for this increased risk through higher overall fees.

So, the main question here is the following: How will Buy With Prime impact the "battle" between Amazon and Shopify?

Now that Amazon is opening the barriers of its marketplace, the value proposition of both companies seems to be getting closer and closer. Of course, Amazon still lacks the capabilities to offer sellers a platform to sell independently, but companies such as BigCommerce have already announced that Buy With Prime will be available to all of its users:

BigCommerce

Other online store providers such as Wix already have a partnership with Amazon to allow its users to enjoy its benefits, so it seems pretty obvious that Buy With Prime will also be available to them.

So, what about Shopify? Will the company allow Buy With Prime? The answer is a resounding no, or at least not yet. Shopify Inc. (SHOP) has taken an entirely different route and has warned its users that trying to activate Buy With Prime on their stores goes against its terms and conditions. In these T&Cs, we can read the following:

You agree to use Shopify Checkout for any sales associated with your online store. "Shopify Checkout" means Shopify's checkout experience that allows Customers to enter their shipping information and payment details after adding item(s) to their cart and before placing an order, including checkouts that occur through the Shopify Checkout API.

Source: Shopify (emphasis added).

Having to comply with the above completely rules out Amazon's Buy With Prime offering, as it would mean that merchants would be using a different checkout than Shopify's. The company doesn't want merchants to include the Buy With Prime option because it would impact Shopify's payment revenue, which would go through Amazon Pay. For Shopify, this revenue is very important and growing fast. So, how does this impact the competitive landscape?

Regarding existing sellers, we think Shopify has high switching costs (the company announced the first price hike in 12 years just last week). Shopify's management has already said that both parties have been negotiating for months, but that they have not moved. Amazon is known to be a very tough negotiator.

Regarding new sellers (those that have not even opened a store yet), we do think Amazon's Buy With Prime will compete effectively against Shopify. If you wanted to start a store under your own brand before Buy With Prime, you would most likely go to Shopify. With Buy With Prime available, there are now more options to choose from. Starting January 31st, a potential seller has the Shopify option, or they can also go to BigCommerce or Wix and integrate directly with Buy With Prime to start selling to high-value buyers (Prime members).

Shopify and Amazon are increasingly competing for e-commerce dollars. Both companies follow different models but their value propositions are getting closer and closer each year. How will this play out? Only time will tell.

In a previous article on the company, we explained why we think many investors mistakenly give Amazon's retail segment the "bad business" label. While retail economics are not the best, this business line gives Amazon optionality. Buy With Prime is another example of this optionality because it wouldn't be possible without the retail business and Prime subscriptions (which, by the way, are supported again by the retail business!).

Retail might appear to have low margins, but these look like they are artificially depressed to reduce regulatory pressures. What would retail margins be if Amazon bundled all the business lines that depend on this segment such as subscriptions and Ads? It's difficult to tell precisely, but not difficult to guess directionally: they would be meaningfully higher. In a business line that gives the company a lot of optionality and supports its moat, one should not be looking so closely at margins.

We hope this 2-part series helped you understand Amazon's new offering, Buy With Prime, and what it means for Amazon, its customers and its sellers. Buy With Prime portrays once again why retail is so vital in providing optionality for the company and how Amazon is slowly continuing to profit from a moat that it has built over the last two decades.

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This article was written by

Analyst's Disclosure: I/we have a beneficial long position in the shares of AMZN either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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