(Bloomberg) -- In the internet Stone Age of 2005, Amazon.com generated 70 percent of its annual revenue from sales of books, CDs, DVDs and other physical forms of media. That financial reliance on relics could have doomed the company once people lost their taste for hard copies of books, music and movies. Instead, Amazon parlayed its greatest potential weakness into a foundation of its future.
Media's Share of 2015 Revenue
21%
Amazon's sales of media shriveled to 21 percent of total revenue in 2015, thanks largely to Amazon's e-commerce diversification into nearly every imaginable product and service. But the company didn't thrive just because it became the store for everything.
Amazon has also used its hold on fading physical media to pivot into digital media -- a web video service, e-books, digital music, audio books and now podcasts -- that have become essential fuel for Prime, the $99-a-year shopping club that is arguably the most important factor in Amazon's retail dominance.
The company avoided becoming a Borders-like victim of changing media habits because it doesn't need to make money anymore on books, music or DVDs as it did in the Stone Age. Rather, like nearly everything at Amazon, the media offerings serve to make Prime more appealing.
The Netflix-like Prime Instant Video service is included as part of the $99 annual fee. Prime members can "borrow" many Kindle e-books just as they would at a public library. Amazon's music-streaming feature is also included as a Prime add-on, and the neglected stepchild seems to be receiving more attention. Just as Amazon has done with web video, its audio books company, Audible, said Thursday that it was producing exclusive podcasts for a subscription service. Audible and Prime aren't connected yet, but surely some Prime members would take advantage if they could download one free audio book a month.
At Amazon, the e-commerce operation is completely optimized for adding names to the Prime membership rolls. That's because customers who are Prime members on average spend $1,100 on Amazon each year, nearly double those who aren't, according to Consumer Intelligence Research Partners. More goodies associated with Prime membership lure more Prime subscribers which leads to higher shopping tabs.
When Amazon pushed its way into Netflix's turf in web video streaming, it seemed like an odd strategy. Paying for programming from the likes of Disney and its own in-house TV production arm also may cost Amazon $2.25 billion this year, Bloomberg Intelligence estimates. But the risk and costs are worth it, because media is becoming a critical reason people sign up and stay with Prime.
"When we win a Golden Globe, it helps us sell more shoes," Amazon CEO Jeff Bezos said at the recent Recode tech conference about the awards garnered by his company's web video programming. Bezos also said Prime members who use the web video features renew their yearly memberships at higher rates than people who don't, and the people trying Prime for free are also more likely to pay for a membership if they use Amazon's video service.
Nearly half of Prime members in a Bernstein Research survey of 1,000 households cited Amazon's web video add-ons among the two most important reasons for subscribing to Prime. (Not surprisingly, the most valued feature was free two-day shipping.) Perhaps more important, more recently enrolled Prime members were more likely than veteran customers to avidly use Prime Instant Video, the Bernstein survey found. That shows video has most likely lured people who previously resisted signing up for Prime just for free shipping.
Amazon is notoriously tight-lipped about Prime's finances, including subscriber numbers. Consumer Intelligence Research Partners estimated there were 54 million Prime members in the U.S. at the end of 2015. Bernstein estimated Amazon ended 2015 with 58 million to 69 million trial and paying Prime customers worldwide. The research firm calculates Amazon is on track to generate an impressive $115 in extra operating profit a year for each Prime member. At 60 million users, that would be $6.9 billion for a company whose cumulative annual operating profit since it went public in 1997 is more than $8 billion.
As usual, Amazon has landed on a way to extend its dominance. It's a rare trick to turn its dependence on media from a risk into an asset.
This column does not necessarily reflect the opinion of Bloomberg LP and its owners.
Correlation is not causation, of course. Amazon discloses laughably little financial information about its Prime members, so it's possible the engaged ones that are most likely to renew are predisposed to watching Amazon's web streaming programming.
To contact the author of this story: Shira Ovide in New York at sovide@bloomberg.net.
To contact the editor responsible for this story: Daniel Niemi at dniemi1@bloomberg.net.
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