How Does Amazon Pay For Free Shipping?

Budgeting, Investing & Retiring

Does your family celebrate Amazon Prime Day? Over half of Amazon customers are estimated to be members of Amazon Prime, a staggering figure. Prime Day 2018 was the biggest shopping day of the year, exceeding even Black Friday and Cyber Monday, with 89 million visitors logging on and over 100 million products sold. Prime Day 2019 starts on Monday, July 15th at 12 a.m. PT and for the first time ever will run for 48 hours.

Amazon Prime members gain several membership advantages, but one of the greatest is free shipping year-round. For only $119 per year, you get free shipping and rapid delivery — and if you use Amazon even semi-regularly, you will save a bundle on shipping charges compared to the $119 membership. That begs the question: how can Amazon afford free shipping with Prime membership at only $119? The price was raised from $79 to $99 in 2014 and from $99 to $119 in 2018, but shipping costs are not the fundamental reason why.

It is not an issue of volume; that actually aggravates the situation. Logically, one of the main points of Amazon Prime is to get people to spend more on Amazon, thus, a successful Prime program adds to Amazon’s overall shipping costs. In 2018, total shipping costs, including sortation, delivery center, and transportation costs, were about $27.7 billion.

One of the main mechanisms that makes free shipping feasible is that merchants are paying fees on the back end that you do not see as a consumer. Presumably, merchants have already priced those fees into their products.

As you look around through Amazon, notice the small indicator that says “Fulfilled By Amazon.” Merchants pay significant fees for the privilege of participating in this “FBA” program, including various handling and packing fees. The real key is for inventory storage.

For Amazon to provide the quick turnaround that customers demand, they must have inventory that is both sufficient and efficient — and that is where Amazon excels. Not only is Amazon good at handling inventory, they are good at pricing inventory fees to balance the needs between Amazon, consumers, and merchants.

Inventory fees are charged by the square footage that merchants’ items take up, with seasonal and product-related factors figured in to maximize fee revenue. For example, the standard monthly inventory charge is $0.69 per cubic foot of volume in the first nine months of the year, but afterwards, in anticipation of the holiday season, the rates go up to $2.40 per cubic foot. That may not sound like much, but keep in mind that Amazon owns more than 11 million square feet of warehouse (aka fulfillment center) space, and leases almost 280 million square feet of additional space. Multiply by the ceiling height to get some idea of the full volume (presumably, warehouses have at least 10-foot ceilings and are probably much higher).

Long-term storage fees for items that sit in the Amazon fulfillment centers for more than a year take up an additional $6.90 per cubic foot per month, with a minimum per-unit charge of $0.15. In September 2018, Amazon changed the pricing for long-term storage from a semi-annual basis to a monthly basis. Returning or disposing of inventory incurs yet another set of fees. This strategy forces merchants to analyze efficiently what items should be kept within the fulfillment centers for Prime offerings, and therefore keeps Amazon efficient by default. It is a highly effective strategy.

Why do merchants pay the fees? Because Prime membership and free shipping moves a lot more product. The increase in sales justifies the increase in costs. Amazon also offers support to merchants, and even allows the FBA for orders placed elsewhere (not through Merchants with enough volume and proper pricing structures come out well ahead on the deal.

For 2018, Amazon had almost $233 billion in net sales and over $220 billion in operating costs – of which the $27.7 billion in shipping costs comprised a mere fraction – resulting in over $10 billion dollars in comprehensive income. With growing revenues, Amazon is able to absorb the shipping element and even work on expanding Prime’s offerings. For example, the mobile app Prime Now delivers items to many parts of the country in less than two hours.

In April 2019, Amazon announced its plan to develop its two-day Prime shipping guarantee into a one-day guarantee. Expect Amazon to continue its path of innovation and fast delivery, to the benefit of consumers as well as to its own coffers. Ready for faster delivery by Amazon drones?

If you want more credit for a big-ticket item this Prime Day, check out our list of credit card offers.

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