Capital Sourcing from Customers: How Amazon Prime Makes Money
What kind of businesses are so compelling that customers will pay in advance of receiving the value from the exchange? How can marketers position their value so that consumers will want to pay in advance?
Collecting customer’s money in advance of product or service delivery is not unique or new; insurance companies and most membership programs (fitness centers, for example) have been collecting cash up front for years. That said, relatively new industries are collecting complete payment up front for a basket of goods or services and using that cash to fund or expand business operations.
In the face of a global pandemic, perhaps the most salient example of a groundbreaking company collecting revenue in advance is Amazon’s Prime service. An annual membership with Amazon Prime is purchased ahead of the value received by the customer in the form of free shipping and access to video, music and other services. While Amazon collects the whole fee up front, the customer now can consume as much of the services they want throughout the entire year.
Do consumers realize that in this scenario they have essentially provided Amazon with the cheapest source of financing, customer capital?
As opposed to debt capital, where companies borrow money and pay interest, or equity capital, where companies give up ownership and often paid dividends, the only “cost” of customer capital is providing the promised goods or services to the customer.
Going deeper into the mechanics of this transaction, a customer purchases an Amazon Prime member and the company promises to provide the benefits on an ongoing basis. At the time of purchase, the cash received, and corresponding liability are recorded. As the Prime benefits are delivered over time, the liability is reduced until the company has fulfilled their obligation to the customer and revenue is realized (12 months of Prime Service). In the meantime, however, the company now has the ability to use that cash; allowing them to expand or provide much needed working capital to continue to operate.
With that in mind, what makes customers want to pay in advance for the service?
According to John Mullins PhD, a customer-funded business model “convinces the customer to pay something up front, whether in full or in part — before they receive what they’ve bought”. He goes on to say there are four reasons for doing so:
- You are solving a customer’s compelling problem
- You have built up trust with your customers
- You have technology that can solve problems others cannot
- Your offering is very different from what’s in the market and your customers want your product or service
In 2005, Jeff Bezos and Amazon constructed a program with the single threaded desire to provide “all you can eat shipping”. At the original price of $79, the free shipping for one year was enticing to customers. With retail competitors at the time offering pay-as-you-go shipping, Prime membership made economic sense to consumers who frequently ordered online. Prime has continued to differentiate itself by bundling compelling client needs with this service, such as prime video.
Costco memberships provide another example. An annual membership is paid in advance for the access to the warehouse. These membership fees accumulate to over $3B a year for Costco. The customer believes that the membership solves a compelling problem of bulk buying and unique offerings at great prices. A relationship of trust causes the customer to “prepay”. Costco uses the capital to deliver the value to customers throughout the year and to achieve shareholder value through profits.
So how can we as marketers, drive our value proposition to be one that motivates a customer to pay in advance? Not only do you need to have a differentiating product or service or superior technology, but the customer must also be made aware of the value your company is offering. Doing so requires a tailored communication strategy that informs the customer and build out the brand to evoke trust between the consumer and the company. In order to utilize the customer capital over a long-time horizon of value, a relationship beyond transactional near-term exchanges must be built with your customers. Relationships are established through ongoing interactive engagement. The digital world catalyzed by the pandemic crisis has rapidly evolved a 1:1 interaction.
In these tough times, financial borrowing may become more difficult and prohibitively expensive. Furthermore, owners may not want to dilute their ownership by giving up equity at lower levels. Profits may also be harder to come by with reduced business activity. As such, being able to count on customers for an additional source of capital becomes increasingly important. Company’s must ask themselves how they can get customers to pay in advance and how they can work with customer money to sustain operations in a risk balanced fashion. Bringing that message to consumers is going to require creative marketers who can clearly and confidently explain the value proposition and build relationships, so customers feel good about you having their cash.
About the Author: Tony Poidomani
Tony is a Certified Public Accountant and teaches Financial Accounting in Northwestern Medill’s Integrated Marketing Communications graduate program. He is the CFO of CSCMP, the leading association for supply chain professional association.
