Amazon Prime Instant Video Is a Huge Loss Leader

By Adam Levy Markets Fool.com

Amazon (NASDAQ: AMZN) has been more forthcoming with information about Amazon Prime recently. The biggest piece of information Amazon disclosed is that its retail subscription services brought in $6.4 billion last year. While that segment includes more than Amazon Prime, it certainly made it easier to estimate how much money Prime brings in for Amazon.

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Digging further into Amazon's 10-K allows us to estimate how much revenue from Prime subscriptions Amazon puts toward shipping revenue, and how much it puts toward everything else it offers through Prime (video, music, etc.). Estimates for Amazon's spending on video and management's comments can help us piece together how Amazon views the economics of Prime Video.

It should be no surprise that Prime Video is a loss leader.

Image source: Amazon.

Let's do some math

For 2016, Amazon reported $6.39 billion in retail subscription services revenue. About 90% of that revenue, $5.75 billion, came from Prime subscribers, according to analyst estimates.

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Amazon also reported net product sales of $94.67 billion for the year. Net product sales include "revenue from the sale of products and related shipping fees," according to Amazon's 10-K. Amazon also reported that retail products generated $91.43 billion for the year later in the 10-K, where it broke out subscription revenue. Retail products include regular shipping charges, but not subscription revenue from Amazon Prime. Those go toward the aforementioned retail subscription services.

So, it looks like $3.23 billion of shipping revenue in "net product sales" came from Prime subscriptions. That leaves around $2.52 billion in Prime subscription revenue for everything else, including Prime Video. (Keep in mind these are still just estimates based on Prime accounting for 90% of subscription revenue.)

$2.5 billion is significantly less than the $8.8 billion Netflix (NASDAQ: NFLX) generated last year. Still, Amazon is successfully competing against Netflix for content both original and licensed.

How much is Amazon spending on content?

Amazon doesn't give exact details on how much it spends on video content. Industry estimates put the number at $3.2 billion for 2016, though. That implies Amazon is taking at least a $700 million loss on Prime Video after accounting just for content costs. It also has distribution and marketing expenses for the product. For comparison, Netflix plans to spend $6 billion on content in 2017. It also spent nearly $1 billion on marketing last year.

Amazon will certainly spend more on content this year. It doubled its content spending and related marketing expenses in the second half of last year, and investors should expect spending to remain elevated after it expanded to 200 countries at the end of last year.

It's clear Amazon is taking a significant loss on Prime Video, but it's easily subsidized by the increased shopping the average Prime subscriber does on Amazon.com. Prime has fueled both Amazon's retail product sales and its third-party sellers service, which grew to $23 billion last year, up 44% year over year.

What this means for stand-alone Prime Video

Last year, Amazon launched Prime Video globally, including in markets where it doesn't include the shipping benefits of Amazon Prime. Stand-alone Prime Video subscribers will pay $5.99 or 5.99 euros ($6.36) depending on their market. That represents a significant discount from the $99 annual fee ($8.25 per month) U.S. Prime subscribers pay. It's also less than the $9 per month for stand-alone Prime Video in the U.S.

The good news is that Amazon is currently allocating less than half of Prime subscription revenue toward video. Last time I checked, $6 per month is more than half of the average Prime subscription price. (Just double-checked. It's still more.)

That means Amazon's stand-alone product might represent a bargain compared to Netflix, but it doesn't mean Amazon is going to take a loss on it. It's just not nearly as profitable. As Amazon CEO Jeff Bezos once said, "Your margin is my opportunity."

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Adam Levy owns shares of Amazon. The Motley Fool owns shares of and recommends Amazon and Netflix. The Motley Fool has a disclosure policy.