For Amazon Shareholders, Prime Boosts Costs And Trashes Profits

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Selling dollar bills for 99 cents apiece is a tough business, and you can’t make it up on volume, so what steps Amazon (NSDQ: AMZN) (AMZN) takes, or doesn’t, to rein its shipping costs in 2012 will have a huge impact on the company’s bottom line.

Net shipping costs – the amount by which Amazon subsidizes customers’ deliveries to encourage them to buy and buy more – were up 82 percent for the first three quarters of 2011, to $1.5 billion. If that rate of increase continued in the crucial fourth quarter, Amazon’s total 2011 net shipping costs would be about $2.5 billion. (Customers paying for shipping – those dummies who don’t have Prime – brought in $1.0 billion during the first nine months, and it grew more slowly, just 35 percent above the year-ago level.)

Revenue was up by a smaller percentage, 44 percent or so through three quarters, and thus net income (it really does matter) fell 38 percent for the first nine months to $454 million, or 99 cents a diluted share.

As YCharts wrote earlier in the week, the Cult of Amazon Prime is a costly one.

Call it Amazon Prime or any off the other shipping promotions the company has used to boost sales over the years, at its most extreme it’s a market share grab on which Amazon is willing to not only suffer reduced margins, but actually lose money on additional sales. Otherwise, it seems, Amazon’s profit in dollars wouldn’t be shrinking. And with its after-tax margins so thin, Prime, if it’s much more successful, could render Amazon a money-losing company. Now that’s customer-friendly.

Net Shipping Costs (in millions of dollars); percent change; percent of net sales

2011-first nine months:—————–$1,503———–82%————-4.9%

2010-full year—————————-$1,386———–63%————-4.0%

2009—————————————$849————35%————-3.4%

2008—————————————$630————45%————-3.2%

2007—————————————$434————37%————-2.9%

2006—————————————$317————32%————-3.0%

2005—————————————$239————22%————-2.8%

The stock market seems mostly indifferent to Amazon’s margin compression, with the recent reduction in its valuation still leaving the stock’s PE at nearly 100. Investors instead seem focused on revenue growth, which is super largely thanks to Prime.

If Amazon figures out how to keep its sales growing while pulling back on shipping subsidies, the stock’s trading multiple will shrink fast as profits soar. But it’s possible that a lot of the customer loyalty is to Amazon Prime – it is cult-like — and that without free shipping online shoppers would shop around more.

Either way, watching Jeff Bezos and his management team during 2012 is going to be fascinating.

Jeff Bailey is an editor for the YCharts Pro Investor Service which includes professional stock charts, stock ratings and portfolio strategies.

This article originally appeared in YCharts.

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