• by Thom Forbes  @tforbes, November 14, 2011

If the main gear in Amazon’s future is customer loyalty, the axle it revolves around is Amazon Prime, the $79-a-year membership option that began by offering free two-day shipping for a family but has been expanding into other areas such as free (if selective) video streaming and, recently, free (if-selective) e-book lending on the Kindle (including the hot, new Fire).

Amazon Prime is so crucial to the company’s success, in fact, that analysts say it’s willing to lose hundreds of millions of dollars a year as it transitions from a purveyor of books on paper to an Internet mega-mall, Stu Woo reports in the Wall Street Journal.

Piper Jaffrey analyst Gene Munster figures that Amazon spends about $90 annually for each Prime subscriber -- $55 in shipping costs and $35 for its deals with studios for digital video content. He also estimates that Amazon sells each Kindle model at a loss of $10 to $15, and points out that the lending library will add costs.

"They're going deeper [with Prime] on the thesis that if they can make [customers] more loyal, they can make more profit, even if they have to subsidize," former Amazon executive David Selinger tells Woo.

Munster estimates that Prime, which was started in 2005, will soon have 10 million subscribers purchasing everything from the latest potboiler to cans of cat food.

Bloomberg Businessweek’s Virginia Postrel reports that traditional publishers aren’t the only ones chagrined by Amazon’s decision to compete with the public library, and it’s not Sue the Librarian who’s upset. It’s those folks who occupy Wall Street and trade stocks for a living because it increases the online retailer’s out-of-pocket costs.

The end game, Postrel posits, is to bundle books the way that cable companies and video services like Netflix do by charging a fixed monthly fee rather than individual charges for (most) items.

“Amazon’s lending library, which comes along with free shipping, streaming video and whatever else the company next decides to throw into an Amazon Prime subscription, is a move toward bundling digital books,” Postrel writes.

Postrel quotes from an 2000 article by economists Erik Brynjolfsson and Yannis Bakos in Marketing Science: “It is easier for a seller to predict how a consumer will value a collection of goods than it is to value any good individually,” they wrote, noting “at the optimal price, more consumers will find the bundle worth buying than would have bought the same goods sold separately. Because of the predictive value of bundling, large aggregators will often be more profitable than small aggregators, including sellers of single goods.”

Right now, though, as anyone searching for a current movie title on Amazon Instant Video will attest, the pickings are, shall we say, not exactly for the gourmet? Time’s Jared Newman finds a similar situation with Amazon Prime’s free Kindle e-book list which, the headline in his Techland blog reports, “Leans on Filler, Public Domain,” including some titles that are already available on Project Gutenberg.

“Out of the 100 most popular books in the Kindle Owners’ Lending Library, roughly half are novels or literary non-fiction, Newman writes. “That’s not to say you won’t find anything worth reading among the Prime eligible free e-books. While sorting through the top 100, I found some gems like Moneyball and Kitchen Confidential. But to find the good stuff, you’ll have to do a lot of digging.”

But Amazon’s game plan isn’t just about diversions like books and movies. It’s about the brass tacks and Pampers and other goods that we used to pick up at local retailers. Don’t think for a minute that this hasn’t escaped the notice of those quaint bricks-and-mortar shoppes. Take, for instance, Walmart, as Jack Neff does in Ad Age this morning.

It’s “playing defense against Amazon's increasingly aggressive moves into packaged goods,” Neff writes, but “e-commerce supports broader strategies for the Bentonville behemoth as it looks to boost its presence in urban markets, take another stab at reaching upscale consumers and build more small stores.”

Walmart is focusing on integrating its store and online marketing. Employees will get credit for online sales from their territory starting Feb. 1, for example, giving them an incentive to promote Walmart.com as well as “the new iPad app, My Local Walmart Facebook app, and its soon-to-be-released refurbished iPhone app to the 140 million weekly in-store shoppers.”

And let us not forget that Walmart has 3,800 stores and 150 distribution centers it can use for services such as "Home Free" -- free shipping on orders over $45 from its stores -- which it rolled out last month.

The respective moves by “Earth's largest retailer and Earth's largest online retailer,” Neff writes, have put them “on a collision course for what could be the retail battle of the decade.” We’ll definitely be keeping score at home.