Amazon vans line up at a distribution center to pick up packages for delivery on Amazon Prime Day, ... [+]
People often make nice-sounding promises and very rarely keep them. If you're running a company and promise customers to offer great service, you really ought to back up that promise with the best capabilities in the industry. Otherwise you will disappoint your customers and they'll leave you for a company the makes ambitious promises and keeps them.
This comes to mind in considering Amazon. For decades, it sold stuff through a website and relied on others to deliver the goods. But, according to the Wall Street Journal, Amazon's 2013 failure to live up to its promises convinced CEO Jeff Bezos that Amazon needed tighter control of all the activities between the customer's order and its delivery.
So Amazon forward integrated into the business of distribution and delivery. As the Journal wrote, Amazon has "blanketed the U.S. with warehouses and package-sorting centers, flooded the streets with vans and taken to the sky." All this was done to help Amazon fulfill the promise of one-day delivery to its Amazon Prime customers who pay $119 a year for the privilege (and get a free online streaming service in the bargain).
Amazon's investment in the capabilities needed to make one-day delivery a reality is a threat to UPS, FedEx and all the retailers who compete with Amazon. It looks to me like Target is responding most effectively to the Amazon threat — Walmart and UPS are also doing well — and FedEx is struggling the most.
(I have no financial interest in the securities mentioned in this post).
The Crisis That Pushed Amazon To Forward Integrate
During the 2013 holiday season orders by Amazon customers were too much for U.S. carriers which resulted in late deliveries and angry customers. To lower the odds of a repeat disaster, Amazon boosted the number of fulfillment, sorting, and other delivery facilities from 65 to about 400. Those facilities are located close to customers so that Amazon can cut Prime delivery time in half to a day, noted the Journal.
Along with the facilities to store goods, Amazon is investing in its own multi-modal transportation network. In the U.S. Amazon is now handling about 4.8 million packages a day while the USPS volume of Amazon packages has dropped by half in the last two years.
Amazon has taken up the slack in the U.S., by partnering with delivery entrepreneurs, offering to pay $10,000 to Amazon employees to become delivery entrepreneurs, renting 15 Boeing 737-800 jets (bringing the total to 20 in addition to 40 larger planes), and seeking to manage ocean freight, according to the Journal.
But fulfilling the promise has boosted Amazon's expenses. Between 2010 and 2018, Amazon's shipping and fulfillment costs have soared 1,022% from about $5.5 billion to about $61.7 billion — representing 25% of Amazon's revenues, according to the Journal.
The Growth Payoff From Forward Integrating
Prime memberships —which make over 10 million items available for one-day shipping — helped boost Amazon’s subscriptions revenue 37% in the second quarter of 2019. As the Journal reported, between June 2014 and June 2019, Amazon's Prime customer count has risen 275% from 28 million to 105 million.
Sadly for Amazon, all these investments in world-leading customer service are not having a spectacular payoff in its stock price. In 2019, Amazon stock is up a relatively modest 15% and as of August 28, it traded 16% below its all-time high of $2,050.
Amazon has long conditioned investors to expect that it will trade off profitability for growth. Fortunately, for the last few years, Amazon has been able to offset these growth investments with profits from its AWS business.
How Amazon Rivals are Responding
FedEx and UPS have responded to Amazon's forward integration strategy in different ways. FedEx (which in 2018 got 1.3% of its sales from Amazon) is cutting off Amazon and hoping to replace the lost business by partnering with Amazon retail rivals such as Walmart and Target.
Meanwhile, UPS — which Morgan Stanley estimates gets 10% of its revenue from Amazon — is picking up the slack and committed to staying with Amazon which will need UPS during the holiday season, according to the Journal.
Is Amazon Taking a Big Risk by Alienating Suppliers?
One logistics expert, Cambridge Capital Managing Partner Benjamin Gordon, sees logistical risks in Amazon's forward integration strategy. Most notably, Amazon is breaking relationships with suppliers. As Gordon said, "In addition to losing FedEx, [Amazon] also lost XPO, the $18 billion logistics powerhouse, in a move that took away close to $1 billion. If Amazon continues to lose partners, they will face shipping failures far worse than what they experienced in 2013."
Gordon also points out that Bezos's aphorism “Your margin is my opportunity” has meant a world of hurt for several transportation and logistics companies that served Amazon. As he said, "New England Motor Freight and Scoobeez have gone bankrupt this year. If Amazon continues to squeeze its suppliers on margin, it will put its logistics partners in an uncomfortable position."
He concluded, "Do they fire Amazon as a customer? Or do they acquiesce to business terms that risk destroying them? Either way, it appears that the very qualities that enabled Amazon to succeed – a ruthless focus on the customer experience and a streamlined process – could cause them disaster in logistics."
Target Is Adapting More Effectively Than Walmart
Two bricks-and-mortar retailers have mounted more effective responses to Amazon.
Target has responded well by making it more convenient for customers to buy and pickup goods. In the second quarter it beat profit and revenue expectations and raised guidance. As CNBC reported, quarterly profit jumped by 17% as its "in-store pickup and same-day shipping services successfully drew more customers."
Walmart enjoyed a 6.1% pop in its shares when it reported second quarter earnings on August 15. According to Reuters, consumers were responding positively to changes in Walmart's strategy. CEO Doug McMillon said that Walmart — which gets 56% of its revenues from food and grocery sales — gained market share in those categories.
Walmart's online sales surged 37% — two percentage points faster than expected. But the top line benefits come at a cost — Morgan Stanley estimates that Walmart's U.S. e-commerce business will lose about $1.7 billion in 2019 ($300 million more than in 2018).
Investors have punished FedEx but have rewarded investors in UPS, Walmart, and Target. FedEx shares are down 6% this year as of August 28; UPS stock has increased 20%; Walmart is up 21%; and Target is the biggest winner — up a whopping 61% in 2019.
