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Is Amazon's Latest Move Going to Crush UPS and FedEx?

Lee Samaha, The Motley Fool

The announcement that Amazon.com (NASDAQ: AMZN) is inviting budding entrepreneurs to become Amazon Delivery Service Partners as part of its crowdsourcing delivery model will naturally concern investors in United Parcel Service (NYSE: UPS) and FedEx Corporation (NYSE: FDX). But is it really that big of a threat? In reality, it could turn out to be more of a help than a hindrance and stockholders in the package delivery giants should not be unduly worried. Here are three reasons why.

A silver wrecking ball smashing a white wall

Is Amazon set to destroy UPS and FedEx Corporation? Image source: Getty Images.

1. Package delivery is a means to an end for Amazon

Unlike Amazon's foray into retail areas such as auto parts or industrial supplies, offering delivery services is not a replication of what it already does best: disrupting traditional retail business through e-commerce. Instead, it's a move driven by the need to ensure adequate delivery of items purchased through Amazon -- where the company really makes money.

This point has particular resonance because of the possibility of political pressure from a task force review on the U.S. Postal Service (USPS) ordered by President Donald Trump. Analysts believe Amazon pays USPS less than FedEx and UPS would charge for the same delivery service. Meanwhile, Trump claims the USPS is losing money by delivering for Amazon, so it's possible Amazon could be forced to pay more in the future.

All told, Amazon could face pressure on its delivery costs in the future as a result of the review, and creating its own delivery services is a way to manage potential increases. For UPS and FedEx, the review could actually be good news because it could take out lower-priced competition from the USPS. In this context, Amazon's move is more of a preemptive defensive maneuver. 

2. E-commerce volume growth is not the issue -- profitable growth is

A lot is made of Amazon potentially competing with UPS and FedEx, or even replacing the business that the e-commerce giant does with the package delivery specialists. It's an obvious corollary given the expansion in Amazon's delivery services.

But here's the thing: There's enough e-commerce delivery volume growth to go around and the problem for FedEx and UPS in recent years isn't one of volume; it's about ensuring profitable volume growth.

In fact, as you can see below, both companies have had issues with margin expansion in the segments most directly impacted by e-commerce volume growth. It's only in the last few quarters that FedEx ground has expanded margin again. Meanwhile, UPS U.S. domestic package margin has been pressured by increased costs associated with increasing network capacity.

UPS Domestic Package Margin Change vs, FedEx Ground Margin Change

Data source: UPS and FedEx Corporation presentations. Reported figures. bp is basis points where 100bp equals 1%. FedEx figures are adjusted to nearest UPS quarter. Chart by author.

Business-to-consumer (B2C) e-commerce deliveries can pressure margin because they can involve bulky and inefficiently packaged items (think mattresses and trampolines), and despite the best efforts of FedEx and UPS to take pricing initiatives, there is still pressure on margin. Moreover, so-called last-mile B2C deliveries to residential addresses are also seen as a low-margin endeavor.

In this context, UPS and FedEx might even welcome Amazon taking on board the kind of less profitable last-mile deliveries that put stress on their networks.

3. Amazon's delivery services could help during peak

It's unreasonable to expect UPS and FedEx to build out a network in order to handle a few days of heavy volume during peak delivery periods in the holiday season. As such, both companies are faced with the quandary of trying to predict on which days the peak spikes will occur and making sure they have enough additional capacity on hand to deal with it.

It may sound easy but FedEx and UPS, in particular, have had significant issues dealing with it. Severe winter weather in 2013-2014 put stress on the companies' networks and they both struggled to meet peak demand requirements. Fast-forward to the winter of 2014-2015, UPS found itself with too much capacity on days when demand was not as strong as expected. The problems resurfaced again this winter, with UPS and FedEx both taking a hit to profits as a consequence.

While the problem of dealing with peak demand won't go away anytime soon, it's possible that Amazon's delivery services will actually help matters because they can be called upon during peak periods -- something that all parties concerned would benefit from.

Don't worry about Amazon so much

It's highly unlikely that Amazon has aspirations to build out a distribution network anything close to what UPS and FedEx have. Moreover, even if Amazon competes directly with the incumbent package delivery companies, it's likely to be for services that might not be particularly profitable anyway.

Meanwhile, there's enough e-commerce growth to go around. The challenge is ensuring profitable growth and dealing with peak demand periods -- Amazon's latest move might just help FedEx and UPS do that.

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John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Lee Samaha has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Amazon. The Motley Fool recommends FedEx. The Motley Fool has a disclosure policy.